Due diligence is a complicated process often made more difficult by time pressures from investors, sellers and third parties. In the financial area, due diligence efforts typically focus on assessing quality of earnings and assets, accounting policies and processes, tax exposure and revenue projections. Other potential risks examined include regulatory compliance, IT structure, HR management and compensation, and others. Often overlooked – or underplayed – in the overall due diligence effort is commercial (or customer) due diligence.

Commercial due diligence is an objective look at the strength of a target company’s customer base. Effective commercial due diligence must be fast, accurate and insightful. Often the window is as short as 2-3 weeks. To be able to gather good data in that small window requires a carefully designed and executed survey methodology, based on responses to a web-based survey. Accuracy is a somewhat complicated issue as it implies getting answers from people that are knowledgeable to answer, and also getting answers that are clear and actionable. And the insightful element of a successful commercial due diligence initiative suggests gathering deeper information than just performance – looking at attribute importance, competitive performance, and loyalty.

The benefits of commercial due diligence include:

• Confirming revenue projections – assessing the likelihood that customers will continue to purchase products and services;
• Identifying competitive vulnerabilities – isolating specific areas of performance that are behind competitors;
• Understanding drivers of customer perception – measuring the importance of individual attributes by their contribution to overall satisfaction;
• Evaluating marketing operational effectiveness – quantitatively determining how well the company is meeting customer expectations and highlighting areas of shortfall.

In addition to the core benefits of conducting commercial due diligence, sponsors routinely obtain insight into challenging strategic questions such as opportunity for additional sales, product development ideas, and added insight into extracting value.

Commercial Due Diligence – The Need for Speed

Commercial due diligence is an objective look at the strength of a target company’s customer base. It is not at all unusual for the window of completion for a commercial due diligence to be as short as 2-3 weeks. To be able to gather good data in that small window requires a carefully designed and executed survey methodology, based on responses to a web-based survey.

The survey should be designed to be completed in under 15 minutes. Exceeding this threshold will result in a lower response rate as customers will grow weary in the task, or will not even begin based on perceived length of time to complete. To meet that target requires careful planning and wording of questions, along with ruthless editing. It is important to stay focused on the objective of the survey – which typically is to answer one or more strategic questions about the target company. Other questions may be interesting and even important, but would unnecessarily lengthen the questionnaire.

The customer contact list should be carefully reviewed for accuracy – both in having the correct individuals identified at each customer, and for correct contact information such as a direct telephone number and email. Valuable time can be wasted in trying to reach a contact that has incorrect contact information, or cannot offer accurate and timely opinions of the company. The firm administering the survey should be capable of filling in missing contact information.

Surveys can be completed via a web-based survey instrument. It should allow a range of type of responses (multiple choice, open-end or write-in, scaled responses, choice of one from a menu of options, etc.) to properly capture the intent of each question. Regardless of platform utilized, the survey should be returned to a third party and their sponsorship should be clearly understood from the design of the web page.

Although customers of the target company certainly have a vested interest in seeing their supplier improve, there is a limit to the urgency they will place on completing a survey – even if it is well-designed and brief. To accommodate customers and minimize the potential for frustration, we recommend offering multiple methods for completion. Following up with non-respondents by telephone not only provides this option, but helps to increase the response rate.

Lastly, to be able to turn around a project in a compressed time-frame, the research/consulting firm managing the process needs to be have the personnel and experience to complete the analysis and interpret the results in a timely fashion without sacrificing any aspect of thoroughness or insight.

Commercial Due Diligence – Hitting the Target

In completing a commercial due diligence project, accuracy is absolutely critical as potentially multiple million dollar decision will be made on results of the effort. Accuracy is a somewhat complicated issue as it implies getting answers from people that are knowledgeable to answer, and also getting answers that are clear and actionable.

