1. Strategic Due Diligence: A Foundation for M&A Success
a strategy+business exclusive
For further information:
Gerald Adolph, New York: gerald.adolph@booz.com
Joerg Krings, Munich: joerg.krings@booz.com
Booz & Company
09/28/2006
© 2006 Booz & Company Inc. All rights reserved.

2. Strategic Due Diligence:
A Foundation for M&A Success
Understanding the rationale for a merger can help leaders uncover the
potential value of a deal.
by Gerald Adolph, Simon Gillies, and Joerg Krings
1
strategy+business enews
T
he art and science of merger a merger. Indeed, strategic due dili- deal has its own value drivers, and
execution have made great gence is increasingly being demand- thus the composition of each due
strides since the late 1990s — ed by boards of directors who want diligence team must change.
a period when stock-market frenzy to be certain that a merger is the Executives should determine which
often led to a rush to judgment, and right choice. areas of the organization will pro-
ultimately to buyer’s remorse. Since What exactly is strategic due duce value in the merger, and draw
then, a more prudent, systematic diligence? Whereas financial and members of the due diligence team
approach to mergers and acquisi- legal due diligence ascertain the from those areas. (See “Building the
tions has emerged, and many com- potential value of a deal and con- Diligence Team,” page 4.) Strategic
panies with an articulated M&A cern buying the company “at the due diligence counterbalances the
strategy have gone so far as to insti- right price,” strategic due diligence danger of institutionalizing and
tutionalize an M&A capability explores whether that potential — replicating a diligence capability ill-
within their walls. however enticing — is realistic. It suited for the task at hand.
These corporate M&A groups tests the strategic rationale behind a Although some standard due dili-
have proven especially good at proposed transaction with two gence best practices can be adopted
managing financial and legal due broad questions. Is the deal com- wholesale into strategic due dili-
diligence — and at focusing on mercially attractive? And are we gence (see Exhibit 1), companies
these critical items early in the inte- capable of realizing the targeted must tailor their process to the
gration process. This is all well and value? The first question requires issues and potential integration
good; yet even the best financial external inquiry; the second challenges of each specific deal.
and legal due diligence practices do demands an internal focus. Each Strategic due diligence thus
not uncover the whole story for any question partially informs the adds an important deal-screening
given prospect, and they certainly other, reinforcing an inquiry that filter. After all, executives must be
do not guarantee success. There is a thoroughly plumbs the wisdom of convinced not only that the poten-
critical third component to due the deal. tial deal value justifies the significant
diligence. We call it “strategic due Above all, strategic due dili- investment being made, but also
diligence,” and it is vital to antici- gence ensures that no two transac- that the business is truly capable of
pating the problems that can derail tions are treated the same way; each realizing this value. Indeed, a sober

3. Two Big Questions
2
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strategic due diligence evaluation analysis is indispensable. However, bined enterprise, and, if so, whether
should help set the purchase price. for an in-market buyer, the com- the projected time frame is realistic.
The buyer should demand a price mercial attractiveness issue may be For an in-market merger, it is vital
that is commensurate with the level more complex. The due diligence that all the associated risks, in terms
of integration risk uncovered and be team involved in an in-market deal of customer and competitive
willing to walk away if that price must gaze into the future and calcu- responses, technology issues, and
isn’t met. late the competitive position of the culture challenges, be weighed.
combined entity, including its When they have been weighed, the
impact on customers, competitors, salient question becomes, Can these
The first question, testing the com- and overall market dynamics. (Will potential risks be managed? If pre-
Exhibit 1: Strategic Due Diligence Methodology
mercial attractiveness of a deal, the merger invite new entrants, for serving increased market share is a
2. Assess Market 3. Profile Key
involves validating both the target’s instance?) After all, customers and key driver of value, for instance,
Segments and Growth Competitor Strategies
financial projections and any identi- competitors will react to the merger leaders had better be sure that the
Inside Out Trends and Technology Trends
“Is the deal
fied synergies using an external lens. in ways that will benefit them — executives of the new company
commercially
attractive?”
