Strategic due diligence and the market contextual plan review

Strategy development and strategic due diligence use the same raw material in opposite directions. Strategy combines market, industry and competitive evidence into a route to sustainable advantage. Due diligence starts with the proposed strategy and tests whether the evidence can withstand an investor’s challenge.

When to use it

Use strategic due diligence and the Market Contextual Plan Review to refine a strategy or business plan before committing capital. The ambition is a plan robust enough to survive forensic examination by a specialist adviser acting for a demanding investor.

Origins

Strategic due diligence grew from the legal, financial and operational investigations used in transactions. As private-equity and strategic buyers focused increasingly on future performance, commercial due diligence expanded beyond verifying historical accounts to examine market growth, customer behaviour, competitive position and the achievability of management’s plan. The Market Contextual Plan Review applies the same outside-in discipline to revenue and margin forecasts.

What it is

Strategy development and strategic due diligence draw on the same three foundations: market demand, industry supply and competitive advantage.

Strategic due diligence, or SDD, is used primarily in mergers and acquisitions; see Creating value from mergers, acquisitions and alliances. An acquirer that does not understand the target’s market, industry and competitive exposure can pay far too much. The acquisitions of ABN AMRO by RBS and HBoS by Lloyds TSB illustrate how severe the consequences of inadequate challenge can become.

The same discipline can improve strategy before a transaction exists. Think of strategy development as the workshop producing a large, bespoke piece of capital equipment. SDD is quality control: it verifies that the output meets its intended purpose.

A sound strategy should fit what customers will pay for and create a defensible distinction from competitors. If it does not, send it back for adjustment. Due diligence is therefore not merely a deal obstacle; it is a way to fine-tune the plan.

How to use it

SDD asks one primary question: Is the firm likely to achieve its plan over the next few years? It then asks whether upside opportunity is greater than the risk of underperformance. The The suns & clouds chart can support the second question. The Market Contextual Plan Review addresses the first.

Begin with revenue. For each business unit, test whether forecast sales are compatible with market-demand assumptions and the expected evolution of competitive position.

Build a table with at least eight columns and, where clarity permits, 14. The optional extra 6 deepen the historical and forward view. Include:

• Product/market segments
• Sales

Sales in the latest year and, where useful:

Budgeted sales for the following year

Sales in the previous year

Sales in the year before that

Compound sales growth over the last three years

Nominal market-demand growth over the last three years

Market demand

Nominal market-demand growth forecast for the next three years. The total row remains blank because growth must be estimated by segment, as it is for column 4.

The firm’s average competitive-position rating on a 0–5 scale for the next three years, or a current rating followed by:

Likely competitive-position rating in three years after the strategy takes effect