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Software companies must conduct thorough due diligence to successfully expand in 2022

by wrich

By: Phil Craig, Associate Partner and Hailey Messenger, Case Team Leader at GRAPH Strategy

Phil Craig, Associate Partner ,GRAPH Strategy

There has continued to be a strong acceleration in the tech sector where software companies seek to build a “complete platform” to enable growth through connections. A complete platform’s value comes not only from its features, but from its ability to connect external tools, teams, data, and processes.

Companies expand feature-sets to try and grow revenues, increase stickiness, drive value, and attract investment. While a good idea in theory, it poses the risk of diluting the core value proposition of a product because adding new features risks devaluing the current software. Often, this means it performs poorly against competitors.

Software expansions should enhance the value of a company’s original offering and encourage retention, yet too often expansions add features simply for the sake of adding more. To avoid this, strong commercial due diligence is needed from the offset to ensure software companies are building and innovating in the right way. 

Avoiding growth for growth’s sake

Hailey Messenger, Case Team Leader, GRAPH Strategy

We recently conducted due diligence on a SaaS company that had quickly established itself as the market leader in a burgeoning category. As they grew, they added functionality and features that led to them inadvertently creeping into a very competitive, saturated marketplace. 

On the surface, their strategy was sensible – it could theoretically increase the stickiness of their tool and grow the organisation. However, it was clear while speaking with its customers that the company had diluted a previously clear product vision, demonstrating an under-appreciation for the reason customers chose them initially.

The expansion was driven by pressure as the company took increasing levels of investment to build new features, which coincided with an over-responsiveness to customer requests. This demonstrated how the company was in danger of losing its USP, having a detrimental effect on retained custom.

The company spent considerable resources developing their new module, which then had to be substantially discounted by the acquiring company, who had no interest in using a newly built, untested, lightweight system. Stronger market analysis from the offset could have prevented this outcome.

We’ve often witnessed firms start with a strong core product before investing in more features to “get into larger markets.” This is a tactic to drive short term revenue that risks harming a core product offering. I cannot stress enough that businesses shouldn’t waste substantial amounts of time and money on software features that customers do not want and haven’t requested.

The solution? Strategic analysis and due diligence

That said, many software companies do effectively expand into adjacent offerings and the unifying factor for most of these success stories is a clearly articulated product vision that is well-understood by employees, customers, and investors. 

The approach is threefold and involves vital consideration from the get-go.

Firstly, it’s important to determine how valuable the features will be both to the product, and stand-alone. Asking the following questions will be essential to this approach:

  • Which customer segments are being targeted? You must be selective, so why these segments/users and not others?
  • What is the value proposition to those groups? Which features will drive that value? 
  • How much overlaps with the core product? How integrated will it be?
  • What price are customers expected to pay for these new products/features? Is it realistic they will pay for this? 
  • How many customers are likely to adopt and over what time frame? If you half that number, and double the length of time it takes to achieve that, does that still look attractive?

Then, you must consider how strategic the new product is by considering the following:

  • How well positioned is the business in the new market on a standalone basis? Does it have a clear “right to win”? If we only had this new feature/product, would it be a strong player standalone?
  • Is it a product/market that potential buyers of the business would value? (e.g. It is something a strategic player would also want to add to their portfolio?)

The final approach should be to determine the impact on the core product’s positioning. This means assessing the following:

  • How is the core product enhanced by the new developments?
  • If we assume time and investment is limited, what are we sacrificing for the core product to allow us to do this new product feature? Is it worth while?

Registering and tackling challenges

As with any business decision focused on growth and innovation, there will be an element of risk involved and it’s important to consider these before and during the development process.

One of the challenges we hear of is overly focussing feedback on a small number of key users, rather than the full database. This can is an obstacle to success because they are typically not representative of your full customer base, so feedback can be inaccurate.

Spending too long in a development cycle and not launching early enough can also be a barrier as lengthy delays can mean businesses become disconnected from the customer feedback. It’s the classic “MVP” push, which many people aspire to but fail to deliver.

A technology industry-specific challenge is that there is never such a thing as a “complete platform.” The world of “things you will need to integrate with” is ever expanding and evolving, so businesses should hold a mindset that you need to continually develop, enhance, and add more value.

Don’t skip the consulting process…

Market analysis and due diligence help investors and companies understand the nature of a deal, the risks involved, and whether the deal fits with their portfolio. Essentially, undergoing due diligence is like doing “homework” on a potential deal and is essential to inform investment decisions.

With software companies looking to grow and move into new markets, the importance of the consulting process cannot be overestimated. Using the diligence period wisely can position you as a more effective business and prepare you to hit the ground running with new feature sets and products.

Ultimately, expansions done right will enhance the value of a software firm’s original offering, and the correct products will get your retained customer’s attention in the right way. Too often our team sees the creation of additional features taking place for the wrong reasons – commercial due diligence will prevent this and ensure an organic growth plan to fit wider business visions.

About the Graph Strategy:
GRAPH Strategy is a specialist strategy consulting firm that supports leading global corporations, private equity and credit investors invest in and build stronger businesses. We adopt a rigorous, evidence-based approach to identify market opportunities, conduct commercial due diligence and design winning growth strategies.

GRAPH has been offering commercial due diligence to the tech sector since inception and has worked on SaaS companies, e-commerce platforms, data management software and more. It delivers research methods, an analytical approach and work products to help ensure businesses are well equipped for development.

https://www.graphstrategy.com/

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