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Complementary Combinations

Many Private Equity deals involve a “platform and add-on” play – predicated at least in part on “bigger is better.”

Among the various benefits of consolidation, some of the most commonly cited value gen opportunities relate to bundling and cross-selling. Just this year, we’ve worked on deals from building products to processed meats where this has been a key part of the investment thesis.

On the face of it, cross-selling can be an enticing opportunity: increasing salesforce productivity while delivering higher value for key customers feels like an obvious win. However, we’ve seen just as many occasions where the opposite is true – either customers just don’t perceive value in a larger bundle, bundling drives down margins (due to expectations for price concession) or even worse, a combination creates confusion and makes each individual element less appealing.

Here are five questions that can help diagnose whether increasing a portfolio of products or services will be successful for an investment:

  1. What is the timing of the purchase for each item in the product or services portfolio? In cases where purchasing is based on large projects – like in commercial and industrial construction and large IT projects – there can be significant advantages to having items in your portfolio that are purchased first (or very early) in the process, enabling pull through for items purchased later.

  2. Are the customer call points one and the same? And if not, are there realistic and actionable referral agents within the customer organization? And are there sufficient operational, relationship or economic incentives to activate these referral agents?

  3. Is someone in the value chain already addressing the need? Distributors, integrators, or EPCs may already capture the value from bundling. This doesn’t mean that you shouldn’t compete, the question is whether you can do so effectively: do we really have the right kind of resourcing and integration across the organization and salesforce to “win” in the market with your basket of goods?

  4. How many items in the bundle do you need? In some cases, the value from a bundle is binary: having all 5 of 5 items commonly purchased together is mandatory. In other cases, having 2 of 5 is all that’s required, and avoiding the 3 lower-margin items is prudent.

  5. Is the brand equity of the two businesses complementary enough to allow for a combo? When building a portfolio through acquisition, investors should have a detailed sense of the brand compatibility – are these brands synergistic, or does putting them together create confusion in the market? Even though two businesses might each be highly regarded, if customers don’t perceive their core capabilities to be sufficiently similar or complementary, then the potential opportunity for cross-selling may be limited (and may introduce entirely new risks to existing revenue streams).

At its best, cross-selling can enable a supplier to gain a better understanding of customer needs, and unlock profitable new customer solutions; but in a surprisingly high number of cases, customers do not actually value the cross-sell at all. This is the dichotomy between valuing a “one stop shop” and preference for the “best of breed.” In the worst-case scenario, the bundler of products and services is simply assisting customers in consolidating spend, applying price pressure and eroding margins.

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