Gartner, the world’s foremost technology consulting firm, defines digitalisation as: “the use of digital technologies to change a business model and provide new revenue and value-producing opportunities; it is the process of moving to a digital business.”
Among the many impacts of a business going digital, usually the most significant for a B2C business is access to new markets as a result of a shift from offline to online distribution channels. The internet has shrunk the world by removing geographical constraints. The impact on business value resulting from this change, however, is hard to ascertain.
For most businesses, using a market valuation method is extremely difficult due to a lack of comparable transaction data. Income methods (comparable multiples or discounted cash flow) are therefore widely used. It seems, however, that the more uncertain the business model, the more likely management and investors are to prefer comparable multiples ahead of discounted cash flows, when the reverse should be true!
The truth is that for the majority of businesses, adequate benchmarks simply do not exist to apply multiples such as price-to-earnings ratios. Multiples do not account for the unique characteristics of each company and how it evolves in a fast-moving digital world. The drivers of value are best derived by in-depth analysis with economic reasoning of what really matters: how will the business itself will generate cash.
If access to new markets is the prime outcome of going digital for a B2C business, then valuation should firstly analyse its market. What revenue might the business generate some years in the future once it reaches “steady state”? i.e. What percentage of what total market will it have and how much revenue will it generate from this market share?
Operating performance measures, such as customer penetration rates, average revenue per customer, and digital sales channel indicators, such as numbers of unique users and their internet browsing metrics, should be used to project revenue and profitability over the years to steady state. Such metrics should rarely be used as comparable valuation indicators in their own right.
Finally, to deal with the added uncertainties of the digital B2C channel, in addition to well-considered sensitivity analysis, probability-weighted scenarios should be used. By considering the likelihood of different outcomes through an assessment of the value drivers, the possible valuation range can be reduced and the valuation more easily defended.
Gartner refers to a change in business model through going digital. Sound analysis of that new business model, and in particular the market in which it is applied, should be the cornerstone of B2C business valuation.
