Forecasting the Future of Your Investment

How a company will perform in weaker economic conditions is top of mind for investors when considering a potential acquisition. The starting point for that analysis is usually an examination of how the business fared during the last downturn. Studying prior financial performance – in terms of revenue, pricing and margins – is a critical first step. How steep was the decline? How fast was the recovery? Which segments (product lines, channels, geographies) were most affected?

However, even the most thorough review of prior financial performance only provides a partial view of what may happen next, particularly since many industries have seen significant structural changes and disruptions since 2008 (for example, cohorts of experienced workers retiring and not being replaced; emergence of new substitutes and business models (e.g. SaaS), major changes in legislation, consolidation and integration along the value chain, etc.).

As someone once said, “It is difficult to make predictions, especially about the future.”

But our experience suggests that a bottom-up, customer-informed analysis can help to create a more robust forecast. The key is to ask the right questions to a large enough number of the right people (i.e., well qualified, current decision makers who have a long enough track record in the sector to observe long-term industry shifts).

Here are four key steps to help you shape that analysis:

1. Identify disruptions

• Where do customers believe we are in the cycle (for their specific sector and industry)?
• What are the major structural disruptions that have occurred during this cycle – that may make the past a poor indicator of future performance?
• Which near-term, additional disruptions do they believe are most likely? What would cause them to occur? When?
• Which disruptions seem unlikely – but would have very high impact?
• What “early warning signs” could indicate a likely change?

2. Map to changes in customer behaviour

• How might overall purchase volume and value change under different disruptions?
• What would be the rate of change? Which categories of spend are affected most quickly? Which are defended until the end?
• Could customers shift to insourcing, rather than outsourcing?
• How would key purchasing criteria change?
• Are there changes in levels of loyalty and stickiness? What prevents switching at the moment?
• How would the purchasing process and key decision makers change?
• Which changes are short-term? And which might have long-term impact?

3. Extrapolate competitive impact

• Which competitors do customers believe stand to gain from changes in purchase criteria and behaviour?
• Which competitors have greatest ability to ride out a downturn?
• What is the overall share of low cost vs. premium competitors today? How might that change?
• What are the barriers that preclude low-cost alternatives from gaining further share (and how quickly could they be overcome)?
• Are there nascent substitutes/alternatives that could drive more radical shifts?

4. Plan for contingencies

• What actions should we take now, so as to win through a downturn?

Of course, “black swan” events can ultimately prove to up-end even the soundest of investment theses. But thorough prior investigation will hopefully equip you to be best prepared, should the worst happen.

Written by James Tetherton