To fairly represent the customer base of a company, it is important to include individual contacts in approximate proportion to their revenue contribution. So, if 15 companies provide 80% of a company’s revenue, individuals from those 15 companies should comprise roughly 80% of the customer contacts developed for a survey. This can be accomplished by identifying multiple contacts at larger accounts and single contacts at smaller accounts.

 Within each account, individuals to be included in the survey effort should be those with direct knowledge of suppliers’ performance. Typical functions or titles include purchasing, operations, quality control, logistics/delivery, and engineering/product development. At smaller accounts, purchasing or executive contacts are often the individuals with the best overall perspective of a supplier.

Questions included in the survey instrument should be direct and easily understood. Most customer surveys ask for ratings of performance for a series of attributes defining the company’s product and service offering. It is helpful to group these by functional area – product performance, sales, customer service, technical support, etc. Within each area, attributes should be clear and concise. So, “delivers products and services in a time-frame that meets your needs and expectations” would be better phrased as “on-time delivery.”

In addition to performance rating questions, it is wise to use the opportunity created by the survey to gather additional insight into strategic issues and questions. Most answers can come from a systematic analysis of rating questions. However, other issues may require additional questions to elicit the necessary information. Some strategic concerns PMG has addressed in commercial due diligence efforts include:

• What is the cause of lower sales performance in one region compared to another?
• What has been the impact of a poor management decision in the past and what is the likely future financial impact?
• What is the perceived price differential between the target and competitors? Is there any upside pricing opportunity?

To address these more nuanced concerns may require additional questions dealing with frequency of purchase, customer share, ordering preferences, etc.

In commercial due diligence, as in most ventures, planning is the biggest determinant of success. An hour spent planning will save four hours of scrambling in data collection or analysis. And in surveys, it is extremely difficult and sometimes infeasible to go back and get answers late in the process.

Commercial Due Diligence – Gaining Clarity

Commercial due diligence is an objective look at the strength of a target company’s customer base.

In addition to speed and accuracy, an effective commercial due diligence project should provide insight that produces exceptional value – in the form of specific improvement opportunities that improve customer value and loyalty, new or expanded revenue opportunities, potential new products and services, and potential strategic moves that may strengthen competitive position or identify acquisition opportunities.

In designing a due diligence initiative, it is vital to gather deeper information than just performance. This includes attribute importance, competitive performance, and loyalty.

Performance measurement allows a determination of the relative level of satisfaction with a company’s efforts on key product and service attributes. It answers the question of whether or not current processes are delivering against customer expectations.

Understanding Importance allows a prioritization of attributes and, subsequently, an allocation of resources to those items or areas that matter most to customers. It is tempting to focus on areas that are rated low in performance. However, that misses an important aspect of the performance dynamic. As an example, sales call frequency may be rated low, but customers are satisfied – they are seeing the sales rep enough, even though he or she may not come by very often.

Competitive performance places rating data in a real-world dynamic. It is almost always the case that Gaining Claritypeople make decision based on a binary choice – “Do I prefer A or B?” Even if there is no direct competitor, a user will usually compare performance to a substitute product. This comparison is vital to understand as it ultimately leads to an understanding of strength of relationship. In particular, if survey responses indicate that the customer perceives he/she is getting better value from a competitor and are more satisfied with a competitive product or service, they are in danger of reducing their volume from the survey sponsor.

Lastly, loyalty is a measure of likelihood of future purchase. Although measuring intent is extremely challenging, on method that has received lasting use is the Net Promoter Score (NPS). This is measured by response to a single question, “What is the likelihood that you would recommend _____ to a business associate or peer?” Results are tabulated using a simple formula and the results can be compared to national data for hundreds of other companies. The NPS can also serve as a dependent variable to identify key drivers. It is typical that fewer than five attributes explain almost all of the variability in loyalty responses.

Incorporating these three criteria – in addition to performance – helps a commercial due diligence initiative to result in meaningful and actionable information that leads to immediate opportunities for improvement and revenue enhancement.