When a potential acquisition is also one of your customers, things can get complicated. Ask these questions to evaluate the costs and benefits.
Businesses in sectors with large supply chains or distributor networks are likely, at some point, to face the prospect of acquiring one of their customers. These business-to-business transactions usually occur for one of two reasons: Your business is making some type of integration play and is actively pursuing a customer that serves a different piece of the supply chain; or you consider acquiring a customer that has put itself up for sale as either a defensive move to ward off competitors or an opportunistic acquisition.
These situations are often fraught with complications. Your sales could suffer if a competitor acquires one of your key customers. Buying a distributor could create problems or conflicts in your other sales channels. Acquiring a large customer could change the market dynamics of your industry; the list goes on.
How do you assess the potential risks and opportunities for this type of acquisition? There are four questions you should ask to help evaluate the costs and benefits:
1. What are the synergies?
This question is central to any strategic M&A transaction. But besides the usual synergies (overhead reduction, facility consolidation, etc.), buying a customer that sells to another customer can often allow you to capture the margin they are charging their customers. Depending on the customer dynamic (distributor vs. additional service), this margin can be substantial. For example, if it costs you $10 to make a widget and you sell it to your distributor for $20, which re-sells it to the end customer for $25, buying the distributor will let you effectively charge $25 to the end customer without increasing your costs.
2. What are the operational and strategic implications?
Buying a customer can often open up an entirely new client base or new market for your business. Make sure you have the right expertise, the right people and the right infrastructure in place to handle the change; otherwise, you're likely to upset your new end customers. It's critical to anticipate and understand potential new challenges such as sales channel conflicts.
3. What are the consequences of not pursuing a deal?
If you don't acquire the customer, will your competitor do so? And does that put your volume at risk? If the customer is selling because of financial distress, do you need to step in to make sure you don't lose significant sales?
4. What is your negotiation strategy?
If a customer is a large enough part of your business, you run the risk of a) losing their business if the negotiations fall apart, or b) having the customer use the leverage of their business to get what they want out of a deal. You have to remain cognizant of how important the customer is to your business and what its alternatives are if it doesn't sell to you. For example, if you're their only supplier, the threat of them leaving you is slim.
Businesses must be diligent when considering any type of strategic acquisition. The additional questions outline here are important when your acquisition target is also one of your of your customers. No one wants to lose a good customer, and with the right plan, strategy, and transaction structure, you can turn a potential loss into an increase in the value of your business.
KARL STARK AND BILL STEWART are managing directors and co-founders of Avondale, a strategic advisory firm focused on growing companies. Avondale, based in Chicago, is a high-growth company itself and is a two-time Inc. 500 honoree. @karlstark