Why Quality trumps Quantity in Due Diligence

Helping our Private Equity client independently verify the quality of the customer relationships of an ERP vendor it was looking to acquire.

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Our Client’s Problem
We deal with many private equity and venture capital companies. As part of their investor data rooms, our client’s get access to information such as customer lists (sometimes in the thousands!). One persistent problem that our clients have is to verify the quality of the relationships that their target companies have with their customers. 

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Verifying the numbers (i.e., account value) is pro-forma work. Verifying whether the client will renew and the quality of the relationship is a completely different issue.

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Our Brief
Our client set an ambitious goal for us: verify that the quality of the relationship between their target company and their top-100 accounts is solid. Our client wanted to understand why customers selected the target ERP vendor, how the project evolved, were there any issues with the vendor (or their systems integrator), what were the challenges faced by the vendor, and the reasons for those challenges.

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Our Method
Needless to say, the client did not have the internal resources to do this type of work. At 4D, one of our founding values is Transparency in our due diligence process. To meet our client’s objectives, we identified specific titles within customer organizations that were responsible for purchase decisions of ERP solutions (usually the CTO/CIO) together with important stakeholders / users of the target ERP vendor. 

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For the top-100 accounts, we identified over 300 individuals that we would try to recruit and ended up interviewing over 30 CXO and CXO-1 level individuals. Our client wanted evidence that the interviews were being done and wanted to hear for themselves what was being said. After going through an extensive Personally Identifiable Information (PII) scrubbing process and identifying ourselves as being hired by our client, we shared our interview recordings with our client which gave them the assurance that the data we were gathering was indeed robust.  

We were told by our client that no other due diligence firm does this for them!

 

Client Outcomes
Out of the 30 interviews we conducted, we classified 8 accounts as “Red”. These accounts were actually some of the largest accounts of the ERP vendor and represented ~20% of their revenue base.

These accounts were failures, in our view, because end clients had a bad customer experience for a variety of reasons. These reasons included:

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1. Lack of Skilled Resources: As clients were going through their ERP transformation programs, their legacy ERP systems were frozen due to expectations of rapid delivery of the new ERP solution provided by the vendor. However, Systems Integrators (SIs) of record in some of these installations simply did not have the skilled resources to implement the solution. This raised red flags with our private equity client as some of these failed relationships were touted by the target vendor as being “marquee” customers. Our due diligence revealed otherwise.
    

2. Lack of Functionality: The original customer list provided to our client listed out the key products installed at various customers. However, upon our due diligence, we learnt that while the target vendor did have the capability in certain domains like order management, this capability was not that deep and many of the customers only implemented portions of their solution. Some customers dropped out of their Store Network solutions, others did not install their marketplace solution which lacked key partner fulfillment functions.

Based on our due diligence and transparency, our client was able to get the ground reality of their potential acquisition. With 20% of the target’s revenue “in jeopardy”, our client decided to pass on the opportunity to buy this company. The target company is yet to be acquired and we are told that revenue growth at the ERP vendor have flat-lined and its valuation has declined by over 70%. 

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In this case, the decision not to buy turned out to be the right decision for our client.

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