A theory too much

I think a financial phrase has no right to exist if it is composed of words which are extremely arbitrary or which cannot be accurately ascertained.  At best, such fluidity can be allowed only in poetry or literature. It can wreak havoc upon businesses as often it would result in distorted valuations of an enterprise.

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Like many other arbitrary financial modeling theories, I am a little confounded by this tenuous concept of “Lifetime Customer Value”  increasingly used by mobile phone service providers and retail chains. Particularly since business can only `hope’ for a customer to last a lifetime ( of your business or that of the customer, it’s not clear yet ! ) even as it’s not certain how long that is going to be.

The lifespan of such theories and their relevance is often determined by the arrival of yet another, more dubious and even deeply confusing theory. Management theorists hog the limelight, make a living by frequent introduction of such questionable concepts and get away with it before its futility dawns on the actual user.  That may be how management theorists get by, but if I can salvage a company from going belly up by blowing this whistle,  I make the day for thousands of shareholders.

It occurred to me while I was looking up this K@W report on the ongoing bidding game for Hutch Essar.   According to this report, the entire valuation of the deal is getting close to $ 20 billion for Hutch Essar, India’s second largest mobile phone services provider, which currently has 22.3 million subscribers and $1.3 billion in revenues.  On the basis of these numbers, the bidder would be paying roughly $1,000 per customer, a tall order since China Mobile’s failed bid last July to acquire Millicom International Cellular SA of Luxembourg, valued its customer at $500 only, a comparable outfit since like Hutch Essar, Millicom is also adding about a million customers a month.  

Wharton marketing professor Peter Fader senses serious disconnects between what he calls the “base behavior of our species” and the valuation assumptions made by both bidders and sellers of companies such as Hutch Essar. The revenue promise held out by Hutch Essar’s existing and projected subscriber base is often seen as crucially linked to how the service is priced and the functionalities it offers. “Here is where the deal makers may be off-key”, says Fader.

Fader suspects the valuation math in deals like Hutch-Essar is far from scientific, basing his assessment on statements in corporate financial documents. “I’ve never seen a case where a company has estimated customer retention — or at least admitted to doing it — in a manner that their shareholders should insist upon,” he says. “They are using very crude estimates of retention; they are assuming that they are constant across customers or over time rather than capturing the huge dynamics that take place there.”  

I am happy that I have some support from a person of considerable academic eminence.  But I am worried about the shareholders of the winning bidder.

Just that the theorists will still be around spinning the next fad.

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