One of the absolute basic requirements of Commercial Due Diligence (CDD) is an assessment of the target company’s business model. This has two aims, one to understand how it currently works and is competitively positioned and how this model is likely to allow the business to meet its sales and business forecasts.
As stated in the Commercial Due Diligence book by Ralph Niederdrenk and Matthias Mueller, a simple way of understanding a business model of a company is to understand the structure and process of how the company goes about making a profit.
In their book, the authors state four main methods, which they call the basic infrastructure for understanding a company’s business model:
Value Creation Model
The Target Company’s Offer
The Target Company’s Offer
The Offer is simply the range of products and services offered by the company in question. What is the combination of products and services that the company offers its customers? Bearing in mind that some of the products and services may be combined such as with the consultancy or systems integration needed for certain software solutions.
For this, you will need to understand each product, service or product/service mix being offered. Obviously a company could have thousands of SKUs or different offers, so in this case, it is important to understand the over-arching categories. This will assist later with the market analysis by understanding the structure of the market, which could be segmented according to these product/service categories.
There are four main types of offer:
Individual Products or Services
This is the very basic offer, which is an individual or independent product or service meaning that customers may not need additional products or services to consume these products.
Additionally, these categories can be split between commodities and specialised products. So one company could offer the same basic type of products with different features according to the requirements of their customers.
A combination of two or more products and/or services.
These combinations could be directly manufactured or be provided by the target company or by third parties. Generally these offers are standardised rather than specialised.
A group of individual products and services which have been specially combined for an individual customer. The aim here is the combination made specifically for an individual customer but with all of the products and services being standardly offered products, i.e. the products and services have not been altered merely the combination.
This is an integrated and individually created solution developed for one individual customer, focused on their individual specific problems. So, for example, a customer in the nuclear power industry might have very specific requirements when compared to a customer of components in the renewable energy sector.
These can be viewed in a matrix with on one axis, the level of integration and on the other axis, the level of bundling.
Price and Condition
The price and condition of the offer is an important element to be considered in the Commercial Due Diligence against the competitive products and services. It is important to understand where the target company fits into the market with its offers. This can get complicated depending upon to what level of complexity the market breaks down into.
The aim is to understand whether the target is a commodity or specialised/premium service provider. Obviously one caution with pricing is to understand discounting, warranties, other services and products added into an offer etc.
Customer Value Proposition
Once you have understood what the target company offers in terms of its product and service offering, the next step is to understand its value to its customers, as to why the customer uses this and what problems they are trying to solve or which needs are being met with these products.
As the Commercial Due Diligence book states, this is different to a segmentation of the end customer industries. We are specifically trying to understand in more detail:
Understanding the difference between the qualities of the product and service the target company offers in comparison to competitor offers. This can include better quality, functionality etc.
This is usually valid where the target company is able to offer a product at a lower price point to its competitors because of its lower price structure.
Customer Relationship Performance
This has to do with how the offer helps the structure of the relationship with the customer. If the target company is taking on some o the customer’s key requirements, such as reducing their risk or integrating with their financial systems, then this is aiding the customer and potentially reducing their costs above just the price being offered.
The key driver in determining how valuable the product and service offer is, is how differentiated it is from the competitors. Too similar and the target will be susceptible to price competition and potential replacement due to economic factors. Too specialised and they may be dropped if their service is to too advanced for their users’ requirements.
“Me Too” – undifferentiated offers – identical to competitors i.e. commodity products
Innovative Imitations – same as competitors with unique elements attached
Differentiation – through performance or price structure
Unique Business Model – ‘Revolutionary’ offer or meeting customer needs in a way no competitor can currently do.
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(Sources: Commercial Due Diligence – Die Strategische Logik Erfolgreicher Transaktionen- by Ralph Niederdrenk and Matthias Mueller, Octavia Life Ltd Research and Analysis)