Companies can achieve this by ways that might threaten the com- know their customers’ needs, can
assessing overall market attractive- bined businesses’ value-creation meet them, and can fend off com-
ness and the competitive position of assumptions. petitors who will surely try to pick
• External interviews — • External interviews —
select experts, customers, select experts, customers,
the target, and how these might As for the second question, a off customers and clients during this
1. Baseline Starting 7. Summary and
and channels and channels
Situation Recommendations
• Perspective on buying • Secondary sources and
change over time. company must make a hard internal period of uncertainty.
needs of priority segments select blind interviews
and growth drivers • Profile competitor focus,
Whether the buyer is out-of- examination of whether the targeted Although testing whether a
• Rough validation of relevant positioning/value proposi-
market size and growth tion, strategic initiatives
market (e.g., a financial buyer) or value of the deal can be realized by company has the capabilities to real-
5. Review Business
prospects • Identify major technology
• Validation of preferred trends and competitors’
Plan
in-market (e.g., a competitor), this the management team of the com- ize projected synergies is particularly
business models in sector responses
• Management briefing and • Perspective on market,
6. Stress Test
interviews technology, and competi-
Corporate Strategy
• Data collection and review tive trends
• Market studies, business • Perspective on top
plans, strategy papers, strategic issues
scenario studies (opportunities and threats)
• Initial hypotheses on • Internal analyses of sales, • Comments on current
current investment costs, and financing strategic plans
- Market segments and • Investment plan supports • Consensus on key
growth trends technology strategy assumptions in the
- Technology trends • Benchmark against business plan
• Internal interviews to
- Competitive threats external ratios and industry • Note main uncertainties
stress test the current
- Company positioning • Consensus on reasonable-
4. Assess Skills and
metrics business strategy
and capabilities • Synergy identification and ness of proposed transaction
Capabilities
• Understand the fact bases
quantification of the strategy
• Test ability to execute the
Outside In
strategy in planned time
“Are we capable
frame and its medium- and
of realizing the
long-term sustainability
• Assess the fit of
targeted value?”
organization(s) and
employees with the
• Internal company analysis strategy
• Validate whether the • Validate that the marketing
capabilities exist within the strategy is in harmony with
company to support the the goals and product
current strategy range to be offered and
• Likelihood that targeted sufficient to achieve the
synergies can be realized forecasted sales
Source: Booz Allen Hamilton

4. Gerald Adolph Simon Gillies Joerg Krings
(adolph_gerald@bah.com) is a senior vice (gillies_simon@bah.com) is a vice presi- (krings_joerg@bah.com) is a vice president
president with Booz Allen Hamilton in dent of Booz Allen Hamilton based in with Booz Allen Hamilton and managing
New York. His work focuses on corporate Melbourne, Australia. He focuses on partner of the Munich office. He focuses
and business unit strategy, as well as assisting Asia Pacific–based clients in cor- on turnarounds and profit-improvement
merger and acquisition issues. To learn porate strategy development and imple- programs for automotive OEMs, suppliers,
more about Booz Allen Hamilton’s work in mentation including mergers and and industrial clients.
mergers and restructurings, visit: acquisitions.
http://www.boozallen.com/mergers/.
3
The Deal’s Rationale
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important when it involves an in-market merger, out-of- the categories in-market consolidation, in-market absorp-
market purchasers are well served by a similar internal tion, out-of-market transformation, and out-of-market
analysis that helps them understand the key drivers of “bolt-on.” Our four categories are broad, but we believe
value in the target company (people, technology, specif- they are useful groupings that can serve as starting points
ic customers) and what the key management require- for shaping any strategic due diligence effort.
ments will be in the new organization. Let’s take these four M&A categories one by one,
recognizing that strategic due diligence always aims to
validate the assumptions underpinning the strategic
To focus strategic due diligence, it’s necessary to pin- rationale.
