In 2018, we conducted dozens of customer due diligence engagements on behalf of private equity and strategic buyers. While all of these engagements were designed to mitigate customer concentration risk and provide insights to accelerate post-close value creation, roughly half included additional objectives to determine the impact that tariffs may have on a deal. Based on thousands of in-depth interviews with B2B decision makers, we have observed five ways that tariffs are impacting M&A deals and portfolio management strategies.
Tariffs can be more disruptive for a company than category-level market research might suggest
When asked whether they think category-wide demand for a product will increase or decrease, customers tend to be quite bullish and virtually always suggest increased short-term demand. However, when customers are asked if spend for the same product with a specific target company will increase or decrease, they are often more bearish. While tariffs do not (yet) appear to be a drag on macro demand, they clearly have the potential to heavily influence share of wallet allocation. If customers are paying more for a product as the result of tariffs, they are likely to be more discerning about the suppliers from which they source, and will favor those with a stronger value proposition.
Willingness of customers to absorb tariffs is highly dependent on the strength of the relationship
Companies with an above-average Net Promoter Score® — a metric which quantifies customer loyalty — are better positioned to pass on the cost of tariffs to customers. This is because “Promoters” (those which are loyal to a company) are often able to justify a price increase given the incremental value they realize beyond the product itself. Conversely, “Detractors” (those which are not loyal to a company) tend to be far less likely to absorb the cost of tariffs and, if prices are increased, are at a heighted risk of shifting wallet share to a lower-priced competitor.
Tariffs are leading some companies to compete on Customer Experience rather than on price
Companies which have been historically differentiated by price are quickly realizing that they need to reposition and establish new competitive advantages. One highly effective approach has been to focus on the Customer Experience. Companies which have mapped the pre- and post-sale customer journey – and have developed strategies to ‘surprise and delight’ customers at each of the major touchpoints along the journey – are successfully protecting themselves from the impact of tariffs. They are also experiencing a substantial return on their investment by sustaining premium prices, capturing a greater share of wallet, and acquiring new customers.
Companies which only grant tariff-related concessions to the “critical few” are more profitable
Companies are being pressed like never before for lower prices and more favorable terms. Post-close, management tends to be quick to grant concessions out of concern for retaining the revenue base. However, when concessions are made for all customers, even relatively small customers, revenue retention almost always results in a drag on EBITDA. Segmenting customers based on the 80/20 rule and only granting concessions to the 20% of customers (the “critical few”) which generate 80% of revenue is a more fair and sustainable methodology for making these decisions. Offering concessions to the 80% of customers (the “insignificant many”) that drive 20% of revenue opens the door to a downward spiral of financial losses.
Tariffs have accelerated ‘Manufacturing 4.0’ implementation
In the manufacturing space, tariffs have led many companies to accelerate the exploration or implementation of Manufacturing 4.0 initiatives. Specifically, these companies are looking to increase their reliance on automation as a way to not only deliver faster, but also to offset price increases through less of a reliance on human capital. For growth equity investors, companies seeking to implement Manufacturing 4.0 are becoming highly sought after given the significant capital expense to implement on a meaningful scale.