In virtually every CIM and VDD doc that I’ve read recently (for B2B business, at least), an early page highlights a set of corporate logos of the target company’s key customers. Logos for large, well known businesses are great; logos for “cool” clients seem to be even better.
100% of our clients prefer that their acquired companies prove to be strong companies. And our diligence assignments always include measurement of the asset's commercial strength relative to customer needs and expectations, and relative to perceptions of competitors and alternatives.
But interestingly, looking back at 2016, only a handful of clients pressed us hard on this set of three important questions:
1. “What defensible advantage(s) does the company hold (that give it sustainable advantaged competitive positioning)?”
2. “What enables the apparent defense(s) to be something that this asset can uniquely hold, or hold onto, so as new owners you can help protect it?"
3. “When these elements are stacked up, how formidable is the advantage?”
We’ve written before about the need to clearly define markets in order to inform accurate sizing (read here and here). But even with the clearest possible definition, one other piece of analysis is critical, and is often overlooked – quantifying what we like to call the Available Market Size.
Different from the total or addressable market size, we define the available market size as being the proportion of annual demand that is “competed” in any one year. This is determined by two key factors:
What is more important when looking at a deal: the strength of demand drivers, or the strength of the target company's brand equity?
With rare exception, Demand – not Choice (brand equity among suppliers) – is more fundamental to a successful acquisition outcome. Both obviously matter, but the balance and the relative performance can be a distinguishing source of a winning investment strategy. Without underlying demand drivers securely in place, few customers are going to waste their time or money considering a product or service – and frustratingly, demand can be fleeting. We have all experienced cases of demand and growth levels dropping post acquisition, and those are never the most fun deals. And you’re not going to win with many investments without strong or growing demand drivers.
Regulation. Probably not top of many people’s list of favorite Commercial Diligence issues. After all, compliance is often an annoyance that challenges budgets and margins.
Yet, regs can also equal opportunity: the potential to increase revenue and enhance barriers to entry. With the right plan, a well-positioned target company may profit by earning the status of “valued partner” for helping customers sort through red tape, and enjoy accelerated replacement cycles and greater upgrades, enhanced pricing, and the chance to drive differentiation from the competition.
Once again, the pollsters were wrong and surprised and with dramatic effect and impact. The experts (i.e., the pundits) primed the pump, offered hardly an uncertain opinion, and the financial investors took a reasonable position. Why did so many of us wake up thinking: we didn’t see this playing out? It seems that the diligence – including listening to experts and relying on what appears as sound statistical methods of surveying -- was dead wrong. Three national UK elections in a row – three poorly predicted outcomes.
What is going on? And what does this imply for commercial diligence?
The problem at play is the result an unfortunate combination of two common flaws: confirmation bias and status quo bias.
Many Private Equity deals involve a “platform and add-on” play – predicated at least in part on “bigger is better”.
Among the various benefits of consolidation, some of the most commonly cited value gen opportunities relate to bundling and cross-selling. Just this year, we’ve worked on deals from building products to processed meats where this has been a key part of the investment thesis.
On the face of it, cross-selling can be an enticing opportunity: increasing salesforce productivity while delivering higher value for key customers feels like an obvious win. However, we’ve seen just as many occasions where the opposite is true – either customers just don’t perceive value in a larger bundle, bundling drives down margins (due to expectations for price concession) or even worse, a combination actually creates confusion and makes each individual element less appealing.
For most private equity firms, the thought of completing an acquisition without first conducting a round of Voice of Customer (VoC) is unthinkable. After all, if a company’s track record is going to be sustainable, it better have a happy customer base (or an extremely sticky service), and it’s almost always a necessity for testing a value generation thesis. Kaiser has a long history of doing work with corporations for whom VoC is truly a way of life. I spoke with John Wilhelm of Kaiser’s Industrials Goods & Services practice about the lessons he’s learned supporting 20 years of this work. Here are a few golden nuggets from John’s rich experience:
In order to pressure test that current business performance will maintain a positive trajectory, and for the benefit of informing just about any commercial value generation opportunity, investors need to wrestle down, as precisely as possible, two things:
What exactly is the Raison D’être of the Target company? We like to think of this question as one that explains the economic problem or value-adding issue that a firm is addressing; the hole, small or large, that they are filling; and the firm’s capabilities, unique or otherwise, that allows them to fill the hole. The key issue is to separate the sundry, ancillary factors that fill out the story (and often add to the confusion) and to find a way to truly zero in on the factor that is most important and that clarifies why the firm has been able to exist on a sustained economic basis
Where exactly are they winning? With which customer segments? Which demographic, psychographic, and geographic customers make up the bulk of the success?