point the value-creation opportunities of each transac- The rationale for an out-of-market transformation
tion. To assist in this process, we have identified two (large target, low integration) is typically to transform
dimensions that influence the strategic rationale and a business by pursuing significant growth and broader
underlying value-creation focus of a deal. These two capabilities in a new, attractive market. These are often
Exhibit 2: Value Capture
drivers are shown in Exhibit 2. On one axis, the degree “bet the farm” deals in which a company either
of integration between acquirer and target drives the size extends the reach of its existing products or services
and number of potential synergies. On the other, the into a new geographic market (such as with telephone
relative sizes of the acquirer and target influence and cable mergers), or diversifies into a new set of
whether “best of breed” solutions from either company products and services (such as with a private equity
Extent of Integration
Low High
will be adopted, or whether the target will simply be group or conglomerate).
absorbed into the acquirer’s business model. In this case, the strategic due diligence process
Out-of-Market Transformation: In-Market Consolidation: Medium
Cautious pace, capturing “best of pace, seeking market leadership and
Mergers that are intended to strengthen current mar- should focus on testing the new market’s attractiveness,
breed” outcomes. benefits of increased scale.
ket position or that seek new growth opportunities by assessing the target’s competitive position, identifying
Out-of-Market “Bolt-On”: In-Market Absorption: Ruthless
either entering a new market or developing new capabil- critical capabilities and resources that need to be
Faster pace, leveraging the acquiring pace, pursuing synergies and capturing
company’s scale. scale benefits.
ities all have their own unique “degree of overlap” and retained, judging potential market responses, and eval-
“relative size,” but we have found they fall into one of four uating whether there are best-of-breed management
categories when we perform this analysis. We have named practices or operating models that should be adopted
across the organization. Also, those performing strate-
gic due diligence must understand the complexities of
Source: Booz Allen Hamilton
governance where there is minimal formal integration;
the systems and policies used to run the still distinct
businesses should be uniform, and “legacy” people
Large
from both former companies should be dealt with con-
Relative Size of Target
sistently. Two distinctive cultures mean that cultural
issues will manifest themselves in myriad ways and
need to be well understood.
Experienced due diligence and integration managers
Small
must be involved in these mergers, and there must be

5. Building the Diligence Team
---
The value of strategic due diligence co-located within a secure environ- 8. There must be a healthy flow of
relies heavily on the quality of the team ment, such as a corporate headquar- information from the due diligence
in charge of the process. Building a ters. Sometimes it makes more sense team to the integration team.
strong team is important both to to locate the team near the target. Therefore, include diligence team
ensure proper assessment of the deal 4. Communicate to the due diligence members in the integration planning
and to facilitate the actual integration. team the strategic and financial team to ensure that diligence rationale
We have identified eight best prac- rationale behind the acquisition. They and data analysis are properly lever-
tices for organizing a due diligence should understand enough detail to be aged.
team: able to identify critical diligence issues. Although many of these best prac-
1. Choose the right people who have 5. Train the team to identify and home tices apply in all merger cases, there
time to lead the project and serve as in on specific issues, including the are some differences in focus depend-
team members. Time constraints and analysis and data required. This ing on the nature of the merger. For
confidentiality will make it difficult to ongoing checklist keeps the diligence example, in an out-of-market trans-
replace these people later in the on track and brings it to a conclusion. formation, it’s important that the team
process. Dedicate specific team It thus helps to avoid the “analysis include those with human resources
resources for the due diligence period. paralysis” that can result from an skills who can identify and retain the
2. Diligence will naturally focus on undirected data search. personnel who will drive value, as well
strate-
certain functional areas. Human 6. Develop and communicate rules of as commercial people who can analyze
resources, information technology, engagement between the diligence product and customer profitability in
finance, operations, and even R&D team and the target company. This these new markets. For an in-market
and marketing may all be involved. Be avoids cultural conflicts and ensures absorption, on the other hand, human
sure to draw team members from all that the team acts in a manner that resources skills are critical to planning
of these areas of the organization. This reflects the acquirer’s intentions. and coping with the impact of head-
adds valuable expertise, and it helps 7. Make available analytical tools and count reductions. But the diligence
the team attain the buy-in from line techniques so the team can rapidly team must also include commercial,
management that can be hard to get if get its arms around potential syner- operational, and administrative people
a key functional area is shut out of the gies and integration challenges. This who can assess the potential value and
integration process. helps the team complete its task with- timing of synergies after the merger.
