Traditionally, due diligence examines financial records, compliance and legal before entering into a proposed transaction with another party. It is performed to confirm the facts or details of a matter under consideration – typically an acquisition. Due diligence will typically consider the structure, assets and liabilities that a business holds and 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 world, the concept of digital due diligence (DDD) has arisen to give an accurate valuation of the digital capability of a company.
There have been some early, awkward attempts at this assessment which have typically focused on the “digital assets” of a company. This has often been limited to websites, search rankings etc., attempting to deliver a financial value on the online presence of a business. This is, however, woefully inadequate for most businesses. To be of any real use, digital due diligence must go beyond a selection of what was typically perceived ten years ago as digital for a business, but should also encompass how a business operates its IP and technology.
This is because DDD must reflect that in a modern, integrated, data-driven world, businesses need to become more automated and make extensive use of technology to do so – the value of that company is inextricable from the value of the technology and how it is used to enable business operations.
This cannot be understated. There are traditional specialist tasks that are no longer attractive to a younger generation – anything from invoice processing and demand forecasting, to route planning and workforce optimization, insurance claims processing and pay-outs or even tracking components and stock through production, warehousing and distribution.
These are not capabilities that would be nice to be enabled 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.
What does DDD look like?
This realization promotes an immediate set of questions for any investor looking to assess the value of a target business’ digital position:
- How connected, integrated and automated is the business?
- How are ways of working tied to data?
- Are the business’ customer and supply chain interfaces (websites, apps and communication) appropriate for a digital world?
- How does the business operate from a technological perspective?
- How accurate, timely and accessible are reporting and analytics to enable business decisions?
- Are the tools and systems fit for the current job AND future objectives?
- Does the business have the right tools or systems?
- Are all technology and services appropriately licensed or contracted?
- What is the data or compliance exposure to risk?
- Are there security risks?
- What is the software and infrastructure license exposure?
- What are the rights of use for third-party data, content and services?
- Who owns domain names and software libraries, algorithms or models?
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, exemplified by online customer interfaces, some business intelligence, analytics and possibly marketing.
But most of the value lies beneath the water as technology determines so many other areas of business including Operations, data, technology platforms, automation, customer management, supply chain and even HR.
How businesses link these two facets is critical. All too often assessments are made without consideration of the deeper 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 future value of efficiencies and opportunities, or indeed the risks that may arise.
Why does DDD matter?
If potential issues associated with the above are not understood, risks and missed opportunities may impact the value of the business and what it can be bought for as the purchaser will have to modernize the company. DDD should inform the potential investor what they need to account for or seek as a valuation discount when it comes to the expected outcomes of the purchase.
In a “digital by default” economy, if objectives are limited by technology, then profitability goals are a lot harder to realize. Of course, it does also work the other way and DDD can reveal a business to be 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-enabled business has a lower operational or capital expenditure initially but has massive scope for growth and value creation.
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 realizing a need for zero additional headcount due to automation.
What is the value of DDD?
In any regard, as businesses move to digital by default, there is an increased recognition of the equal importance of the value of the “digitalness” of the business. Previously this has been hugely neglected, but now investors and owners alike recognize the need for an outside-in view when it comes to assessing their business’ position. This has been driven by the realization that these business owners see that they are not keeping up with competitors. There is the threat of new entrants who can exploit new technology, leapfrog legacy processes and outperform industry standards, from the very beginning.
Of course, the pandemic has also had a profound impact. Many business owners have realized they were stuck in physical locations and this has limited business flexibility/agility. This created a focus on the need to change and to employ technology and processes to 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 many drivers for assessing digital value pre-COVID. However, the pandemic has accelerated this massively.
When it comes to company size, smaller companies typically feel the weight of the legacy and 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.
From Digital Due Diligence to value creation
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 always consistency in the tools used throughout ANY size of company – 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 modernization and value creation – 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.