Commercial due diligence, especially involving your target’s customer base and supply, is critical for obtaining an accurate view of their operations and position in the marketplace.
The underlying goal must be one that presents a realistic view of the acquisition’s future growth potential, an assessment that relies on three distinct analyses: operational stability, market strength, and forecast validation.
The due diligence process should include a strategic, commercial analysis to understand the qualitative aspects that drive corporate performance.
Without a thorough review of each, you risk assuming vulnerabilities that can frustrate the most well-intentioned projections, dragging down earnings, and ultimately ROI.
Commercial due diligence
While financial due diligence delivers critical details about historical trends, it’s important not to overlook an examination of recent business performance, which can yield important insights into projected future earnings. To that end, the due diligence process should include a strategic, commercial analysis to understand the qualitative aspects that drive corporate performance. Consider these five areas:
- Customer counts
The true value of a company’s future earnings is directly tied to its customer base. To assess the strength of the seller’s customer list, analyze the customer base. Disproportionate revenues coming from a select few clients indicates the customer list may be less stable than if sales were spread evenly over a number of clients.
The durability of customer relationships is critical for meeting future expectations. As such, it’s important to understand the level of intimacy with the top purchasers, as well as the employees responsible for maintaining those touchpoints.
- Product line strength
No matter the strength of your customer base, you risk compromising their loyalties without a quality product line. Examine the seller’s portfolio carefully to gauge product stability, paying close attention to new offerings, and weighing those against the seller’s skill set and alignment with future customer demands.
As to the seller’s skill set, verify whether those self-professed attributes are capable of delivering the results that they promise. If not, you’ll need to determine whether those skills are easily obtained elsewhere — and at what cost.
- Sales projections
If sales are spiking higher, look to see whether the increase is organic or attributable to risk-related events. If the latter, distinguish risks that are fleeting or long-term risks in order to gain an appreciation of likely disruptors.
Assess whether forecast projections are logical in the context of your target’s customer relationships. For instance, if sales with a tech startup are projected to triple, due diligence will flag that projection and perform a more realistic assessment.
Perform a comprehensive industry analysis to understand short- and long-term trends, noting any uncertainties. Some industries in particular bear close scrutiny, including healthcare, energy, telecommunications, and manufacturing. You need to look no further than the case of Blackberry to understand how quickly technology evolves and the importance of reviewing current consumer trends and performance data to predict future performance.
- Sizing up the competition
Assess the seller’s marketplace position and value propositions against those of its competitors. Like the Blackberry, look for factors (technology, consumer preferences) that could threaten long-term financial health while charting the growth (or decline) of their market share. If there’s been recent M&A activity among competitors, that could also impact future earnings.
- Salesforce dynamics
Explore the fundamentals of the seller’s sales organization to understand how business is secured and retained. This can reveal hidden, though important, business relationships. For instance, certain industries offer ongoing price reductions. If so, make sure the seller has been accommodating these unique expectations, to ensure your post-integration projections are accurate.
Supply chain due diligence
At a time when supply chains have evolved to become truly global and borderless, the risks for disruption have never been greater. Market fluctuations, volatile foreign exchange rates, political turmoil, labor unrest, and natural disasters all present risks that can interrupt the supply chain, causing part shortages and production slowdowns (or even shutdowns). In some instances, they can impact cash flow and trigger financial instability.
Recognizing the sizable risks the supply chain can pose, a critical element of your commercial due diligence should include a thorough review of the acquisition’s supply chain. As such, performing a comprehensive review of the supply chain is critical for properly measuring your target’s risk, stability, and even potential for future growth. Evaluate the following areas to mitigate such risks:
- Consider spend concentration
Look carefully at the spend concentration among suppliers, particularly for highly strategic/critical commodities and categories. If there doesn’t appear to be a balance of qualified suppliers in critical categories, this could be pointing to potential risk with supply chain disruptions.
Note any products that are procured from a single source. Such an arrangement may present profound risks, depending on the supplier’s stability, whether it offers backup facilities, and its sphere of operations.
- Determine the supplier’s footprint
Assess the footprint to understand any known or probable risks, such as those related to geopolitical, disaster, political, economic, or environmental factors. And especially when the target has relied on a single supplier, understand the availability of other qualified suppliers, should an event compromise supplies from the primary source.
- Review contracts
For suppliers that provide exclusive products or materials, the weight of the target company’s contract can impact fulfillment. That is, if the company presents a very small percentage of the supplier’s business, delivery during a supply chain event may face a greater chance of disruption than if they represented a larger percent of the supplier’s business.
- Examine supplier performance
Next, review all supplier relationships, assessing their performance and strength. The former is tied to specific metrics — cost, quality, and delivery — while the latter addresses more subjective dynamics based on trust, collaboration, and efficiency. Understand which suppliers are thriving and where there are opportunities for improvement.
- Assess management processes
Finally, while the target may (and should) maintain robust supply chain monitoring, does the supplier offer the same? Assess, if possible, the supplier’s qualifications and management processes of their supply chain. Such an analysis will provide a truer picture of the total supply chain risk.