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Competitor Forecasting in Commercial Due Diligence: How to Chase Down a Moving Target

Why competitor forecasting matters. In a typical commercial diligence process, a significant amount of work is conducted to understand how the end-market and channels will grow and develop - ‘market forecasting.’

However, much less attention is paid to competitor actions and plans – ‘competitor forecasting.’ Think of your recent CDD reports – how many pages were dedicated to market growth/trends? In comparison, how many were focused on assessing likely competitor actions and the associated implications?

Unfortunately, of course, competitor actions can materially affect the outcome of your ROI. Significant game changer examples include:

  • Competitors materially changing the nature, direction and amount of resource provided to new product development;
  • New entrants that bring to the market different capabilities or a different business model than the traditional competitors;
  • Competitors who determine to adopt the same buy and build strategy that is part of your value gen plan.

Each of these examples demonstrate how significantly the industry structure can change, and why it is immensely valuable to 1) forecast the prospect; and 2) assess the impact of competitive actions effectively.

While the concern is (arguably) more pronounced in technology spaces - given the inherent leverage of many tech categories – the fact that so many industries are rapidly transitioning to “tech enabled” means that the theme should be addressed in a great many deals.

Competitor actions impact most key valuation model assumptions, including:

  • Sales volumes and churn
  • Pricing
  • Customer acquisition costs
  • R&D levels
  • Acquisition timing and multiples

Diligence thinking

Currently, many diligence thought processes work as follows:

  • Market conditions (customer growth, KPCs, current competitor offerings, etc.) are such that the best opportunity for growth is “X”
  • Therefore, let’s do “X”

Instead (leaning on game theory) I suggest that the process should be:

  • The market conditions are such that the best opportunity for growth is “X”
  • It is likely, based on an assessment of competitor patterns of behavior and performance that we will see companies A and B do “X (and/or Y)” in the next __ years
  • As a result, we will do “Z”

Therefore, commercial diligence needs to address the second line: what are competitors (current and prospective) likely to do over the life of your investment?

Enhancing the diligence process

Competitor forecasting is a non-obvious exercise – especially so for technology companies, as my colleague Jeff references in his recent GRAPH Paper titled Avoiding Asymmetric Competitors in Technology Investing. There are many frameworks that explain what you should consider with regard to industry structure and competitive behavior (e.g., Porter’s Four Corners). As for how to find to find this out, we suggest six questions for each competitor (or threatening new entrant) to drive the analysis:

  1. What are their key objectives and driving aspects of their corporate strategy? Objectives that prioritize revenue/share growth over profitability are informative, and histories of new product lines, market expansion, and/or capability hiring are significant indicators.
  2. What are the competitors’ genuine core capabilities? When these capabilities are highly valuable for the exercise of “X,” this is especially important.
  3. Who owns the business? Each financial sponsor, corporate and founder/owner will have varied capabilities and reputations for investment, operational improvement, conservatism and/or nimbleness (and more).
  4. How long has the leadership been in place, and what other major team changes have there been? What are they known for?
  5. What is the competitor’s (and leadership’s) track record for (similar) change to “X?”
  6. And, what ‘buzz’ or signals are customers reporting?

Finally, there is the increased threat of a non-traditional, disruptive competitor with a different set of objectives, business model and driver of its valuation. I again refer to Jeff’s recent piece.

Most diligence exercises touch on these points for a couple of competitors. But they all too often get limited consideration (and are frequently confirmation-seeking analyses) and the findings are not synthesized into a competitor forecast and what it implies means for your investment. We believe that many investors give this subject little attention due to the reasonable assertion that no one can reliably predict the future. But, of course, this is no less true for market/customer forecasting. We hold that with dedicated and strong investigation you can often see very clear signs of a competitors’ future, and an investor with resources and creative energy can turn what would otherwise be interpreted as an unwelcome threat into a plan to create their own game changer, and a great(er) ROI.

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