Should M&A due diligence incorporate primary market research?

The due diligence process for mergers and acquisitions is intended to validate the decision and minimize risk.  Unfortunately the resources and rigor devoted to the activity can be undermined by common biases that distort reasoning. Well-documented by behavioral economists like Daniel Kahneman, biases include:

  • Confirmation bias leads people to ignore evidence that contradicts their preconceived notions.
  • Affect heuristic: When evaluating something we like, we tend to minimize its risks and costs and exaggerate its benefits; when assessing something we dislike, we do the opposite.
  • Anchoring causes decision makers to weigh one piece of information too heavily in making decisions.

These biases are especially prominent during an acquisition because decisions makers often want to say “yes”. Prior to any meaningful due diligence decision makers construct reasons to support why the acquisition makes sense and the benefits it brings. Many companies use primary research and external research consultants to mitigate against their internal bias and reduce overall uncertainties.

Specifically, research is used to:

  • Gauge the overall health of the acquired company’s customer base: How satisfied are their customers?  Will customer spending with the company increase or decrease in the future?
  • Forecast growth, size the market: If the acquisition is driven by expectations for growth in an immature market, does customer/prospect data support growth projections? When and how quickly is growth likely to occur?
  • Identify risks: How will a change in ownership impact churn and switching? Will customers be more likely to switch if two major rivals combine? Did they select a smaller vendor initially for a specific reason?

Although the benefits of conducting primary research as part of due diligence are clear, there are challenges associated with doing so.

  • The short period of exclusivity means that research needs to be executed and results delivered in time to inform the decision.
  • Confidentiality is critical and the research must be conducted in a manner that shields the intended use of the data and the identity of the companies involved.

While there’s no silver bullet for dealing with these challenges—they are what they are, to a large extent—it helps to work with a research partner that understands the category and can quickly move the project forward.

Just as market research isn’t needed to test every product idea or ad campaign, it is used selectively in the due diligence process.  Typically our clients turn to us for assistance when:

  • The investment is significant; stakes are high and primary data is need to validate the decision and mitigate risk.
  • The investment falls outside the management team’s core expertise; existing internal knowledge and experience isn’t enough to inform the decision.
  • The company understands the potential for decision bias and has made primary research a routine part of due diligence.

For companies seeking increased rigor and objectivity in strategic decision making, consider incorporating primary market research data into processes like due diligence.