What is digital due diligence?
Due diligence is the investigation and audit based on examining financial records, compliance, and legal before entering into a proposed transaction with another party. It is performed to confirm the facts of a matter under consideration – typically an acquisition.
Due diligence will typically consider the ‘hard’ numbers of assets, and liabilities that a business holds, though it may also consider ‘softer’ aspects such as the company culture. It is ultimately orientated towards delivering an accurate present and future valuation of a business.
However, as businesses have had to move to a digital-by-default position to operate in a post-pandemic world effectively, the concept of digital due diligence (DDD) has arisen. This aims to give an accurate valuation as to the digital portfolio within a company.
There have been some early, awkward attempts at this assessment. They have typically focused on a company’s “digital assets”. This has often been limited to an appreciation of the technology stack, software, websites, search rankings etc., attempting to deliver a financial value on the online presence of a business.
It is, however, woefully inadequate for most businesses. To be of any real use, digital due diligence must encompass the impact of digital on HOW a business operates.
DDD must reflect that – in a modern, integrated, data-driven world, the value of that company is inextricable from the value of the technology and how it is used to enable the business operations.
What does DDD look like?
This realisation promotes an immediate set of questions for any investor looking to assess the value of a target business’ digital position:
- How integrated is the business between departments, or indeed with suppliers and customers?
- How automated are key business processes?
- How are ways of working tied to data?
- Are the business’ customer interfaces (websites, apps, and communication) appropriate for a digital world?
- Are the business’ supplier interfaces (websites, apps, and communication) appropriate for a digital world? What is behind the difference?
- How accurate, timely and accessible is reporting and analytics to enable business decisions?
- Are the tools and systems fit for the current job AND future objectives?
- Are all technology and services appropriately licensed and/or contracted?
- What is the exposure to risk for both data and compliance throughout the business?
- Has the company mapped out both physical and digital security risks?
This can be understood as a digital iceberg. Typically, most assessments of digital due diligence focus on that which can be seen above the water. This is usually online customer interfaces, some business intelligence, analytics, and possibly machine learning.
But most of the value lies beneath the water as technology determines operational, supply chain and even administrative issues.
All too often, assessments are made without considering these deeper, technological issues such as code development, security, and data flow.
This gives a very static picture of the digital value of a company at any one point in time, rather than the future value of efficiencies and opportunities, or indeed the risks that may arise. This makes it incredibly difficult to create an accurate ‘future value’ of the company under investigation.
Why does DDD matter?
DDD should inform the potential investor what they need to account for / seek as a discount when it comes to the expected outcomes of the purchase.
In a ‘digital by default’ economy, if objectives are limited by technology, profitability goals are a lot harder to realise.
Of course, it also works the other way, and DDD can reveal a business is worth far more than initially anticipated.
It is also important to highlight the difference between the value of these digital capabilities and the existing assets, liabilities, and risks of the business. Typically, a digital portfolio has a lower operational or capital expenditure initially but has massive scope for growth and value creation. Gaps may have significant negative operational efficiency and effectiveness impacts.
This is especially true when the correct use of technology reduces the need to invest elsewhere to supplement legacy ways of working. One example of this could be seen in realising a need for zero additional headcount because of automation.
What is the value of DDD?
The real value of DDD is not just confined to justifying a discounted purchase price.
Rather it is necessary because a company that is unaware of the connection between its technology and its operations is simply not going to survive.
This cannot be understated. There are traditional specialist tasks that are no longer attractive to a younger generation – anything from invoice processing to demand forecasting to route planning to workforce optimisation, insurance claims processing and payouts, or tracking components and stock through production, warehousing, and distribution.
These are not tasks that it would be nice to replace by automation. They are tasks that MUST be replaced by automation. Consequently, the technology and digital capabilities that enable these tasks create a key aspect of the value of a business.
In any regard, as businesses move to digital by default, there is increased recognition of the equal importance of the value of the “digitalness” of the portfolio. Previously this has been hugely neglected, but now investors and owners alike recognise the need for an outside-in view when assessing their business’ position.
This has been driven by the realisation that these business owners see that they are not keeping up with competitors. There is an especial threat of new entrants who can exploit new technology and leapfrog legacy processes, and outperform industry standards from the very beginning.
Of course, the pandemic has also had a profound impact. Many businesses owners have realised they were stuck in physical locations, this limited flexibility and agility. It created a focus on the need to change and to employ technology and processes that drive flexible working. For many businesses, this has been more than just putting in Microsoft Teams – it has been a large-scale overhaul of operations, removing on-site IT and embracing new options.
As a result, there are pockets where DDD is picking up a lot – industries such as travel and hospitality, healthcare, education, and utilities. All had a lot of drivers to assess digital value pre-COVID, the pandemic has accelerated this massively.
When it comes to company size, smaller companies typically feel the weight of legacy technology investment. They stay stuck as they face the need to maintain business as usual and are consistently privately owned. By comparison, large brands must make an overt position of how they compete and thus need to address their digital maturity: not necessarily with the idea of informing acquisition but how to improve.
Digital due diligence and ROI
Thus, for smaller businesses, digital due diligence is often couched in terms of being sold / bought and for larger enterprises, it resonates more as digital maturity.
But there is a lot of consistency in the tools at use throughout ANY size of companies. The same platforms and environments are found in different businesses regardless of size. Consequently, there is a great deal of consistency in how businesses can approach DDD. The hallmarks are looking at what to invest in, in what timeframe, how to approach the change and what is foundational to create the business of tomorrow. This gives a roadmap to ROI on that investment and an accurate value of the digital capability within a business.
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