Real Deals asks Palladium's Meelimari Arro, due diligence lead, why digital is more than just your website, how Palladium found their due diligence niche, what they've learned and how to keep up with digitally-savvy competitors.
Digital has fundamentally changed the interaction between individuals and organisations. This, in turn, has shifted our behaviour and the expectations customers have.
Digital is a broad term. What does it mean to private equity?
Firstly, digital isn’t a thing, it’s everything. Digital has fundamentally changed the interaction between individuals and organisations. This, in turn, has shifted our behaviour and the expectations customers have. To adapt, businesses need to change their thinking from linear to exponential; from audience as a channel to community; from product to platform; from customer transaction to customer relationship and value beyond the transaction; from push to pull; from consumer to co-creator. Failing to take advantage of new technologies and not noticing how digital has changed society and the economy leaves businesses vulnerable to disruption. For private equity investors, digital is high on their agenda, but they often don’t have a method or the expertise to assess digital in due diligence.
Given how all-encompassing digital is, surely this would already be part of regular commercial or IT due diligence?
It sits somewhere in the middle of commercial and IT diligence, with some overlap. For example, we complement commercial due diligence with digital customer/market trends from the largest, real-time, unbiased consumer panel that exists (the internet). Unfortunately, it is not quite standard practice yet, but private equity firms are slowly waking up to the idea that digital diligence is a must have not a nice to have. According to MIT, business leaders estimate that 28 per cent to 40 per cent of their revenues are threatened by digital disruption. We have seen the same in the businesses we talk to. It is one thing to look at the tools and technologies digital businesses use, but understanding how digital business models work and how the business is addressing new customer behaviours, disruptive technologies and ecosystem changes requires a new skill set. Both IT and commercial providers have tried to incorporate elements of digital into their offering but have been unable to provide the level of depth that we can with a team of highly specialised consultants.
You didn’t have any previous private equity experience. How did you start in this space?
We were asked by a private equity firm to have a look at their investment opportunity. We didn’t know what should go into in a due diligence, but we are digital experts and know what good digital performance looks like. We approached the new industry like consultants approach a problem, and throughout the process we learned what the private equity industry is after to tailor our existing assessment methodology. Being new to the sector, looking at the due diligence with a fresh pair of eyes and not being afraid to ask stupid questions or break all the rules has been beneficial. As you know, innovation usually comes outside of an industry. It’s been a gradual evolution, but we’re now recognised in the industry for our award winning due diligence and regularly work with around 20 private equity firms. I think this is not despite our lack of private equity background, but due to it.
What goes into your due diligence work?
We look at three areas to make our digital assessment, including the proposition and business model, the go-to-market strategy and operations. We use digital data that people leave behind when they interact online to make conclusions about the customer and market trends. The internet is effectively the largest, real-time consumer panel that exists. We also look at the possibilities of the business model being disrupted by new technologies, substitutes and indirect competitors. We then review the go-to-market strategy, looking at customer centricity, digital marketing, digital attribution / KPIs, tools and processes. Lastly, we look at the business’s operations from the product delivery method to data, the drivers of innovation (values, climate, resources) and the leadership team. The resulting digital due diligence will show which areas the business is lagging behind its peers in, and what investments are required to achieve true digital excellence. Depending on the depth and time constraints, it often includes recommendations with an estimate on the upside that feed into the full potential plan.
So you make recommendations?
Yes. We’re often asked to implement our recommendations. Our approach to digital transformation focuses on customer experience strategy, business model innovation and change management. Having developed a deep understanding of these areas during diligence, it is a natural fit for us to help our clients make those ideas a reality.
You’ve made some interesting discoveries in your work. Tell us about some of them?
Yes, for example, we had an instance where an insurance broker was aiming to reduce reliance on purchased leads and broker referrals in favour of generating businesses directly through digital channels. We concluded that the direct digital channel is unsustainable due to a high customer acquisition cost resulting from a Google penalty that the business may never recover from. Our digital due diligence allowed the investor to write off the benefits of the new channel and more accurately price the company.
On a more positive note, we have validated amazing investment opportunities too: whether it is quantifying the strength of the brand through digital data or projecting the e-commerce revenue uplift through improvements to the merchandising and marketing processes. We’ve also spotted missed opportunities. For example, we identified an opportunity to shift the business model to a platform business based on existing but undervalued assets; and discovered a mismatch between how the business positioned itself and how customers articulated their problems (or ‘jobs to be done’) by scraping over 200 different small business forum, social media sites and analysing the intent behind people’s searches.
Some firms do their own digital due diligence in-house. Won’t others do the same?
Some GPs already have an internal function for digital due diligence, and it is a pleasure to work with a head of digital that leads this process and understands what “good” looks like. However, coping with the volume and the depth is challenging, so they often bring in external advisers. At Palladium, our talent is very specialised, which allows us to cover a breadth of different topics (from product, innovation and data to digital marketing) and delve deep.
What practical advice do you have for businesses who want to start incorporating digital?
Digital is more than your website. It’s not just your IT procurement or SEO audit. It should encompass the entire organisation, ways of working and digital thinking.