Mergers and acquisitions are very important in the medtech industry. For emerging companies, they provide access to resources and represent an attractive exit strategy for owners. For larger players, they create scale, bring innovations to market, and help to replenish pipelines.

In recent years, M&A activity has been comprised more of acquisitions than mergers. Most deals have a price tag of less than $300 million, often below $100 million. As much as 80% of deal volume falls below $300 million in transaction value.¹ As large device and diagnostics companies rely more than ever on acquisitions to drive portfolio growth, finding the right acquisition and fit is critical. Medical device and diagnostics companies are too often disappointed in the results of their acquisitions. For example, a common problem occurs when post-acquisition sales results do not match overly optimistic expectations.

Excessive optimism can result from many factors. While it is sometimes due to misplaced faith in management predictions, it is often due to unfamiliarity with a market, as well as unrealistic assumptions of commercial synergies or product adoption rates. The acquirer will end up paying too much, saddling the merged entity with expectations that are impossible to meet.

Good go-to-market due diligence—understanding the customers’ buying process, the selling process to drive adoption, and the best post-deal sales model—helps to screen out potentially bad deals, gives acquirers a more accurate assessment of value, and provides a head start on integration. Though no less important than other types of due diligence, go-to-market due diligence is often neglected or done insufficiently.

An Acquisition Goes Wrong

While M&A deals struggle to meet expectations for many reasons, we have found a typical pattern when buyers do not properly scrutinize commercial synergies in depth that appear viable on the surface. Acquiring companies overestimate how much they can sell or the benefits of a broader portfolio, build unrealistic expectations, overpay, and then fail to meet these expectations. Consider an example based on an actual experience in the industry. “Joel Hamilton” is a division president at “DeviceWorks,” a cardiovascular device company with $400 million in annual sales. Joel was eager to increase the size of DeviceWorks’ portfolio while giving his team something new to sell. When “Lungtec,” a producer of equipment used to monitor patients during surgical interventions, retained an investment bank to sell the company, Joel saw an opportunity.

Joel believed that the combined companies could leverage their surgeon relationships to accelerate sales of both companies’ products. The cross-selling opportunities were enormous, and did not seem difficult to exploit. As the negotiations continued, it became clear that DeviceWorks would have to pay a high price for Lungtec. In order to justify the price, the combined company would need to increase sales 25% each of the next three years, which seemed reasonable given the high price of Lungtec units and the company’s relatively low market penetration. The investment bank argued that such growth represented only a few additional units per salesperson. The company agreed with the plan, and the deal was consummated.

But a year and a half after the deal closed, Joel found himself in a hole. Sales of Lungtec’s products badly trailed projections. Suddenly, Joel was under pressure to cut costs aggressively in order to meet profit targets, and he was forced to trim the sales team. Even worse, Joel lost some of his most experienced salespeople. Sales results continued to struggle, and upper management pressured him to reduce the sales force even further. Where did he go wrong?

As the price of the acquisition was high, the sales projections needed to rationalize the amount that was paid were also high. DeviceWorks had no direct experience selling the product it was buying, and Joel underestimated how difficult it would be for his salespeople to sell capital equipment. The decision makers for each product were different. When the DeviceWorks business development team examined the situation, it appeared that there was overlap. But only after the acquisition did Joel realize their strongest contacts (cardiovascular surgeons and interventionalists) were not the primary decision makers for the new product which had broader application across critical care. In addition, the new product had a long selling cycle with intense clinical service during trials and a highly complex interdepartmental process to gain hospital approval.

Making matters more difficult was that DeviceWorks’ most experienced representatives disliked the new smaller sales territories that were created with the expanded portfolio, and compensation suffered because sales targets had been set unrealistically high. With lower pay and bad morale, the best sales representatives went elsewhere.

The DeviceWorks example shows a pattern that is too common in acquisitions: sales synergies become a plug-in number in a spreadsheet, creating unjustified expectations or overoptimistic sales projections that are without factual base.

As Joel discovered, relying on his gut instincts of the situation does not give an accurate picture of sales synergies from an acquisition. A better approach involves a close examina¬tion of the buying process, as well as the sales and service model, which allows a close examination of forecasts and illuminates the true value of commercial synergies. This approach helps to validate the likelihood of being able to leverage current sales force footprints and relationships.

Channel strategy is also important to consider. It is not uncommon for medtech startups to use channel partners; occasionally, these partners significantly affect sales post-acquisition. Many M&A deals may be predicated on creating a combined sales bag for the direct sales force, and thus an acquirer needs to consider carefully the possibility of disrupting relationships of the channel partner. To illustrate, a company considering the acquisition of a product sold for spine procedures needed to examine the implications if it took over a product from distributors and transferred it to its direct sales team. The company needed to weigh the difficulty of transferring relationships with influential surgeons—and the possibility that former distributors would compete directly after the close—against the gains of the direct sales team.

