CDD Plan of Attack: Risk of Overstatement of Digital Disruption Signals (and Opportunity)

The risk of ‘digital disruption’ is pertinent to almost every industry today. Naturally, acquirers look for signals that a target company will be able to brace the oncoming winds of change and enhance its products and services to meet the demands of an increasingly connected and digital world.

Management teams looking to gain investor confidence and their enthusiasm (along with the consultancies behind the VDD and IM), commonly underscore digital investments and game-changing prospects to boost the multiple. When valid, a digital transformation story can be an indication of a management team that is ready to tackle important challenges to fend off erosion, drive margin and share improvement, and even transform the business model.

On the other hand, the emphasis on the digital opportunity can be a signal that management, whether by their own design or that of previous advisors, has focused their attention on chasing what is a known popular and shiny object, perhaps losing focus, and concerningly, puffing up a valuation.

In one of my recent diligence cases, management of Target Co. (an information business providing valuable data to product manufacturers) was confident in the excellence of its core product but was also strongly pitching investments directed at two distinct digital opportunities: 1) moving into an adjacency related to e-commerce; and 2) enhancing its core product with advanced digital features and service attributes. Both offered a value gen. story that held strong logic.

The problems:

  1. The commercial diligence determined that despite management’s claims, customer and customer prospects expressed significant concern about the Target Co.’s prospect for winning on this battle ground (due to its disadvantage in getting access to certain valuable data points). There were other players who were better positioned and were gaining greater traction due to having a perceived greater right to win
  2. The coverage that the target company best served was for retail segments that faced the least chance of gaining ground with e-commerce – for critical reasons cited by core industry participants that held a strong evidence base
  3. The format and packaging of the data that was provided to customers was of far less imporant Driver of Choice for selecting the vendor than were other critical criteria

In other words, the Target Co.’s management was at risk of over-investing.

In this case, the resilience of the core business still made the investment sensible – but the digital story deserved far less underwriting than promoted. The deal still went through, but this client did so with a better grounding and sound valuation (and the data needed to win over the executive leadership team).

When facing today’s common questions and opportunities for digital transformation, consider actioning these five steps:

  1. Focus first on the customer decision-making process
  2. Validate if the value gen thesis is aligned with the views and vision of the customer base. How significant are the perceived switching costs, how sticky is the Target Co. today? Do customers need “new” or do they need “better,” and – given their business needs – how do they define better? What problems do customers need or would enjoy seeing solved?
  3. If there is active switching or adoption (even at low levels), determine the root causes and Drivers of Choice (what are customers seeking in a solution and solution provider?)
  4. Assess if the Target Co. is sufficiently positioned and, if not, determine if it’s still early enough to allow for effective capability building and a successful pivot to change customers’ views on the business
  5. Determine if the management team (or your ops team) can pull together the needed resources and capabilities that will allow the Target Co. to deliver “the new” better than most

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