In BVR’s Benchmarking Intangibles study, on the average, commercial customer relationships represented the largest intangible asset (aside from goodwill) valued in the over 300 purchase price allocations reviewed.
The value of a customer relationship reflects the present value of future incomes from that relationship, and the value reflected in a purchase price allocation should reconcile to the sum of all of the values of individual customer relationships held by an acquired company. Unfortunately, it would be prohibitively expensive to perform such a proof. The valuation would take into account expected income stream, the sustainability of any competitive advantage, market share and position, and the causal relationship between marketing actions and customer reactions.
The multi-period excess earnings model (MPEEM) has been the traditional method of choice in the valuation of customer relationships. The May 2012 issue of Business Valuation Update (BVU) Ed Hamilton and PJ Patel outlined the distributor method (DM) as a more suitable alternative for some circumstances. Now a response by Dan Guderjohn and Robert Reis in the October 2013 issue of Business Valuation Update raises concerns about this method.
Conceptual and practical issues: The basic premise of the distributor method is that the returns to a customer relationship asset are analogous to the economic profits earned by a hypothetical intermediary. It attempts to show how the subject company’s economic characteristics would differ if the investment in customer relationships were relegated to an outside entity. Guderjohn and Reis (both with Corporate Advisory Associates), say that, “on further inspection, a number of concerns, both conceptual and practical, become evident.”
For one thing, the distributor method ignores any potential value in the relationships between a company and its distributors, according to the authors. “Contractual agreements and value-added services provided by a distributor can generate customer relationship value at the distributor level,” they say. Also, they point out that distributors are not homogeneous. “While conjuring up a hypothetical distributor might sound easy, it becomes a very difficult task once one begins to consider the myriad forms a distributor can take,” they contend. The article details more of the authors’ concerns.