3. Ensure that the diligence team is in the allotted time and budget.
high-profile, executive-level participation from both sides, ucts and services, and capture scale benefits within its
especially when it is clear that the capture of “best of operations. Most current mergers in the automotive and
breed” outcomes requires culture change. A strong ana- utility industries fall into this category.
lytical team must drive the market and competitive assess- For such a merger, strategic due diligence should
ment, and the human resources team needs to focus on focus on assessing potential customer value, including
organizational and cultural issues. If there are areas of revenue upside and risks; validating synergies and iden-
consolidation, functional representation is critical to tifying challenges when consolidating areas such as
ensure buy-in from management. administration, operating infrastructure, and work force;
The strategic rationale for an in-market consolidation determining which processes and assets are best of breed;
(large target, high integration) is to create a market leader and assessing cultural fit and integration risks, such as
that can realize benefits by improving pricing and mar- loss of key people in nonconsolidated areas.
keting, rationalizing operations, and leveraging assets, This strategic due diligence team should have strong
such as technology and skills. The acquiring company cross-functional representation from both companies
may want to increase market penetration with its prod- involving managers who will also lead the actual integra-

6. 5
strategy+business enews
tion. Human resources support is resources can the company use to The buyer is likely to be
needed to manage the organizational accelerate growth while preserving focused on eliminating excess capac-
challenges, as is analytical support the core of what it’s acquiring? ity by closing plants, merging sales,
from corporate headquarters. Ideally, Besides this parenting ques- reducing overhead, improving mar-
Realizing Full Potential
experienced due diligence and inte- tion, strategic due diligence for an ket pricing, boosting utilization
gration managers should be involved. industry buyer should focus on test- rates to increase the return on assets,
The strategic rationale behind ing the new market’s attractiveness, and absorbing the acquired business
an out-of-market “bolt-on” (small tar- determining the target’s competi- as efficiently as possible. Therefore,
get, low integration) is to create a tive position, identifying what criti- the strategic due diligence focus
new platform for growth through a cal capabilities to retain, and should be on validating these
relatively small acquisition. This addressing any cultural issues. This assumptions, pursuing ways to
expansion could be into a new geog- due diligence group should include accelerate synergies, and assessing
raphy — which is common among a strong analytical team to drive potential customer and competitor
regional hospitals in the U.S. and market and competitive assessment, responses that may impact market
mobile telephony — or into entire- an HR team to focus on organiza- upside and risk.
ly new product or service offerings, tional and cross-border cultural In this case, the due diligence
such as a vertical integration play issues, and functional representa- team should be drawn principally
when a company seeks to broaden tion in areas of coordination. from the acquirer to ensure owner-
its capabilities and leverage its scale. Likewise, when the out-of-mar- ship of integration goals. The team
When geographic diversifica- ket “bolt-on” involves a financial should be cross-functional with a
tion is a factor, the rationale for the buyer or conglomerate, the same strong operational focus.
merger may involve taking advan- emphasis should be placed on test- Involvement of senior (or chief)
tage of deregulation, “rolling up” ing the new market’s attractiveness, human resources and information
small players in a fragmented indus- ascertaining the target’s competitive technology executives is often criti-
try into a more coherent regional or position, and retaining key person- cal in managing work-force reduc-
multinational player, or expanding nel. Cultural differences are unlikely tion and system integration.
the scope of the business. Most like- to need addressing beyond creating
ly, little consolidation will be need- policy consistency and ensuring the
ed beyond eliminating redundant interests of both sides are aligned. Strategic due diligence requires an
functions such as corporate staff, The strategic rationale for an up-front investment of money as
information technology, and in-market absorption (small target, well as the time of some of a com-
human resources. Strategic due dili- high integration) is that, by acquir- pany’s most capable managers —
gence should include a focus on ing a competitor in the same mar- even before the deal is certain.
identifying opportunities to leverage ket, the buyer can capture Indeed, the team should be careful-
best practices, product develop- operational synergies through lever- ly structured to guarantee the right
ment, and infrastructure across the aging its existing asset base. Markets skill set and influence; and it should
group. Even though these “bolt- that often see in-market absorptions be established early enough to kill
ons” may operate fairly independ- are U.S. retail banking, second- and the transaction if it determines that
ently in the new organization, the third-tier auto suppliers, and tech- the strategic rationale and hoped-for
purchaser should ask itself about its nology acquisitions by the likes of synergies simply are not attainable.
