Valuing customer relations requires quantitative and qualitative judgments. Yet, little guidance on valuing this increasingly important intangible asset is available while most BVWire—UK readers are facing this issue more frequently in an economy that is migrating toward desirable long-term relations.
Perhaps the best available summary of customer value factors is now available from a new BVR webcast, Using Asset Attrition to Determine Useful Life, with Ray Rath (GlobalView Advisors). Rath’s presentation can be downloaded here. Rath has done as much research and teaching on valuing customer relationships as anyone in the BV profession.
The analyst needs to understand that two elements are required to define a customer relationship. First, the entity must have information about the customer. Second, the customer must be able to directly contact the entity. These two conditions eliminate the value of walk-in customers, which are normally valued elsewhere in an analysis.
Some factors that increase the value of a customer relationship include:
- Lower rates of attrition or ‘customer churn’;
- Longer customer relationships;
- Higher product differentiation that creates barriers to entry by new and existing competitors;
- Higher switching costs and quality of alternatives;
- Better business health or profitability, which suggest lower attrition rates; and
- More stable customer types (business customers may have more value than individual customers).
Rath suggests that analysts begin with at least two years of customer and termination data. He recommends that analysts review the data by anticipated revenue rather than by customer counts. Importantly, ‘different subgroups perform differently,’ so make sure that the data are segmented as needed. ‘You don’t want to treat a £1 million customer the same as a £100 customer, because the lower value attrition rate is not as important to the business.’ Business reporting units may have different attrition rates, and geography or the type of customer often make a difference.
The presence of customer contracts may eliminate the need for an attrition analysis, Rath observes, since the business valuator can value each contract individually. Another factor analysts must address is how to remove growth from new customer revenues, since this growth may be valued elsewhere. Multiple years of revenue by customer can improve the defensibility of these analyses.
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