keymodels
Strategic due diligence and the market contextual plan review
How should strategic due diligence and the market contextual plan review be measured and interpreted?
Contents
An investor-style challenge of whether revenue and margin plans are consistent with market growth, competitive position and industry intensity.
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
Sales forecasts
Planned sales in three years
Planned sales growth over the next three years
A backer’s perspective
How achievable are the planned segment and total sales given market dynamics?
What level of sales would a prudent backer be prepared to finance?
Market Contextual Revenue Review
| Next three years | Next three years | In three years | Next three years | achievable? | In three years |
|---|---|---|---|---|---|
| 3 | 4 | 5 | 6 | 7 | 8 |
Look for inconsistencies among:
The firm’s historical sales growth
Expected market-demand growth
Present and future competitive position
A company with strong past growth and an improving competitive position would normally plan to outgrow demand and gain share. A business with a weak record and only a tenable position needs powerful evidence if its sales plan also exceeds market growth. The forecast may still be right, but the strategy must explain why and show how the position will strengthen.
Next, test margins. Build a second review with 11 columns:
The same product/market segments
Profits
Latest-year sales
Latest-year profit margin, preferably contribution margin or otherwise gross margin
Latest-year profit, calculated as column 2 multiplied by column 3
Market Contextual Margin Review
| Segments 1 | Revs (£000) | Pro t margin (%) | Pro t (£000) | Competitve intensity (L/M/H) | Competitve intensity (L/M/H) | Plan pro t margin (%) | How achievable? 8 | Likely pro t margin (%) | Likely revs (£000) | Likely pro t (£000) |
|---|---|---|---|---|---|---|---|---|---|---|
| Segments 1 | This year 2 | This year 3 | This year 4 | Now 5 | Next three years 6 | In three years 7 | How achievable? 8 | In three years 9 | In three years 10 | In three years 11 |
| A | ||||||||||
| B | ||||||||||
| C | ||||||||||
| Others | ||||||||||
| Total |
Optimising the corporate portfolio Creating value from mergers, acquisitions and alliances The corporate restructuring hexagon (McKinsey) Creating parenting value (Goold, Campbell and Alexander) Core competences (Hamel and Prahalad) Strategically valuable resources (Collis and Montgomery) Strategically distinctive resources (Barney) Distinctive capabilities (Kay) Distinctive competences (Snow and Hrebiniak) Dynamic capabilities (Teece, Pisano and Shuen) Deliberate and emergent strategy (Mintzberg) Integrative thinking (Martin) Stick to the knitting (Peters and Waterman) Profit from the core (Zook) The market-driven organisation (Day) Value disciplines (Treacy and Wiersema) Disruptive technologies (Christensen) Blockchain technology (Tapscott) Co-opetition (Brandenburger and Nalebuff) Growth and crisis (Greiner) Good strategy, bad strategy (Rumelt) Fast/forward (Birkenshaw and Ridderstrale) Innovation hot spots (Gratton) The eight phases of change (Kotter) Strategic due diligence and the market contextual plan review
Industry competition
Record current competitive intensity—low, medium or high—using Porter’s The five forces (Porter).
Assess whether intensity will increase, ease or remain stable over the next three years.
Profit forecasts
Record planned profit margin in three years.
A backer’s perspective
Judge whether the planned margin is credible given the industry dynamics, including the overall total.
Estimate the margin a prudent backer would finance.
Bring in the likely sales result from the revenue review.
Calculate likely profit as column 9 multiplied by column 10.
Again, seek consistency. Flat margins can be credible when competitive intensity is stable; rising margins can fit an easing industry. Rising margins amid intensifying competition are not impossible, but they demand a strong explanation. Possible sources include:
Improved purchasing
Higher utilisation
Greater productivity
Product-line rationalisation
Business process redesign (Hammer and Champy)
Cost discipline
The complete story must be coherent, internally consistent and supported by evidence.
Top practical tip
Start with segment revenue and reconcile every forecast with market growth, historical performance and the competitive-position change the strategy is expected to create.
Top pitfall
Do not become the “dreamer” whose sales forecast has no relationship to market demand. A plan is not credible merely because its spreadsheet balances.
Further reading
- Howson, P. (two thousand and three). Due Diligence: The Critical Stage in Mergers and Acquisitions. Gower.
- Perry, J.S. and Herd, T.J. (two thousand and four). “Reducing M&A Risk Through Improved Due Diligence.” Strategy & Leadership.