When J.P. Morgan spent $175 million to buy student financial aid firm Frank, it thought it was getting access to millions of young customers. It turns out that wasn’t the case, according to the bank’s subsequent lawsuit accusing Frank of fabricating more than four million student names in order to boost its acquisition appeal.
The debacle should be a loud wake-up call for any company considering an acquisition and for any firm that wants to attract investment. While Frank’s alleged malfeasance is extreme, it’s far from unusual for companies to present an overly rosy picture of their marketing performance and for investors to miss red flags.
Tal Shlosberg
Acquiring companies often get carried away with a target’s exciting top-line growth prospects and fail to do the necessary deep-dive due diligence on its marketing. The growing complexity and fast-changing nature of online marketing are adding to the risk of missing potential holes in a company’s marketing claims.
Given that an underperforming marketing operation can break a deal or seriously undermine its returns, CFOs should be paying close attention to the issue and ensuring that the right due diligence is being performed.
Any potential acquirer should be demanding the keys to the marketing department so they can fully assess a company’s data and metrics, its use of technology, the effectiveness of channels and campaigns, and the strength of its team. Some holes can be so big as to rule out the deal or force a major revaluation. Others are opportunities to understand how to better allocate marketing resources and optimize the strategy to drive growth.
Given that an underperforming marketing operation can break a deal or seriously undermine its returns, CFOs should be paying close attention to the issue and ensuring that the right due diligence is being performed.
The following are the biggest marketing red flags a buyer might discover:
1. Customer Churn. If customers aren’t sticking with a company long enough to justify the cost of acquiring them, it’s usually a sign of deeper problems. It may be that the company has poor customer support or a lack of product quality. It may reflect a lack of competitive pricing or a failure to effectively communicate with customers. A big red flag to watch out for is when companies artificially hold down their churn rates with ongoing discount incentives for customers. If a company has fueled growth by running campaigns offering big discounts, it’s a warning sign that customers may not buy at a higher price and that churn rates will rocket once the discounting ends.
Companies can fall into a high-churn trap if they fail to do a detailed analysis of the customers they are acquiring and the marketing tactics being used. One successful yearly subscription business I worked with experienced a mystifying spike in churn rates post-COVID. A third-party audience analysis tool revealed that the company’s database was dominated by low-income customers that accounted for most of the churned customers who had not renewed their subscriptions. Upon further research, it turned out that the company’s Facebook “lookalike” campaigns were created with mostly low-income first-purchase customers, resulting in a customer base made up of mostly low-income churners.
Running a similar audience analysis of the email database or simply testing Frank’s email list pre-acquisition could have saved J.P Morgan a $175 million headache.
2. Poor Martech and Customer Tracking. For both B2B and B2C businesses, it’s crucial to evaluate whether they are properly measuring the effectiveness of their marketing. Companies that don’t have the right technology in place to track customer conversions and churn in detail are wasting marketing dollars and missing growth opportunities. It can also lead companies to wrongly segment customers due to poor data, resulting in ineffective targeting and engagement. A surprising number of businesses have no accurate idea of how much their different marketing channels contribute to sales. If they did, they would be able to concentrate their spending on the most effective channels to get a far better return on investment.
Third-party platforms may limit the control that companies have over their own marketing efforts, making them vulnerable to changes in the platform’s algorithm, targeting, and ad policies.
3. Inaccurate Forecasting of Market Size. Every company looking for investors or acquirers has the incentive to exaggerate the size of its potential market. Don’t buy it. A B2B company may cite its total addressable market as two million businesses. But that is unlikely to reflect reality once you consider factors such as competitors, geographic limitations, regulatory changes, or changes in consumer behavior. A far better starting point for valuing a company is its serviceable obtainable market (SOM), which measures the potential market after those limiting factors have been applied.
4. Platform Dependency. A company’s marketing operation becomes a lot more vulnerable if it’s heavily dependent on one advertising platform. That’s exactly why e-commerce and mobile app companies that relied on Facebook were hit so hard by Apple’s privacy changes. Third-party platforms may limit the control that companies have over their own marketing efforts, making them vulnerable to changes in the platform’s algorithm, targeting, and ad policies. Customer data may be owned by the platform, creating barriers to customer engagement, retention, and loyalty.
Disasters like the Frank acquisition and the recent meltdown of crypto firms are only going to increase the pressure on companies to tighten their due diligence processes. Performing detailed marketing due diligence should be a big part of that, enabling companies to avoid worst-case scenarios and achieve the growth and value they expect from deals.
Tal Shlosberg is the founder of growth marketing company Conveyor.
