Common Elements of Customer Relationships determines whether a (intangible) customer relationship asset exists for IFRS 3 Business Combinations, one should consider several elements that create that intangible asset. Common Elements of Customer Relationships
For a customer relationship asset to exist, it should have an informational component or factual information about the customer that is important and useful to the company. Common Elements of Customer Relationships
This information may include such attributes as name, address, telephone number, email address, social security number, customer account number, credit rating, insurance information, or other third-party payer information. It may also include account information, date of first and last purchase, accounts receivable balance, trends, the amounts purchased (last year, greatest, etc.), customer payment record, and other account information.
Further, the informational element may include information relating to the customer’s purchase preferences, frequency, seasonality, trends, purchase responses to sales, promotions, solicitations, and price changes, and purchase responses to new offerings. It takes time and money to assemble, maintain, and use the customer account information. The company maintains this information in order to manage its customer relationships and motivate its customers to continue purchasing the goods or services offered by the company.
Expectation of repeat patronage of its customer base
The company has the expectation of repeat patronage from its customers based on the customers’ historical purchase activity, which creates value for customer-related intangible assets. This expectation translates into the expectation of future revenue, income, and cash flow.
Customer contracts formally codify the expectation of future transactions from customer relationships. Even in the absence of contracts, companies will seek to build on past interactions with customers in order to sell them products and services in the future. Common Elements of Customer Relationships
There are two traits of repeat patronage that are important in valuing customer relationships. First, every customer contact will not lead to an expectation of repeat patronage. For example, the quality of interaction with a walk-in retail customer is typically not considered adequate enough to lead to reliable expectations of recurring business.
Second, even when adequate information is present, not all expected repeat patronage may be attributable to customer-related intangible assets. This is because some companies may operate in monopolistic or near-monopolistic industries, where repeat business can be directly attributable to a deficient availability of acceptable alternatives to the company’s products or services.
In addition, recurring patronage may also be more appropriately attributable to the strength of the company’s trade names or brands. However, typically, if the company continues to provide satisfactory products or services and use the customer information effectively, it may expect reasonable continued patronage.
Lifespan of customer relationships Common Elements of Customer Relationships are required
Customer-related intangible assets create value over a finite period of time. Without efforts to continually reinforce the customer relationship, customer lists will decrease over time due to customer mortality, the effects of competition, or the emergence of alternate products and services. In addition, the concept of present value further erodes the economic benefits of sales to existing customers in the distant future. As a result, customer relationships are assets whose economic value decreases with the passage of time. Common Elements of Customer Relationships
Dependence on other assets Common Elements of Customer Relationships are required
Customer-related intangible assets are often dependent on the existence of several other assets to generate value for the company. Typically, most assets of a company, including fixed assets and intellectual property, are essential in creating products or providing services to its customers. Through the sale of the products or services, the company is able to develop relationships and collect information from its customers. See Customer relationships valuation for a real life example of a calculation.
Consequently, the value of customer relationships depends on the company’s ability to sell products and services in the future. As a result, in order for companies to extract value from customer-related intangible assets, they must have other assets in place. Common Elements of Customer Relationships
Components of the customer base
The customer base is the sum of the (1) customer list, (2) customer account information, and (3) expected future business with the customer. The customer list, which typically includes just the customer name or identification and contact information, is a tangible component of the customer base and the physical manifestation of the intangible asset. Companies may rent or license customer lists for non-competing purposes. See Customer relationships valuation for a real life example of a calculation.
The customer account information component, typically contained within a database, includes purchase history and trends, as well as customer preferences and responses to promotions. This information allows the company to maintain and develop a relationship with the customer. This information typically has a greater value-in-use than value-in-exchange to the company. Common Elements of Customer Relationships
Expected future business that the company anticipates with the customer is a function of the age and expected remaining useful life of the relationship. The customer’s purchase history and the company’s ability to influence the customer’s future purchases also influence the expected future business component. Customer relationship value depends significantly on this component of the customer base. Common Elements of Customer Relationships
The customer base typically includes all of the existing customers as of the valuation date. For some purposes, one may define the customer base as both the current customer relationships with a finite life and the goodwill component of future relationships (all expected future customer relationships from new customers replacing current customers as they retire). Common Elements of Customer Relationships
Some customers may enter into specific contracts with the company. Many types of customers do not enter into contracts but typically continue to do business with the company as long as they are satisfied. The company expects a satisfied customer to continue purchasing goods or services. Common Elements of Customer Relationships
For example, although a physician does not have a contract with the patient, he expects the patient to return to his office when the patient needs medical care. This intangible asset is typically called the “customer relationship asset.” Common Elements of Customer Relationships
Order or production backlogs are also considered to be customer-related intangible assets. While a customer list can be sold or exploited, an order backlog or a contract has a confirmed income stream associated with it.
In the customer relationship analysis, it is important to determine if the subject is a single customer, the sum of all individual customers, or the assembled collection of all customer relationships. Customers are typically categorised by the type of product or service they buy. Commonly, customers of the same type or in the same industry will be influenced by similar factors, exhibit similar consumption patterns, have similar risk factors, and be similarly affected by competitive influences.
Factors to Consider in the Valuation of Customer Relationships Common Elements of Customer Relationships are required
Although all three generally accepted approaches may be used in the valuation of a customer relationship intangible asset, some may be more applicable than others.
The cost approach is frequently used to value customer databases or related intangible assets and to estimate the informational content value of the customer or customer database. However, the cost approach may not be feasible if replacement or recreation periods for an asset are long. This approach does not value the business expectation value of the customer relationship. Thus, it is used infrequently in valuing customer relationship assets. See Customer relationships valuation for a real life example of a calculation.
The market approach may generally be used to value customer lists because there are sufficient data regarding the sale or license of customer lists. However, one should note that these transactions provide data regarding the rental or sale of the customer lists for non-competitive purposes and that companies continue to own their customer relationships.
Further, intangible assets are typically unique and are frequently sold with other components of a business enterprise. Therefore, the market approach is frequently untenable in the valuation of customer relationship intangibles due to the lack of transactional data for sufficiently comparable assets.
Therefore, the income approach is frequently used to estimate the value of customer-related intangible assets. When valuing intangible assets using an income approach, one typically selects an appropriate valuation method for each of the assets based on its characteristics and significance in generating revenue for the company.
The income approach methods commonly used to value customer relationship intangible assets are as follows:
- Multi-period excess earnings method,
- Distributor method,
- Relief from royalty method,
- “With and without” method, Common Elements of Customer Relationships are required
- Greenfield method,
- Differential cash flow method.
See also: The IFRS Foundation