Elevate Your Due Diligence Process: 6 Questions Buyers Should Ask to Optimize Value Creation

How private equity investors can mitigate risk and optimize ROI in the buy-side due diligence process.

Now more than ever, buyers are employing an exceptionally critical eye throughout the due diligence process. Where buyers were once optimistic in finding reasons to believe in higher valuations, they are now focused on mitigating risk that may lead to downstream challenges, while also evaluating value creation levers that will drive revenue and earnings growth. This environment requires investors to be more rigorous when assessing an acquisition target.

Despite headlines around growing dealmaking confidence, there is conflicting information around market durability and projections. There are countless opinions on if, when, and how much interest rates will change, while the Fed continues to keep higher rates longer, calling for patience and a ‘new normal.’ This makes it difficult, if not impossible, to predict what the market might look like in the coming months and years.

As elevated interest rates impact both the initial investment and the cost of a “buy and build” approach, sponsors may choose to de-prioritize or exclude inorganic growth opportunities from the value creation roadmap, leading to increased scrutiny on critical drivers of organic growth, such as price and volume sustainability. Alternatively, justifying an add-on approach results in a greater burden on businesses to demonstrate the commercial sophistication required to operate as a platform for add-ons or a strategic target.

With this level of uncertainty, buyers are seeking out more clarity and granularity in their diligence process, as well as a new value creation blueprint they can feel confident in. How can they best approach potential transactions to ensure they translate into successful value creation and growth for their acquisitions? We’ve outlined 6 key questions buyers should be evaluating in the transaction process to best set them up for success in the holding period and ultimately maximize their exit value.

1. How Sustainable is the Existing Pricing Strategy?

While growth from pricing has one of the highest impacts on revenue and net profit, price decline can have just as much of an impact. A major red flag for buyers is a company that seems to have a healthy pricing strategy on paper, but the data doesn’t quite support the story. Going into due diligence, buyers need to understand in detail—clearly backed by data—the answers to the following questions:

  • Can the company prove the sustainability of their pricing? E.g., has pricing affected volume, is pricing power broad-based or limited to a few areas in the business
  • Is the company ready to execute on defensive pricing? What is their approach? (E.g., Flat decreases, negotiations, customer/product segmentation, prioritization, selling on value)
  • What have they had to give back in price—where and why?
  • Do they understand customer sentiment? (E.g., Price sensitivity, perceptions of competition, willingness to pay, ease of switching providers)

Understanding the sustainability of the existing pricing strategy enables buyers to decipher if the valuation is appropriate, how much tangible upside exists, and the risks to realizing expected profit returns. Most importantly, it builds confidence in the ability to manage and optimize price in the value creation process, even with market uncertainty.

2. The Pure Pricing Play – Is There Any Room Left for Net Pricing Growth?

It’s worth uncovering if pricing may still be a significant lever to support valuation or if the target will need to adopt a defensive pricing strategy to maintain and increase volume. While the business may feel they have responded as well as they can to the higher cost environment, there may be additional opportunity. Situations where there may still be significant upside:

  • Businesses that have historically conducted only uniform (i.e., peanut butter spread) price adjustments
  • New products or markets
  • Long-term contracts
  • High-volume quoting
  • Cost is outpacing price
  • Highly differentiated products/services
  • Limited customer or product value drivers within a pricing strategy

INSIGHT2PROFIT’s Transaction Services include Quality of Pricing® and extend into broader Quality of Profit services that validate pricing upside and risk, surface profit growth opportunities, and validate the level of difficulty and implementation readiness to realize those profits.

Additionally, many of our recent clients have turned their focus to current margin and cost versus price comparisons to pre-COVID (2019). Many investors seek to understand how the current margin profile compares to pre-COVID and the subsequent inflation, if the business can be expected to return to historical figures, and what can be considered the new baseline or normalized earnings. In essence, investors want to understand if historical benchmarks are still relevant or if the industry has shifted such that buyers need to more broadly adjust pricing and margin expectations for the acquisition target.

3. Can the Business Grow Outside of Price?

For many buyers, there is a significant concern around how businesses can maintain or grow revenue and margin when price adjustments are a less reliable option. There are a growing number of questions around sustainability of price when volume is in question, and the endless balancing act of price, cost, and volume to ensure margin goals are met. This means pure pricing (i.e., price changes) alone isn’t enough. Companies need to demonstrate how they can grow business through increased volume or mix optimization as well to demonstrate sustainability.

Customer and Product Mix

Customer and product mix refers to which customers are purchasing which products over a period of time. A shift in margin can be attributed to a customer switching to a higher or lower margin product. Businesses can utilize mix to increase profitability by driving more profitable transactions—whether through more profitable products or more profitable customers.

Too often businesses see margin decline and ascribe it to mix, but don’t have visibility to where and why it’s occurring, if it’s a one-time event or an emerging pattern, and where mix versus price or cost is driving margin change.

Buyers will benefit from conducting detailed analysis to understand mix impact. This includes:

  • What type of customer, product or service, channel mix exists today and how has it shifted historically
  • How are changes in mix affecting margin
  • Where is mix having a desired or unintentional impact – products, customers, regions, or other factors
  • What type of programs exist (e.g., promotions, positioning) that may be unintentionally causing mix changes
  • Which is more important to growth plans – top-line growth or overall margin

Once understood, businesses can make strategic decisions that optimize mix to support growth plans, whether that’s promoting higher-margin products or upselling lower-margin customers.

