Valuation of Customers in Growth Companies - a Scenario Based Model

24 Pages Posted: 10 May 2005

See all articles by Markus Rudolf

Markus Rudolf

WHU Otto Beisheim Graduate School of Management

Manfred Krafft

University of Muenster

Elisabeth Rudolf-Sipötz

Independent

Abstract

In this paper, we evaluate growth stocks by modeling a company's customer equity. We start with the observation that the number of customers in successful start-ups increases very quickly (exponentially) in the first few years. Then the customer base converges towards an industry average. On the other hand, the number of clients in poorly performing start-ups rapidly declines until bankruptcy occurs. These observations imply a bathtub shape to the probability distribution for the number of customers in the initial years, i.e., low probabilities for the number of clients close to average but high probabilities for extreme realizations. The valuation procedure we present here is based on a binomial scenario tree technique for the number of clients and the cash flow generated by each client. We show that the model can explain higher company values than can traditional net present value calculations. Furthermore, and in contrast to traditional valuation models, increasing the volatility in the change of the number of customers increases the value of each customer.

Keywords: Bathtub Distribution, Bifurcation, Customer Valuation, Customer Equity, Growth Company, Mean Reversion Process, Momentum Process, Real Option, Start-up, Valuation

JEL Classification: G3, M3

Suggested Citation

Rudolf, Markus and Krafft, Manfred and Rudolf-Sipötz, Elisabeth, Valuation of Customers in Growth Companies - a Scenario Based Model. Available at SSRN: https://ssrn.com/abstract=717681

Markus Rudolf (Contact Author)

WHU Otto Beisheim Graduate School of Management ( email )

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Manfred Krafft

University of Muenster ( email )

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