By Anthony Bahr, Vice President
It is well-documented that roughly 60% of the value created by a merger or acquisition can be attributed to top-line growth. But, in today’s persistently low-growth economy it can be difficult for companies to organically increase revenue.
This reality, combined with near-record high amounts of dry powder and a loose monetary policy, has fostered an environment where it can now be more efficient to acquire revenue growth versus retaining and developing customers.
However, these “Buy and Build” strategies are based on two shaky premises:
1. Top-line growth (which accounts for about 60% of value creation) assumes customers at a target company are loyal, will be retained post-merger, and will maintain their share of wallet allocation.
2. Bottom line efficiencies (which accounts for roughly 20% of value creation) assume the synergistic effects of merging overlapping companies will result in cost savings.
We know that betting the success of a merger on the latter is a hit-or-miss proposition since only about 60% of mergers deliver the planned cost synergies and, in about a quarter of all cases they are overestimated by at least 25 percent.
And the former is an even more risky supposition, as the primary barrier to an effective integration is the ability to retain and expand the customer base.
This is not to suggest that "Buy and Build" is not an effective way to utilize capital; on the contrary, in many instances, this approach may be the best pathway to value creation in today’s economic climate. However, we would suggest that a successful "Buy and Build" strategy does demand rigorous due diligence, especially customer due diligence to validate the notion that customers will be retained post-merger.
The Importance of Customer Due Diligence
Commercial due diligence most often informs acquirers about exogenous factors such as the size and trajectory of the market, industry trends, the competitive landscape, and the buying process. Customer feedback usually plays a role, but often takes a backseat to these more macro topics.
We’ve been able to validate that the strength of the relationship between a target company and its customers is one of the most significant indicators of the target’s value. Why? Because a company with a strong reputation, a proven ability to service top accounts, and respected senior management is the most likely to retain and expand its customer base post-merger.
This is paramount to the success of a "Buy and Build" strategy since, after all, the objective is to integrate companies that can quickly create value by accelerating top-line growth in a low-growth environment.
Given this, we suggest that robust and detailed customer feedback should be the foundation of commercial due diligence and not an afterthought.
When gathered thoughtfully and analyzed comprehensively, customer feedback will answer many of the same questions as your other market analyses, with the critical added benefit of securing the perspectives of customers who are vested in the success of the company.
Conducting Effective Customer Due Diligence
The customer due diligence that is being conducted today all too often applies a ‘check the box’ methodology. These online surveys offer many pitfalls. Random sampling assumes all customers carry the same weight—they don’t: 20% of your customers generate 80% of your revenue. Then there are dismal response rates (often less than 6%), questionable data quality, and poor user experiences. Yes, they generate content (often less than five quantitative questions), but they provide little to no context.
These surveys can be considered cursory disaster checks, but they don’t provide the level of insights to qualify as reasonable customer due diligence. We utilize a different approach which we call Quality of the Customers® (QofC®) to ensure that customer due diligence is as comprehensive, insightful, and actionable as possible.
QofC® is built on the Voice of the Customer (VOC) methodology actively exercised in the market research industry for decades. Like VOC, QofC® focuses on querying customers qualitatively and quantitatively about their thoughts and experiences with the target company, without ever indicating that a transaction is under consideration.
QofC® sets the standard for customer due diligence and includes the following best practices:
- In-depth, one-on-one telephone interviews
- Sponsored by the target company, with senior-level encouragement to participate
- Apply the 80/20 rule and interview customers at accounts that are in your top revenue quartile
- Interview multiple contacts at each account to secure a representative perspective
- Contextualize all closed-ended questions with the use of open-ended narrative and adaptive probing
- Creating a win/win situation where both the target and the acquirer receive valuable feedback on how to enhance the business moving forward
- Deepen customer relationships by following up with them to share top-line findings and discuss how the company will respond to their feedback
The questions asked in a QofC® will vary based on the category and unique learning objectives, but we almost always include exploration of the following:
- Customer satisfaction and loyalty analyzed in conjunction with the Net Promoter Score®
- Buying process
- Competitive landscape and reasons for selecting other suppliers
- Pricing risks and opportunities
- Market trends
- Growth outlook for the market
- Unmet needs and pain points
- Innovation roadmap
The Value of Conducting Customer Due Diligence
When done right, customer due diligence not only validates the results of other due diligence efforts (revenue forecast, margin projections, SWOT analysis, etc.) but also provides a post-close playbook for a faster integration and growth plan, as was the case with a client in the automotive industry:
Feedback from customers helped create a focused and effective integration plan for the first 100 days after an acquisition. The potential target in this case was in the automotive industry. Speaking to customers helped the acquirer see that there were engineering priorities that needed to be addressed to increase business in the future. As a result, the acquirer was able to isolate immediate synergies that enabled the integration plan to move forward rapidly, and these improvements were able to be implemented in the first 100 days post-close.
In other cases, we’ve seen QofC® customer due diligence greatly impact the trajectory of a deal:
One of our clients was recently looking to acquire an LED lighting manufacturer. However, customer interviews revealed that over 50% of top accounts complained of late deliveries and poor service. “There’s nothing I like about them,” said one customer. The potential acquirer found that competitors were greatly preferred and very likely to win any future business. Our client withdrew their offer.
But don’t just take our word for it. Rob Ospalik, Partner and Co-Head of Global Operations at Baird Capital shares on his process including QofC®:
“On the front end, insights into customer relations is, in many ways, the most important thing that we want to understand about a company that we’re investing in. The value is created at the customer relationship.”
To learn more about Strategex's customer due diligence practice, contact Anthony Bahr, Vice President.