own “parenting abilities.” What IBM and Cisco Systems. But the advantages of strategic due

7. Three Common Themes of Failure
---
Strategic due diligence is a challenging allocate resources more effectively, • “It’s Just an Audit”: Due diligence is
task, to put it mildly, and there are any and it will lead to a richer and more more than an audit. By validating the
number of ways to veer off course if nuanced view of the diligence issues. assumptions that underpin the busi-
careful attention is not paid to the • Analysis Paralysis: Inevitably, some ness plan and detecting risks or incon-
work. However, we have identified issues will remain in doubt, but the sistencies early, diligence aids
three “themes of failure” that most team must be rigorous about defining management’s long-term stewardship
1. Failure to Focus on Key Issues 3. Failure to Allocate Adequate
often derail due diligence. an end point for the analysis. Part of of the company.
Resources
being focused is knowing when to check
something off the list, when to report it
2. Failure to Identify New
• Fools Rush In: Time will be tight, but to management, and when to move on.
Opportunities and Risks
don’t rush through the necessary step • Choosing the Wrong People: The best
of clarifying the rationale for the deal people for the due diligence team are
and sources of expected value. This probably also the company’s most valu-
step determines which hypotheses able managers. Find a way to put them
need to be tested and avoids wasting Although time constraints prevent any on the job rather than choosing people
time gathering irrelevant data. major recasting of a company’s strate- who happen to have time available.
• Reinventing the Wheel: Don’t be so gy, a quick stress test of manage- Also, make sure to choose people with
distracted by the process that the ment’s key assumptions about its the right expertise; don’t overlook man-
analysis suffers. When possible, use a business may show opportunities for agers from the functional areas of the
common diligence methodology, growth or a strategic refocus that may firm that will be affected by the deal.
standardized formats, and simple create significant value. • Insufficient Time: The due diligence
project management software to • Being Afraid to Rock the Boat: Even process will be a time-crunch affair,
manage and share relevant diligence when a deal seems imminent, it is not but don’t make the problem worse
data. This will save time, keep the too late to probe deeply into its merits. than it is. Give the team as much time
process focused, and thus permit a Ask the target company’s manage- as possible, and don’t be trapped by
higher level of analysis. ment both broad and specific ques- artificial or arbitrary deadlines.
• Reluctance to Share: When diligence tions to gain a deeper understanding of • Insufficient Resources: Support the
information is not shared adequately value drivers and key risks. Also, iden- due diligence teams with the resources
among all diligence teams, it’s impos- tify and interview customers and the of the firm. This includes space to
sible to focus effectively on the larger competition. This is all part of reaching work, equipment, software, staff, and
issues at hand. A clear flow of data sound conclusions on possible trends access to the right data and people.
through the use of regular (as frequent (such as the emergence of a substitute And, as much as possible, relieve them
as daily) updates can quickly identify product or service) and risks (such as of their daily responsibilities so they
“deal killers”; it can also help the team the market entry of a new competitor). can focus on the task at hand.
• The Unquestioned Assumption:
to realizing each transaction’s full potential. +
diligence go well beyond the ability to stop an ill-con- provides a strong platform for the actual integration.
ceived deal. If the deal moves forward, the full benefits All these benefits depend, however, on manage-
of strategic due diligence will manifest themselves. ment’s ability to approach each deal as new. The power
First, strategic due diligence can help set the value of strategic due diligence is its focus on the specifics of
and purchase price of the deal. Second, it can help artic- the deal. We are not saying companies must reinvent
ulate and buttress the strategic rationale for the deal, the whole wheel for every deal, but they must not reuse
instilling greater confidence among stakeholders that too many old spokes. Strategic due diligence acknowl-
the company’s claims about projected benefits are rea- edges the unique nature of every deal and offers a path
sonable and attainable. Finally, strategic due diligence

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Originally published as “Strategic Due Diligence: A
Foundation for M&A Success,” by Gerald Adolph,
Simon Gillies, and Joerg Krings.