How to put a value on customer relationships

4th Jul 2007

Whilst often labelled an 'intangible' asset, customers are far from elusive in nature. They walk, talk and hand over hard-earned cash in return for products and services. In retail, companies track their customers’ buying habits by monitoring store card and loyalty card data.

In telecoms, customers pay their monthly bills and in banking every customer transaction is logged. Putting an economic value to customer relationships is therefore not as difficult a task as you might think. They are both identifiable and measurable. There are three main customer valuation techniques: market, cost and income.

1. Market approach

The market approach to customer valuation focuses on identifying comparable transactions. Like buying houses, if your neighbour’s house sold for £300k and yours is pretty similar, then there is a good chance yours is also worth about £300k. Adjustments have to be made, of course, for elements like the state of repair and the willingness of the buyer. Differences such as this occur when acquiring customers. Aviva, for example, achieved annualised cost savings of £100m in 2006 from its acquisition of RAC which would have to be stripped out of any comparison.

2. Cost approach

The cost approach consists of the historic cost of building the customer list, such as promotional spend, acquisition prices and servicing. It also considers the cost of replacing the list. The cost approach is generally not considered the best approach to valuing customers, but can be useful as a sense check.

3. Income approach

The purpose of the income approach is to calculate the future economic returns expected from the customers over their useful lives. This amount would then be discounted to reach the net present value of those cash flows. An analysis of historic activity and future trends is important when forecasting revenues. And elements like customer churn rates, loyalty and profitability are all important components. In practice, the income approach is generally the most accepted methodology to use when valuing customers and other intangible assets, with the remaining methods being used largely as sense checks. An illustration of each of these approaches can be seen by valuing the customers in the following case studies.

Virgin Mobile

When Virgin Mobile was acquired by NTL for £962.4m in April 2006, what really changed hands were the 4.2m customers. Access to the Virgin brand was negotiated under a separate licensing agreement with Sir Richard Branson and as Virgin Mobile piggy-backed on T-Mobile’s spare network capacity, it had no infrastructure of its own to speak of – it was virtually a virtual company. Here, we have a good example of all three approaches to valuing customers. The market approach is simply the acquisition cost minus Virgin Mobile’s assets, which were valued at £61m, divided by the number of customers.

This values each customer at £215, or £903m in total. Virgin Mobile’s accounts state the cost of acquiring each customer was £28, or £117.6 in total, which is the cost approach. The income approach forecasts the discounted profit from Virgin Mobile customers based on Virgin Mobile’s annual churn rate of 17.5 percent over a five year period. Costs of 35 percent are taken off the average revenue per user to arrive at an estimated profit per user. This values each active customer at £173. If a ten year period was used instead of five, the cost per customer would increase to £285. So, although this valuation is admittedly simplistic, we have three different figures for the value of each customer: what was paid, £215; what it would cost to acquire them, £28; and what they are each worth annually over a five year period, £173, and over a ten year period, £285. If the synergies NTL expected to generate as a result of the acquisition are factored in and we acknowledge the brand had some element in both acquiring the customers in the first place and that access to the brand was also some of NTL’s motivation, then what NTL paid seems about right.


The RAC is another good example to illustrate the customer valuation approaches. In March 2005, Aviva bought RAC for £1.1b. In its annual report, Aviva broke out the intangible assets purchased as a result of the acquisition. £260m was assigned to the brands RAC and BSM and a ‘market’ value of £132m was put on contractual customer relationships. This would value each of RAC’s 6.7m customers at only £20. However, such valuations in annual reports need to be treated with caution. A more commercial market value for RACs customers is likely to be around £186 each. This is arrived at by just looking at the residual intangibles and what is driving value. This must be the case even after recognising the significant synergies that would have been possible between Aviva, the world’s sixth largest insurance group and RAC, which also sells a range of financial services to its roadside assistance customers. Using the income approach, the active RAC customers are valued at £227 each over a five year period and £374 over ten.

These figures use an annual customer churn rate of 10 percent and RAC’s published customer profitability figures. So we have again the three different values from the three different approaches: £20 from the ‘market’ approach in the accounts; £186 from the market; and between £227 and £374 from the income approach. These numbers are similar to those of Virgin Mobile. In fact, the average difference between them is 0 percent which demonstrates that valuing customers can be accurately and subjectively benchmarked.

Brand value

These two examples are cases where significant acquisition value is identified as residing in customer relationships. In many other sectors the brand holds the power. For example, the value of customer relationships in Premier Foods’ recent £460m acquisition of brands including Oxo, Campbell’s Soup, Homepride, Batchelor’s and Fray Bentos is likely to be negligible as all the value lies in the brands. This is because the brands’ customers – retailers and consumers – all engage with the brand and not the brand owner, it doesn’t matter to them who owns the brands. In other sectors, such as financial services and telecoms, customer inertia is prominent – the brand can change without the customers much caring.

For instance, when Banco Santander, the Spanish bank, purchased Abbey in 2004 for £8.2b, what it wanted was access to Abbey’s 18.3m customers. It staged a two to three year programme to change the brand and name to that of Banco Santander which is due for completion in 2007. To say that customer lists are intangible and therefore difficult to quantify can be wrong. In the majority of cases where significant business value is held in customer relationships, as with Virgin Mobile, RAC and Abbey, you even know their names.

Thayne Forbes is joint managing director of Intangible Business, the brand valuation, strategy and development consultancy. He is a dually qualified chartered accountant and marketer and has carried out over 100 intellectual property valuations for some of the world’s biggest brands, including Laura Ashley, TimeWarner and Vodafone. Read more features, practical case studies and white papers about the customer business case.

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