Cross-selling and Upselling

Cross-selling, the practice of selling related or complementary items, can increase both volume and margin with a larger basket of goods or a shift to a higher-margin product. With the proper analysis and machine learning capabilities, a business can identify target products or services a customer is most likely to add to the portfolio of products and/or services they purchase. Businesses that can effectively cross-sell—or have the clear ability to build the capability—are positioned to generate significant, sustainable value.

Upselling is the practice of encouraging customers to purchase a similar but higher-end product, positively impacting product mix and ultimately margins.

These commercial strategies have a direct impact on a company’s ability to grow both revenue and margin.

Market Basket Analysis

Market basket analysis mines data to identify historical patterns in customer behavior to better inform how to best nurture your customers. This type of analysis is utilized in alternative growth strategies such as wallet share, cross-selling and upselling, sales enablement, bundling, loyalty programs, promotions, SKU rationalization and inventory management.

Leveraging customer behavior patterns and preferences enables sales to manage and grow their customer base more efficiently and effectively. For example, this analysis can provide a salesperson meaningful information such as which product recommendations a customer is most likely to purchase, alerts when a customer misses a recurring order (churn management), or relevant quantity break information to drive volume.

Market basket analysis is a key strategy to drive sales, improve customer retention, and increase ROI. As a foundation for so many organic growth opportunities, it should be a critical point of evaluation for buyers.

Sometimes investors express skepticism around the financial validity of these types of opportunities because they can be difficult to measure as well as complex to implement. However, bypassing these growth opportunities entirely can leave profit on the table. Instead, it is critical that investors leverage more sophisticated analysis and opportunity assessment capabilities. INSIGHT can help drive conviction with robust, purposeful data engineering, commercial maturity benchmarking, and a powerful analytics engine that can clearly validate the opportunity through the data.

4. What is the Business’s Level of Commercial Maturity?

A pricing strategy is just that, a strategy. For businesses to realize maximum growth, that strategy needs to be implemented, measured, adjusted for optimization, and consistently evaluated. This path of continuous improvement generates continuous growth. However, businesses that lack commercial maturity will struggle to implement any growth strategy to the level required to feel its benefit. As such, buyers should closely evaluate a company’s commercial development, the associated risks, and potential upside. Areas to consider include:

  • Sales performance tracking & accountability
  • Customer and product/service segmentation
  • Price management systems & tools
  • Price measurement and data analytics systems
  • Internal pricing resources
  • Centralized pricing processes and controls
  • Leadership buy-in on pricing and sales goals
  • Sales training (e.g., negotiation strategies, value prop selling, customer communications)

These areas can strongly indicate the risks associated with implementing a pricing initiative or other organic growth strategies as part of your value creation plan. It can also surface opportunity for buyers to transform a company’s commercial practices into something more profitable. As such, these are crucial for buyers when assessing a company’s value.

5. How Well are the Company’s Customers and Competition Understood?

Over the last 6 months we have seen a growing number of buyers incorporate more detailed market intelligence into their due diligence process. Specifically, buyers are interested in customer perceptions of price, value drivers, willingness to pay, and price sensitivity. Additionally, buyers seek a clear understanding of the competitive landscape, especially through the lens of the customer. These factors are a critical data point in driving conviction and determining the validity of future pricing actions or other organic growth initiatives.

Example market intelligence studies that add incremental value in the buy-side due diligence process:

  • Customer perceptions of competitor value and price
  • What triggers customers to switch suppliers
  • Essential factors influencing customer purchase behavior
  • Price sensitivity by product line, customer group, region, or other key segments; gauge reaction to price changes
  • Competitor price adjustments
  • How are competitors structuring their pricing (e.g., price levels, fees) as well as their costs (e.g., how they compensate laborers)

6. Does the Data Back Up the Story?

Quality data is imperative to successfully answer the above questions and most other scenarios that arise in the due diligence process. Buyers will inevitably find themselves assessing companies that either lack sufficient data, quality data, or both. However, not addressing data quality (e.g., attribution, segmentation, integration of disparate data sets) or making assumptions is detrimental to valuation. Buyers should invest in purposeful data engineering to transform all available data into a usable state such that the value story is clear and drives conviction.

Also, there has been a higher level of scrutiny placed on the financial size of the opportunity and the underlying assumptions and path to execution After weeks or months of evaluating a potential investment, buyers need to be able to defend with absolute certainty the potential financial upside and to understand the roadmap and requirements to realize upside and minimize risk. Quality data is the key to this certainty, driving confidence in the numbers and reducing risk.

Increase Buyer Conviction with INSIGHT2PROFIT

Buyers want less risk and more confidence. Leaning on price increases alone isn’t enough to boost valuations in today’s market environment. Buyers need to identify meaningful pricing and commercial opportunities they can be certain will drive sustainable profits and ROI. INSIGHT’s proven buy-side due diligence solution offers investors valuation validation, investment conviction, and risk mitigation. Contact INSIGHT to learn how we can provide speed to clarity with our Quality of Profit Services.

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