The late University of Chicago professor Milton Friedman misdirected capitalism’s trajectory when he issued his 1970 doctrine that the purpose of a business is to increase shareholder value. It led companies to put all sorts of systems and structure in place to deliver on that doctrine with disregard for customers and the environment. This is not sustainable.
Decades before Friedman, Henry Ford had a better grasp of reality. He said “a business that makes nothing but money is a poor kind of business.” He argued that organisations exist to advance something – technology, quality of life or anything else with the potential to ease or enhance our lives in some way, shape or form.
To give ourselves something more tangible to focus on we can refer to the father of management consulting, Peter Drucker who stated that the true purpose of a business is to create and keep customers. Put simply, the organisations interests should always be secondary to the interests of the consumer. This is the key to building a sustainable organisation.
What causes organisations to stray off course is quite consistent. It occurs when leaders become more dedicated to serving their own short term interests than the ‘infinite game’ [cf Simon Sinek] of building an organisation that can last – and they drag their organisation down with them.
Looked at in this way, the inadequacy of traditional business valuation methods are apparent. Multiples of EBIDTA or multiple of annual revenue are open to gaming by self-interested shareholders focused on short term results.
To add texture to business valuations – it’s important to think about customer value. Customer value can be defined as the total lifetime value of a company’s customer base. Companies can increase this value by acquiring more customers, retaining them for longer, making their experience simpler (and often less expensive to deliver) through digital improvements and so on.
To value a business through this lens – here are some metrics to consider:
- Number of new customers acquired during the reporting period and the net number of new customers remaining at the end of the period.
- Number of existing and active customers (these are customers who have been customers for more than one year and who have made a purchase in the last year).
- Revenue per new and existing customer.
Using these metrics you can readily develop a view on the valuation of the business and test it against other valuation methods. Taking a ‘customer value’ approach to valuation can yield rich insights. It’s a systemic approach to valuation. Contact me to discuss how this idea can be applied to your organisation.
Read about value creation through purpose based branding..
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