When companies fail to scrutinize apparent synergies in a deal, they can miss otherwise obvious issues. In another example, a company thought there would be significant value in acquiring a product complementary to its own, since both products were used in the same procedure. But when the company actually examined this possible synergy, it became obvious that although the surgeons in common were the users, they had little influence on the brand choice. That decision belonged to a colleague. This simple observation made the acquisition considerably less attractive and fundamentally changed the value of the deal.

Through a structured approach and a more thorough commercial due diligence process, companies can help their acquisitions meet goals far beyond increasing short-term sales.

Go-to-Market Due Diligence

Go-to-market due diligence consists of the three steps listed below. Although not the first activity in the due diligence process, it is important that companies complete such an evaluation before doing any serious value assessment of the acquisition. This process does not have to take months to achieve, but instead can be completed in parallel to other types of due diligence. The first step entails understanding the customer buying processes.

1. Study the Customer Buying Process

The customer buying process is the set of steps a customer executes when evaluating and implementing a purchase, beginning with recognizing their needs, evaluating alternatives, and selecting and implementing the solution. A robust buying process definition also includes the key stakehold¬ers involved and their needs at each stage of the process. Prospective buyers can tap numerous sources for this information, including customer interviews and sales leadership expertise. Once a prospective acquirer understands the buying processes, it has the foundation to validate forecasts to see if expectations are truly realistic. For example, a company that sold single-use disposable surgical devices acquired a company selling capital equipment that was complimentary to the acquirers’ products. When it studied the buying process, the acquiring company realized that hospitals usually convened a committee of decision makers before buying the new product line, which diluted the effect that existing sales force efforts could have on marketing the product.

2. Understand the Selling Process

Executives must understand the selling process for the business or product line they are interested in purchasing. This consists of the key activities of the sales team to guide customers along the buying process and the skills needed to perform them well. It is important to understand all of the major tasks and activities of the field sales force, which include everything from strategic negotiation and tenders to routine service or implant support. For example, the skills required to sell to hospital executives can be quite different from those needed to support and train individual clinicians, and assuming a sales force can do both effectively is extremely risky.

3. Design the Future Sales Model

Understanding the most appropriate post-acquisition sales model design is also important. For example, executives evaluating an acquisition in a complementary space should know whether the products they plan to acquire demand a specialized sales role, or whether the company’s current sales force can sell them effectively. They must know the answers to fundamental questions involving responsibilities, sales channels, and territories, the amount of combined resources needed, and how well current sales skills fit in ideal roles. Answering these questions provides estimates of synergy and is an important input into valuation. It also gets the combined organization a head start on integration as sales leaders can quickly begin implementing the new plan after the deal closes without spending precious time contemplating the design of the sales model.

Throughout the process, it is essential to include the stakeholders who will ultimately manage the combined organization. Sales managers on the due diligence team can leverage their knowledge gained for a rapid assessment of the skills and capabilities of the new team and for more effective field execution.

Conclusion

Successful M&As in the medtech industry require companies to examine closely the customer buying process and the required selling process, and to create realistic expectations for the organization post-acquisition. Buyers need to understand sales force overlaps, conduct research with customers, and map out selling processes to compare between companies. Only then can the true value of a potential acquisition be assessed.

We have seen the benefits of this approach played out numerous times. Most importantly, companies screen out bad M&A deals before they happen. Those deals that make sense will be properly valued, and companies get a head start on integration when they know what aspects of the sales forces overlap, what synergies actually work, and what changes they will need to make in order to make the merger successful.

For those in the medical device and diagnostics industries, M&A is an essential part of successful portfolio strategies. It is the intrinsic nature of M&A that often causes executives to approach an acquisition with rose-colored glasses. As M&A in the medtech industry continues its rapid pace, the stakes for success will continue to be high. Those companies that conduct a thorough go-to-market due diligence process can see where true synergies lie in a deal and can best position themselves for successful acquisitions.

Reference
1. “M&A Market Rebounds From Lows,” MDDI Magazine, December 2009.

Pete Masloski is a principal in ZS Associates’ Evanston, Illinois office and is the leader of ZS Associates’ medical products and services practice. He has experience in an extensive range of sales and marketing issues, such as opportunity assessment, sales model and channel design, and incentive compensation. He holds a BSE in chemical engineering from Princeton University and an MBA with distinction from Northwestern University’s Kellogg Graduate School of Management.

Brian Chapman is an associate principal in ZS Associates’ Zurich office. While at ZS, he has worked with medical device and diagnostics companies on a range of sales and marketing issues, including sales force effectiveness, organizational design, opportunity assessment, channel design, new product launch strategy, value proposition development, territory alignment, and incentive compensation. Prior to ZS, he worked in the chemical industry in a variety of technical and commercial roles. He has a BS in chemical engineering from Michigan Technological University and an MBA with distinction from the University of Michigan Ross School of Business.