Taking Price Seriously in Commercial Due Diligence (CDD) Mandates

Using pricing as a lever is massively powerful, yet pricing is an often overlooked and underappreciated part of diligence. Several years back, one of the large corporate finance consultancies did some modeling using income statements from the top 1000 firms – they found that a 1% increase in average price with an “inelastic” customer base (i.e., no resulting change in demand) resulted in a 10% increase in operating profits. In my experience, most analysts react to this finding one of two ways: either they shrug and say, “yes but…in a vacuum…and there’s never NOT a change in demand,” or they are shocked but frankly intimidated by the promised impact. Price is a complex topic, and because making relatively small changes to price can have substantial impacts on outcomes (pricing has an amplifying effect), investors have historically been hesitant to really address pricing in the diligence window. Instead, price has been relegated to one of many “key purchasing criteria” (or “key buying factors”) – considered coequal with customer support, product quality, and other considerations – but unlike price, a typical company cannot adjust 1% of product quality and return a 10% increase in profit. So, detailed attention to price pays off, but how much can you afford to add to your plate in an already compressed diligence window?

The short answer is more than you think – by adding just an extra couple layers of granularity to some already common questions.

Here are our four key builds for your customer interviews:

  1. Reserve price for later in your interviews: The vast majority of interviewees feel that pricing specifics are confidential when they’re not, and they require “warming up” first – two-thirds of the way into a cordial conversation is a great time to introduce the topic
  2. Get very specific in your pricing definitions – focus on granularity. What does “competitive price” really mean for the target company? Is it plus or minus 2%? 5%? 10%? You would be amazed how often we discover from customers that competitive pricing is plus or minus 10% of the target company’s current pricing, which is a massive opportunity for value creation. If an interviewee is hesitant or vague on detail, you can prompt “I just heard someone tell me they’d switch for 1%,” and let the person correct you (“no way, no one [i.e., I don’t] cares about 1%, but definitely can’t be more than 5%”)
  3. Awkward silence can be your friend. This is an old trick, but sometimes creating an awkward silence can give an invitation to interviewees to go deeper, and lets the customer give more explanation and anecdotes for finer precision
  4. Look for signs of thresholds or pending price pressure. Customer behavior is not elastic or inelastic overall. Is the target company in a window in which there is relative inelasticity of demand, and can they afford to move price without having too much volume decay? Sometimes price reaches a point where that threshold is going to start leaning against them. Signs to notice: customers describing or forecasting a change in the importance of price

In addition, aim to spend time with the Chief Revenue Officer or Chief Commercial Officer. Ask about the history of the target company’s pricing approach as well as the quality of accounts, how they are contracted, and the quality of those relationships. Elevate questions around how price is negotiated and structured.

If you don’t spend enough time on pricing during diligence, you run the risk of making assumptions around pricing, missing an opportunity to have more confidence in a business than you would have otherwise had, and missing a chance to inform management of a pricing opportunity. Even the most sophisticated PE investors tend to look at price opportunistically, and it should be a fundamental consideration on every deal and part of every diligence mandate.

And finally, even if pricing doesn’t prove an obvious lever in the diligence window, you may want to look at it as a long-term value gen driver (we describe these shifts as pricing journeys). The extra time available in a hold window affords a lot more ability to examine the many levers of price.

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