Customer Due Diligence Done the Right Way

Last time I talked about 5 Common Mistakes Business Acquirers Make With Customers. The point is that when strategic or financial buyers take a look at the customer base they are soon to acquire, the due diligence they perform is simply inadequate. So, what does it take to perform world class, or even just adequate, customer due diligence?

1. Collect the right information from the right customers. I know it sounds obvious, but I can tell you that the same mistakes are made frequently. People collect good information but not the information they really need to know to assess how likely revenue is to continue after the deal. I see some due diligence really focused on the market (which is very important) without much attention to the real relationships. Another mistake that is often made is talking to only the customers that the target company wants you to talk to. That is not going to get you the information you need. The other mistake that I see constantly is how the information is reported to the buyer. One report I saw recently was essentially a transcript of every conversation. Don’t get me wrong, that is information that should be available, but the buyer should not need to read every comment and draw his or her own conclusion as to the quality of the relationships and more importantly, the quality of the earnings stream they are buying.
2. Collect and analyze information in a scientific and validated manner. This is a big one. I can’t tell you how many due diligence reports I have seen that are not rooted in validated methods. A report that details calls to someone (that someone being the person the target wants you to talk to) at the five biggest customers? See it all the time. Is it adequate? Maybe, but only if those people are the right people at the customers and those five customers comprise an overwhelming and representative portion of the business. Conclusions drawn without adequate analysis of the data? Yep. The rule, not the exception. In order to really understand the customer base and use the analysis to understand the quality of the revenue stream you are acquiring, the analysis should be empirical, supportable and objective. Here is the good news for us finance types: this heavily qualitative data can be converted into data that can be interpreted like the quantitative data we are comfortable dealing with. But that must happen in a scientific manner to be reliable.
3. The conclusions should be objective and drawn by someone independent. I know how you might feel about this one. In fact, I have always felt that I could assess target customers that I was acquiring better than someone from the outside. Thing is, I wanted the deals to work. I wanted the customers to be solid and to represent a strong customer base that I could count on. I wasn’t independent. I found that when I had someone independent, someone more objective, assess the customers, I had better information…especially when that someone was experienced at understanding customers and their perspective of the experience they have and expect to have with the company.
4. Evaluations must be made with perspective. Let me give you an example of what can happen here. What if I told you that 43 percent of the customers at the target firm were really happy and intended to continue to do business with the company, maybe even buy more. How would you interpret that 43 percent? Is that good or bad? I’ll tell you … it depends. You must add some perspective to this finding. If the company you are acquiring is in the semiconductor industry, the 43 percent might be terrific, in the highest quartile. If the company is in a service business, it might be in the lowest quartile. You must have some benchmarks or other ways to gain perspective and understand the analyses. Most due diligence reports I have seen fail on this one too.
5. The findings must be relevant to the buyer. OK, I know this sounds obvious, but this one can be a little trickier than you might think. This means that the findings must tell the buyer what he really needs to know. A lot of reports I see will tell the buyer how satisfied the customers are or provide a net promoter score based on their likelihood to recommend the company. All good and what you need to know, right? Maybe. These are the things you need to know only if they have a strong tie to purchasing behaviors (and frankly, based on our analyses, these two rarely do). Without linking the data and analyses to the financial results and purchasing behaviors of the target’s customers, you won’t know if the results are relevant to you or not.

Hopefully, you are getting the idea that just calling up a few customers and hearing what they have to say is neither diligent nor what is due. This is the biggest asset you are buying. Make sure your due diligence is telling you what you need to know.