Customer Due Diligence

Customer

Due Diligence Acquiring More Value by Phil Bounsall and Bruce Kidd

The Walker Index™ $3,600 $3,200 $2,800 $2,400 $2,000 $1,600 $1,200 $800 $400 $0

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Over the last 15 years the Walker Index has outperformed the S&P 500 by a multiple of eight. Why? Because companies that comprise the Walker Index are customer-focused, always looking to understand and leverage their most critical asset – their customer base, and customer bases they are looking to acquire. * The Walker Index is a stock comprised of current Walker clients. Companies are included in the index only during their tenure as Walker clients.

Customer Due Diligence

Customer Due Diligence: Acquiring More Value For any company interested in growth, here’s a sobering statistic: Research shows 50 percent of all acquisitions ultimately fail to add value to the shareholders of the acquiring firm. Surprising? Yes; considering that in the often rigorous process of due diligence, acquirers pay hefty fees to accountants, attorneys, consultants, and other experts to verify historical financial statements, mitigate certain legal risks, validate intellectual property, and quantify the size of markets and growth potential within those markets. While all of these initiatives are important – even essential – to a successful merger or acquisition, they don’t tell the full story. So, what’s missing? When considering the full scope of due diligence, few companies perform any adequate investigation of the asset that is almost always the single most important to be understood–the customer base. This customer asset can make up as much as 80 percent of the transaction value, yet far too little attention is paid to it. Although it’s true some firms may call a few of the targeted company’s largest customers, hope of gathering much more than anecdotal feedback from this is slim. With so much market pressure to grow revenues and profits, acquisitions must generate the results anticipated. In reality, the best, most reliable customer due diligence involves an empirical approach–turning information about the customer relationship into reliable, validated, quantitative data and actionable insights.

Three-phase approach Driving better decisions

AFTER

90 DAYS POST

PRE-DEAL

Thorough, well-executed customer due diligence is best accomplished in three phases:

DUE DILIGENCE

POST-DEAL

ONGOING INTELLIGENCE

As the deal is being negotiated, forge an understanding of the target company’s customer relationships and market position and how that plays into the company’s value.

Accelerate the investigation by identifying and developing specific strategies for retention and growth within the customer base. The goal during this phase is to mitigate risk and enhance value.

By monitoring and leveraging customer relationships, companies can optimize their return on investment. Never cease trying to understand your customer to solidify your competitive advantage.

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Customer Due Diligence

Six Critical Insights About customers S

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The financial status and value of any company is almost always tied, directly or indirectly, to the health of its customer base. To say the single most important asset an acquirer is buying is the seller’s customer base is not an overstatement. That’s why thorough investigation–competent customer due diligence – is so crucial before pen hits paper to close the deal. What can a company expect to learn from taking a closer look at its potential “new customers?” Quite a lot, actually. Customer due diligence arms the acquiring firm with critical insights about the target’s customers, including:

1. Stability How loyal are customers to the target company? Many acquiring companies make the mistake of looking merely at historical customer retention data to determine the stability of the customer base. The most effective way to gauge stability is to gather empirical evidence, digging deeper to find out things like how much revenue is tied to each customer. What kind of relationship has the target built with its customers? How much value do customers perceive the company delivers? Using forward-looking, validated science is the best way of turning a soft concept like “customer stability” into something prospective and tangible that can be analyzed empirically.

2. Stickiness What are the customers loyal to – products, intellectual property, management, account team, etc.? Chances are that while the acquiring company is performing its various due diligence activities, it’s also developing the broad strokes of an integration plan, assessing how best to combine the targeted company into its operations. Inevitably, this process is bound to identify areas where efforts are duplicated and may even reveal some soon-tobe casualties such as management teams, internal processes or account staff. Before these big decisions are made, customer due diligence helps ensure the acquirer doesn’t react too quickly by discounting or even eliminating a key driver of customer loyalty.

3. Opportunity Is the customer base primed for growth? Conducting customer due diligence before the transaction takes place sets the stage for more positive performance after the sale. The due diligence process will help quantify how much opportunity is really out there. It’s designed to identify which customers are primed for growth and to pinpoint others that may be tapped out. It also will signal if there is any low-hanging fruit related to revenue generation that can help jumpstart integration efforts in the early days after the deal closes.

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Customer Due Diligence

4. Risk How much revenue and how many customers are at risk of leaving? Prior to the merger or acquisition, it’s crucial to know how many customers may defect, and more importantly, how much revenue is tied to those customers. A complete customer due diligence plan can also create an at-risk profile, offering the acquirer insights as to which customers are most likely to take their business elsewhere–small companies, corporate clients, etc. Understanding the at-risk profile can help the acquiring firm effectively manage the risk and address any subsequent fallout.

5. Competitive position How do customers view the target vis-à-vis its competition? It can be eye opening to discover how the target company compares to its competitors in the minds of customers. What are the company’s strengths or weaknesses when it’s stacked up against others in the market? These learnings can help determine what leverage the target company has in the marketplace and how to maximize it. While analyst firms provide information on competitive position and the market, insights about demand and competitive advantage derived directly from customers are more valuable and actionable.

6. Actions What steps should be taken to optimize the value and stability of the customer base? In a nutshell, the customer due diligence process offers the acquiring company valuable intelligence about what actions to take to make the target firm’s customer base more valuable and profitable. These action items can arise at nearly all levels of the company–from the senior executive suites on down to individual account management levels. Done right, these actions not only reduce the risk of acquisitions, but they also deliver quick value accretion.

