Improving the odds of M&A success by asking new questions

Summary: This paper makes the case for a strong marketing component in the due diligence process, to increase the chances of a transaction that builds value by uncovering revenue enhancing strategies and opportunities. To do so requires seasoned, independent marketing due diligence advisors who ask questions that traditional due diligence advisors might not ask and who can interpret a wide range of answers and marketing documents. The primary example concerns a family-owned business in consumer package goods that doesn’t fit the normal business/marketing mold.

Many people outside of the consumer package goods business would be surprised to learn that the failure rate for new products is generally agreed to be over 92%. Year in and year out, more than 10,000 new products are introduced and every year more than 10,000 are pulled off the shelves and tossed in the dustbin of rejected concepts. What’s that loud flushing sound?

A great many of the deceased are “me too” copies of successful brands. Others are slightly tweaked revisions of existing products that have been given minor changes or enhancements consumers really don’t want or need. Still others are simply terrible ideas that see the light of day because some corporate godfather issued an edict, or “group think” shanghaied the development process and no brave soul had the courage to sound the alarm.

But there is another industry where the batting average is almost as poor … and for many of the same reasons: mergers & acquisitions.

Many in the M&A community believe the failure rate exceeds 3 out of 4 and the frequently cited KPMG study puts failures at 83%. Frankly we found this surprising so we dug a little deeper.

Most agree that a merger or acquisition is deemed unsuccessful when it fails to increase shareholder value. The honeymoon or grace period is generally 4 to 5 years during which the combined entity has time to realize the anticipated synergies as well as execute its integration plan. But only 1 in 8 succeed in increasing the shareholder value of the combined entity. Even if shareholder value has stayed the same, one has to ask, “what was the point?” A lot of time and money was expended and the ball wasn’t moved down the field.

There is a growing body of work both here and in the UK that is tackling the issue and identifying the reasons for failure. Several recent studies have pointed the finger at a primary culprit: the lack of a marketing perspective in the due diligence effort. There are things about a company and its brands that the balance sheet doesn’t reveal. It cannot answer questions such as:

What is the acquisition target’s relationship with its customer/consumer base?

How well do they really know them?

How skillful are they in reaching them and persuading them to buy the brand?

How long can they hold on to them and how often do they have to replace them?

What makes this brand preferred over its competitors?

There are hundreds more potential questions covering all aspects of the brand and how it is sent to market. And taken together they give the acquirer a chance to see just how good a marketer the target is, the level of skill and the quality of the talent. They begin to identify growth or revenue enhancement opportunities that should be the ultimate objective of the M&A activity. (If growth isn’t an objective we have to ask why the acquisition was pursued in the first place.)

Unfortunately, none of the answers are found in the financials. And skilled lawyers and talented accountants often don’t know the right questions to ask or how to interpret the “marketing speak” responses they get. In this arena it literally takes one to know one. Or correctly it takes an experienced one to know one. It takes years to acquire the knowledge and the scars, not just a semester or two of Marketing 101.

Perhaps an example is in order.

We know of a family-owned company that will probably be in play sometime in the next 3 years. It is a very successful enterprise with a product that created an entire grocery category and is still the leading national brand.

The company has always been debt–free. Or at least it was until a new plant was built and the overruns drove them to the bankers’ doorstep. (But that is an entirely different story for another day.)

The marketing and sales function is modest and short staffed even in light of the fact that they have huge national customers such as Wal-Mart.

In the next couple of years it is highly likely the family will decide to sell, and someone will make an offer, perform a traditional due diligence effort, close the deal, reduce staff and budgets to cut costs and completely miss the point.

If they don’t ask the right questions during due diligence or post-deal integration, they will miss an enormous opportunity or unwittingly set in motion events that will wither the intrinsic value of the business.

So just what is the magnitude of the opportunity this company might have in store for the marketing-savvy buyer? It may be growth, significant growth. Growth measured in multiples not in percentages.

In spite of sales approaching $100 million this brand has miniscule levels of unaided awareness among consumers, meaning it is not top of mind with a significant number of consumers. In fact, its aided (read that prompted) awareness numbers are not much higher. Increases in these numbers will yield dramatic growth in sales and profit.

And it will do so quickly. The brand has a significant amount of “headroom” or potential to grow its user universe.

