What are Intangible Assets?
An intangible asset is an identifiable non-monetary asset without physical substance. Some examples of intangible assets are Trademark, Brandname, Software, Technology, Customer Relationships, and Goodwill.
To recognize an intangible asset, the following three criteria need to be met:
- Identifiable
An intangible asset must be identifiable. Identifiable means the asset should either be separable or arise out of a contract (for example, franchise rights) or arising out of law (for example, copyright), whereas goodwill is not separable.
- Control
An intangible asset must be controlled by a particular entity.
- Future Economic Benefits
By virtue of owning/controlling an intangible asset, an entity must accrue an economic benefit in some form.
Customer-related Intangible Assets
Customer-related intangible assets arise out of a pre- existing relationship between an entity and its customer. A relationship can be contractual or merely based on an entity possessing relevant information about its customer.
Consider a situation where two competitors – Company A and B –operate in the same business line and have the same brand recognition. However, Company A has an established customer base and has collected customer data on purchasing habits, contact information, and other related data, whereas Company B is primarily reliant on the wholesale channel to market its products. How would you value them? To value Company A using similar parameters as Company B would be unreasonable as Company A has long-term direct relationships with its customers and has strategically used its customer data for supply chain management, etc. This provides Company A with a competitive edge, and Company B faces a barrier to entry as it does not possess similar insights into customer behavior and preferences. This advantage will reflect in superior operating margins of Company A.
A real-world instance of the same can be seen in the Indian Paint Industry. In the 1970s, Asian Paints revolutionized its business model by discontinuing its earlier business model that relied on traditional dealerships/wholesalers and started supplying inventory directly to the retailers. Simultaneously, Asian Paints started using the power of a mainframe computer to manage and track inventory right from the point of production to the point of sale (retailers). This produced a treasure trove of insights into consumer behavior while eliminating 30-35% dealer commission. The market capitalization of Asian Paints versus its peers clearly reflects the value add and importance of customer relationships.
Types of Customer-related Intangible Assets
- Customer Relationships
Customer relationships can be contractual and non- contractual. If the entity develops a relationship with customers through contracts, they meet the criteria of separability, control, and possible future economic benefit. If this relationship arises out of non-contractual rights, they have to meet the criteria of separability to be recognized as an intangible asset. An example of a non-contractual relationship would be submitting personal data to participate in promotional activities such as a lucky draw.
- Customer Lists
A customer list is a form of customer-related intangible assets consisting of customer information - their names, contact information, sales generated, etc. This list can further be divided into different databases based on demography, zones, age groups, etc., which helps businesses target products/services according to their target audience. Customer lists are created by an entity when engaging with customers over a long term . These relationships can be contract-based or non-contractual.
- Order Book or Order Database
These are sales orders and purchase orders generated over the course of regular business activities. These orders meet the recognition criteria even if the contracts are cancellable.
Some real-world examples of creating, defending, and monetizing customer-related intangibles include:
- Tech giants like Google and Facebook provided their platforms for free to users and, over time, collected valuable data about their users. Now these tech giants gain the majority of their revenue through advertisement (advertisements target users based on the data these tech giants gather regarding user behavior and advertisement preference).
- Facebook had been losing its younger demography to other social networking sites/apps like Instagram and Snapchat. To regain its influence over this demography, Facebook acquired Instagram in 2012. Today, Instagram is more valuable than Facebook.
- Paytm, which collected large amounts of data by facilitating millions of transactions, is planning to open a business consultancy service on the basis of data collected by them. These services aim to facilitate small and medium businesses in identifying locations to set up operations/attract customers through the insights. Paytm has gained a competitive edge by analyzing large amounts of data.
Customer relationships are generally the most important and valuable customer-related intangible acquired during a business acquisition. Therefore, let us evaluate how and if various valuation approaches can be used to value customer relationships.
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