WitW #008:
What is it worth?
Do you ever feel like you’re in the dark when it comes to answering this valuation question? Does it seem like we’re grasping at shadows on a cave wall, struggling to connect the form of an asset’s price with the substance of its value? And what if your question involves the valuation of software and data?
Well, then today’s Tuesday recording of Wednesday in the Woods, live from the Learning Loft, is right up your alley. We cover three approaches to understand the “worth” of things – including the valuation of software and data.
In each of these contexts, it’s important to remember that worth is “in the eye of the beholder” like a seller or buyer.
To understand approaches based on cost, it helps to start with a few basic questions about an asset:
How much did the seller originally spend to produce it (R&D, setup, etc.)?
How much would the seller spend to create it today (using know-how and assets)?
How much would a specific potential buyer spend to do it all over?
A good cost accounting system can be a huge help to answering these questions, but there are always missing pieces. Further, costs like labor and energy can change over time, across regions, or for organizations with different sizes or cultures. Which costs are the right one to use?
The financial value approach is what you’d expect from a first-year MBA course:
How much revenue is the asset generating for the seller?
How much expense is the seller currently avoiding due to the asset?
How would these answers change if the seller were to hypothetically change its activities? (scaling marketing or a synergistic service line)
How would a specific potential buyer answer these questions?
Many of these questions come back to a discounted present value of cashflows. But whose discount rate or cost of capital applies in which currencies? As above, if you shift the people, process, and technology across firms, do input costs or output values change?
The third approach we cover today is focused on market-observed prices. Understanding value with market prices often comes down to two questions:
Is there a directly-comparable asset that has observable prices?
Is there a population of indirectly-comparable assets with observable prices?
When assets have direct “comps,” we can often use single transactions or simple averages as a mark. However, in most interesting cases, only indirect “comps” are available.
These situations require parties to:
Collect data for these indirect comps – data model required!
Develop a model for explaining the observed prices of these comps
Use the model to set a mark for the asset of interest
If it feels like these frameworks are based on real property like buildings or cars, well…that’s because they are. If you wonder whether there might be better approaches to valuing intangible property – especially things like software and data – well, you’re not alone.