Why won’t a traditional due diligence effort unlock the treasure chest? First off, it is possible no one will ask what consumer awareness levels are. Such questions don’t often appear on a traditional due diligence checklist. If someone does ask the question, the response will probably be “they are high” which will be an unintentional misrepresentation of the facts based on nothing more than a few focus groups. The company has never run legitimate, quantifiable consumer research. No awareness benchmark. No awareness tracking. Almost the entire marketing effort is seat of the pants and planning-by-anecdote is the order of the day. Heck, they didn’t even bother to buy retail scanner data until 36 months ago!

These very low levels of both aided and unaided awareness are not just among the general consumer audience -- it is true among users of the brand. Even its most loyal consumers often refer to the brand by the color and shape of its packaging and not the brand name. As a result, there is an enormous audience of new triers and occasional repeat buyers that can be tapped with a minimal but consistent marketing effort. The initial post-deal work should not be cost cutting, but brand expanding. Small amounts of real consumer advertising will drive awareness efficiently and the resulting trial and increased purchase frequency will yield immediate bottom line results.

We say “real” consumer advertising because past efforts have been an inconsistent jumble of short-lived messages. The media plan has been “hit or miss” and usually limited to ½ page FSI coupon ads in the wildly cluttered Sunday newspaper. A non-marketer hearing that 35 million ads appear 4 times a year may take the answer at face value and think this is a serious effort. A seasoned marketer will see the plan for what it is: a promotion tool designed to whip up a broker sales force. Ironically, it is a sales force experienced enough to know it will be an ineffective consumer effort. A non-marketer may see the resulting low coupon redemption rates as a blessing: low redemption means low out of pocket cost. A marketer will see it as a warning: low redemption means low visibility. (There’s that flushing sound again!)

So why will increasing marketing investment yield better results than cutting it out? The limited user universe is wild about the product. They seek it out. They share it with those they care about. They keep coming back for more. Pretty rarified air for a grocery store product. The opportunity for some acquirer may not be unlike having the chance to buy Ben & Jerry’s in the late 1980’s. Among its loyal consumer base, this brand is approaching the “consumer monopoly” that Warren Buffet often speaks about. Imagine being able to easily attract hundreds of thousands just like them.

But all is not rosy. And an unbiased marketing perspective during the due diligence effort will reveal potential hazards.

Consider …

It is quite likely the acquirer may be someone in a similar grocery category who will believe that all they need do is fold the brand into their existing portfolio, sales force and distribution channel. And doing so may prove to be a disaster because 1) this brand is distributed differently than its primary competitors, 2) it is authorized and purchased by a different buyer within the grocery chain, and 3) it occupies an in-store location separate from the rest of its category. All of these anomalies are reasons for the brand’s strength and potential. Changing them could spell its demise. The acquirer needs to ask:

Who is the sales force?

Most of the competition is direct store delivered by a dedicated sales force; this brand is sold by brokers and delivered to the chain warehouse.

How is the product delivered?

Most of the competition is delivered at ambient temperature; this brand is shipped and stored frozen and kept in the backroom freezer until it is time to display it for sale.

How is the product displayed?

Most of the competition sits on a shelf; this brand has succeeded in getting permanent racks in thousands of chain grocery stores without paying placement fees.

How many SKUs does the product have?

Most of the competition has 20+ SKUs; this brand has 6 (and only because 3 new ones were introduced in the last 24 months!)

Opportunities and tiger traps abound. But we digress.

So what does all this tell us? It makes a compelling case that every merger, acquisition or buy-in would benefit from a strong marketing component in the due diligence process. It can reveal hidden opportunities and prevent potential disasters. (Diet Raspberry Snapple anyone? Damn, there’s that sound again.)

In the weeks and months ahead we are going to explore the subject in greater detail. You are welcome to come along for the ride.

Earlier we mentioned the need for an unbiased marketing due diligence effort and that’s the subject of an upcoming paper. An acquirer may have several resources for marketing advice: their own marketing department, their advertising or public relations agency or even the management team they may put in place at the target company. And each one is the wrong choice for marketing due diligence work. In the next few weeks we’ll tell you why.

If you would like to receive future white papers or learn more about the marketing due diligence services of Growth Trinity Group, contact Lowell Wallace at (224) 766-0968 or email him at lwallace@growthtrinity.com.

Copyright 2012 Growth Trinity Group, LLC. All rights reserved.