The Target Co. is playing in a great space (e.g., strong tailwinds, right segment(s), etc.), has product(s) that attract valuable customers, the diligence indicates that the product line is differentiated, and the management team is presenting a very good, if not great, growth case. Unit economics are strong, and the IC can reasonably conclude that this might be a great opportunity. A nice find and exciting prospect.

When we look back at diligence agendas, however, we find that one commercial diligence topic is commonly insufficiently considered: the Channel.

Most investment teams will leverage the expert networks to get an explanation of “how the channel works.” And I do not think we, at GRAPH, ever completed a commercial diligence without strong Voice of Customer inputs from customers in the Target’s primary channels. But what is often neglected is the analytical exercise measuring the relative strength and advantage of the company’s play in the channels. In any five-year horizon, among the competitors that, for the most part, have the positive attributes noted above, relative channel advantage will often prove to be the top determinant for who wins the most – and possibly who ends up building a moat that drives more sustainable returns.

If you think about the yields and companies that you most admire, I suspect they are not the ones where the operator got to the market first. They are not the ones that simply meet a common reference “they know how to play in the channel.” Rather, the greater win is the company that cuts its own channel and the unique channel play itself provides enough small, but useful, advantages for customers to drive preference. Think Microsoft with its original play to convince IBM to pre-load IBM PCs with MS-DOS (which was a modification of already available 86-DOS from Seattle Computer Products). It is human nature to seek all known and available advantages to address needs, but the ‘known and available’ depends on what's obvious and present when customers enter the market - and that is the role of the channel, and the opportunity for those that drive an impactful and advantaged (channel) design.

In channel discussions, most folks are interviewing the operating executives and industry experts in diligence and cover the flow from the ‘Factory to the Purchase Order,’ when the exam needs to start from the other end: the customer. Diligence can track activities from determination to resolve the need to the end point of purchase (as well as capturing the cases when prospects curtail their efforts to discover and/or purchase). A channel becomes a differentiating aspect of business performance when producers architect their channel to resolve friction.

I recommend two valuable and relatively easy activities in commercial diligence:

1. Define and measure relative channel advantage, i.e., …

• • …the degree to which Target Co.’s channel approach creates differentiated advantage for customers; and
  • …how the Target Co. measures relative to competition on this front

Note, we are not referencing product differentiation above.

2. Obtain insights from customers (the needs and friction points) that should inform the value generation plan on how to carve out a unique play to realize relative channel advantage, and then set…
   • …specific milestones and target performance measures
   • …inspiring objectives - e.g., can we go from number 3 in the market to number 1 and build a genuine moat?

For clarity – while our reference to channel in this discussion includes reselling entities, it also needs to include the various and more creative means that a company can use to reach and gain the attention of the most relevant decision makers and critical influencers to drive mindshare, availability, and purchase (which is why products with network effects become such big winners – as customers become a critical element themselves of the channel).

Regardless of where in the graph the Target Co. maps in its baseline measure (relative to having any channel advantage), the analytical framework and underlying primary research with customers should serve as the basis for laying out a two- or three-year plan aligning the Board and executive leadership on the specific indicated actions, quarterly metrics, and expectations for gains.

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