Jan 8, 2024 Written by Tamar Barlev

The ROI of Rigor: Financial Impacts of a Product Audit on M&A

Mergers and acquisitions (M&A) is stressful enough, so there’s no room for needless complications. Ergo, ensuring a smooth transition and a successful integration is crucial for sustained growth. One often overlooked aspect that can significantly impact the outcome of M&A deals is the comprehensive evaluation of a target company’s products through rigorous product audits and digital due diligence. So today, we’re going to be looking right at it.

Let’s get started.

Defining the Basics: Product Audits and Digital Due Diligence

Before we delve into the financial benefits, let’s unpack the fundamentals. Product audits involve a meticulous examination of a company’s product offerings, assessing their technological health, security, and overall value proposition. Digital due diligence, complementing this examination, extends its reach to the technology infrastructure and intellectual property, meticulously evaluating potential risks and hidden opportunities. Check out our Digital Due Diligence Playbook & Checklist for PE to learn the questions you need to ask to conduct a comprehensive product audit.

Product Audits as Risk Mitigation

One of the primary advantages of conducting product audits is risk mitigation. Imagine purchasing a seemingly promising company, only to discover hidden vulnerabilities in its product line post-acquisition. Product audits act as a protective shield, identifying and addressing risks like outdated technology, security loopholes, and compliance issues beforehand. By uncovering these potential pitfalls, you’re not only avoiding future headaches, but also safeguarding the deal value from unforeseen setbacks. As a case in point, a 2019 PwC study revealed that companies incorporating comprehensive product audits prior to M&As experienced 20-30% lower post-acquisition integration costs.

1. Outdated Technology

The use of obsolete software or hardware can jeopardize the efficiency, functionality, and security of a product. Conducting product audits allows for the timely identification of outdated technology within a target company’s portfolio, including obsolete coding languages, deprecated frameworks, or unsupported software versions. Addressing these concerns pre-emptively ensures a smoother integration process, minimizing the need for immediate costly upgrades. This, in turn, protects the deal value by preventing unexpected expenses related to post-acquisition technology modernization. Remember the 2017 Yahoo-Verizon acquisition? Yahoo’s reliance on old servers and software significantly hampered the process.

2. Security Loopholes

Vulnerabilities in a product’s code or infrastructure can be exploited by malicious actors, potentially leading to data breaches or other security incidents. Product audits scrutinize security measures, identifying potential loopholes like weak encryption, poor access controls, or inadequate data protection protocols. Addressing these loopholes early in the due diligence process allows the acquiring company to safeguard its reputation and customer trust. This proactive approach not only preserves the value of the acquired products but also prevents potential financial losses associated with data breaches and security incidents. Target’s 2013 data breach serves as a stark reminder of the consequences of neglecting security due diligence.

3. Compliance Issues

A lack of adherence to industry regulations, legal standards, or internal policies can result in legal ramifications and brand damage. For instance, Meta’s recent $1.3B GDPR fine serves as a cautionary tale. Product audits include a thorough examination of a company’s adherence to relevant compliance standards, uncovering any potential violations or shortcomings. Addressing compliance issues proactively ensures that the acquisition aligns with regulatory requirements. This not only protects the company from legal ramifications but also maintains or enhances the perceived value of the acquired products in the market.

Hidden Value Unveiled: Enhancing Deal Value Beyond Risk Mitigation

Comprehensive product audits excel at unearthing hidden pockets of value within a target company, extending far beyond risk mitigation. These can include untapped markets, undiscovered intellectual property, or underutilized technology. Identifying and leveraging these hidden gems not only enhances the strategic value of the acquisition but directly contributes to the overall deal value.

1. Untapped Markets

Product audits may reveal opportunities for expansion into new markets, identifying gaps in the current market coverage or underserved customer demographics. Capitalizing on untapped markets enhances the revenue potential of the acquired products, directly contributing to increased deal value. Investors can leverage this information during negotiations to secure a more favorable deal.

2. Undiscovered Intellectual Property

Patents, trademarks, or proprietary technology that the target company possesses but hasn’t fully exploited or monetized are ripe for discovery. Through product audits, potential hidden intellectual property assets can be unearthed, ranging from innovative algorithms to underutilized patents. Recognizing and leveraging these assets not only adds to the strategic value of the acquisition but can also lead to additional revenue streams. This discovery directly impacts deal value, making it a critical aspect of the due diligence process.

Informed Investment Decisions: The Power of Knowledge

Investing in a company without a clear understanding of its products is akin to navigating uncharted waters without a map. Product audits empower investors with crucial insights, enabling them to make informed investment decisions. Armed with a comprehensive understanding of a target company’s products, investors can:

1. Negotiate Better Deal Terms

Insights from product audits allow investors to negotiate from a position of strength, addressing identified risks and potential value points during deal discussions. Negotiating better deal terms based on thorough product assessments ensures that the acquiring company pays a fair price, considering both the existing value and the potential for future growth.

Imagine, for example, identifying an untapped market segment through a product audit. This knowledge empowers you to negotiate for a lower initial purchase price while incorporating provisions for revenue-sharing based on successful expansion into that market. By quantifying the potential upside revealed by the audit, you secure a deal that benefits both parties in the long run.

2. Resource Allocation Efficiency

Understanding the intricacies of the target company’s products allows investors to strategically plan the allocation of resources post-acquisition, focusing on areas that will drive maximum value and growth. This could involve prioritizing investments in product development for high-potential lines, increasing marketing efforts for under-promoted offerings, or streamlining support operations for products with known inefficiencies.

By allocating resources efficiently, not only do you reduce operational costs, but you also accelerate the realization of synergies between the acquiring and acquired entities. This, in turn, enhances the overall deal value by streamlining post-acquisition operations and maximizing profitability.

Quantifying the ROI of Product Audits: Putting Numbers Behind the Benefits

To put it in perspective, a KPMG study indicates that every dollar invested in comprehensive product audits and digital due diligence results in a return of 3x on average, and one by Bain & Company found that firms who conducted DDD achieved 5-10% higher portfolio returns. The direct correlation between the rigor of due diligence and enhanced deal value showcases the tangible financial impact of this often underestimated aspect of the M&A process.

The Bottom Line of Product Audits

In the fast-paced world of M&A, the ROI of rigor cannot be overstated. Product audits, coupled with digital due diligence, not only protect your investment from unforeseen risks but also unveil opportunities that can significantly enhance deal value. As the saying goes, “knowledge is power,” and in the realm of M&A, the power to make informed decisions is a game-changer. So, before you dive into your next acquisition, consider the financially impactful insights offered by comprehensive product audits – it might just be the key to unlocking unprecedented success.

Need some help with all of this? We know it’s a lot. Reach out to us—as product strategy, UX design, and software development experts, we’d love to talk.