Maximizing the investment post-deal After the merger or acquisition is finalized, the due diligence process evolves to integration to maximize the value of the combined enterprise. Discovering ways to connect with just-acquired customers is an important end result, as is understanding how to create competitive advantages with the new customer base. Other aspects for exploration include determining which customers are ripe for growth or cross-selling opportunities, and how the acquisition is impacting customer experience and commitment to the acquiring firm. All of this leads to a successful integration plan.

“Walker’s expertise related to pre-acquisition due diligence served us well as we navigated the complex process of understanding the target’s customers. Their approach is unique and goes well beyond the typical ‘checklists’ of the well-known M&A due diligence process.” Charlie Cumbaa

SVP New Business Ventures Blackbaud

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Benefits of a third-party Customer expert When it comes to customer due diligence, it’s wise to consider the benefits of hiring a third-party expert in customer loyalty – much the same way an acquiring firm would hire a CPA firm to review financial records or an attorney to review legal documents and asses legal risks. Here’s what a third party like Walker can bring to the table: •

Domain expertise – Experts in customer loyalty have the ability to scientifically validate the customer base as a viable asset, taking into account the factors that drive customer loyalty.

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Independence – Because third-parties are independent and not directly involved in the deal, target companies may be more comfortable with the customer due diligence process.

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Objective, unbiased resource – As expected, without a vested interest in the outcome of the deal, third parties can objectively provide unbiased information from which to make key decisions during a merger an acquisition.

One success story Although customer due diligence is most valuable if conducted before acquisition, its worth is truly evident any time the process is employed. In fact, one leading fiber optics firm built customer due diligence into its corporate acquisition strategy after a prior acquisition experience didn’t generate the desired – or anticipated - results. Interestingly, the company actually discovered the value of such due diligence after financial projections provided by the target company later proved to be inflated. An aggressive post-acquisition customer due diligence effort helped the company identify the issues and challenges at hand with the new customer base – one of which was dissatisfaction with the acquired firm’s outdated products. Walker worked in partnership with this company to develop a pre-acquisition customer due diligence program that delivers aggregate insights about the customer base, allowing the company to make better informed decisions about forecasts. Post-acquisition, this information is shared with account teams and used to develop revenue analyses, make recommendations for new products and services, generate customer segmentation studies of both loyal and at-risk customers, and pinpoint opportunities for future growth. Our client reports that the customer due diligence program has paid for itself many times over, with return on investment estimated at roughly 500 percent in the first year.

How to get started It’s never too early to consider your customer due diligence process. A few key steps will make the process more efficient: 1. Engage a firm experienced in understanding customer relationships and mergers and acquisitions transactions. 2. Let the target know that customer due diligence is a non-negotiable part of your process. Tell them that it can be done without signaling to the market about an imminent deal. 3. Build the customer due diligence into your letters of intent, including access to customer databases with contact information. Set these steps in motion early on and the process will flow nicely.

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About the Authors Phil Bounsall President As president at Walker, Bounsall is focused on the development and execution of strategies and operating plans designed to enhance Walker’s position as a global leader in customer strategy consulting. Bounsall is a frequent speaker on the topic of driving growth and profitability through customer focus, speaking to organizations like Strategic Account Management Association, CMO Club, and Association for Corporate Growth. Phil first joined Walker Information in 1994 as chief financial officer after a 12-year career with public accounting firm, Ernst & Young, where he focused on entrepreneurial companies and corporate finance transactions, including mergers and acquisitions and public and private offerings. He also spent five years as chief financial officer of Brightpoint, Inc., a global company providing distribution and logistics services to the wireless communications industry and growing through acquisition. He then joined Walker again as executive vice president in January 2004.

Bruce Kidd Senior Vice President Growth Initiatives As senior vice president, Kidd leads Walker’s sales and business development initiatives. Kidd works with senior leaders of companies in all industries to address growth opportunities within their current customer base. He also leads Walker’s services designed for private equity firms and corporate acquirers. Prior to coming to Walker, Kidd was most recently Director of Entrepreneurship for the Indiana Economic Development Corporation (IEDC) and managing director of the state’s 21st Century Fund, which invested $80 million in dozens of high-tech start-up companies during his tenure. Prior to joining the IEDC in 2005, Kidd was vice president of the Indiana Venture Center where he assisted entrepreneurial companies with strategy decisions and planning, capital formation, and other key issues growing companies encounter. He is a member of the Association for Corporate Growth, a frequent speaker on customer strategies and engagement, sits on the Board of Advisors for Key Bank (Indiana) and the Small Business Council, and serves other forprofit, not-for-profit, and philanthropic organizations.

About Walker Walker specializes in advising Fortune 1000 companies and middle market companies with growth strategies based on enhancing customer loyalty and related customer engagement, including innovative approaches to segmenting, valuing, obtaining, retaining, and growing customers. Walker’s diverse team of consultants are market leaders in providing tailored, comprehensive solutions to help companies achieve their business objectives and, ultimately, grow shareholder value.

Walker Clients Include: • ACI Worldwide • Adobe • Avaya • Blackbaud • Ingram Micro • Castrol • CDW • Cisco • D&B

• ExactTarget • EMC • McAfee • Merit Capital • Navidar Group • NCR • NetApp • Pepsi • Tetra Pak

“Walker understands their clients’ needs when it comes to providing the guidance and dialog needed, supported with facts, in the due diligence process. Customer focus is evident in how they go about their business.” – Belden Americas

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