Data has a value to the companies that rely on it. When they ask their accountants to put a figure against it, however, the outcome often falls well short. As ever more organisations become data-driven, David Reed considers what it will take to get data on the books at its true price.Data has a value to the companies that rely on it. When they ask their accountants to put a figure against it, however, the outcome often falls well short. As ever more organisations become data-driven, David Reed considers what it will take to get data on the books at its true price.
What do the dates 18th May 2012 and 31st July 2013 have in common? They are the date on which Facebook was first floated at $38 per share and the day when its shares finally rose back above that initial price. In between, shareholders were looking at a $48 billion loss with shares trading as low as $18 at one point while the social network looked for ways to firm up its revenue streams and commercial assets.
One magic word appears to have made the difference - mobile. Reporting that 41 per cent of total ad revenues were now coming from its mobile platform finally reassured investors that Facebook knew what it was doing.
Yet in between, the social network had passed the magic mark of having one billion registered users. That is a remarkable achievement and ought to have told shareholders that Facebook had a future. Leaving aside the question of whether the IPO was actually over-priced, the weakness in the business model of Facebook has always been that it possesses very few assets. That makes it hard for investors to realistically price the company.
If this example serves a purpose it is to underline the gap between how the market values digital companies and how the accountancy profession does it. Given the dizzying market capitalisations which a new generation of dot.coms have been reaching, this gap between perceived and book value is growing larger.
Nowhere is this more evident than around the issue of valuing data as an asset. Two years ago, the World Economic Forum published a report called, “Personal data: The emergence of a new asset class.” It served as an important rallying point for those identifying data as the new oil - a metaphor used by the WEF - and arguing for ongoing investment and better protection for organisations which had come to rely on this raw material. The report itself describes personal data as “a post-industrial opportunity”.
What the report failed to address, however, was any definition of that asset class. While recognising the need for a globally co-ordinated approach to regulation, infrastructure and standards. To understand the significance of this failure to address the asset question, imagine that the report was about real oil - any business holding exploitation rights to an oilfield will book them as an asset. Does the data gathered through interaction with the market place, from social mentions and search through to enquiries and ongoing customer relationships, not represent a similar opportunity?
An attempt was made to deal with this problem in 2008 when the International Accounting Standards Board introduced International Financial Reporting Standard 3. This aimed at closing the valuation gap which had historically been described in company accounts as “goodwill” by setting out standards by which five classes of intangible asset could be put onto the balance sheet. One of these five was “customer-related” and under this heading, companies could value four types of asset: customer lists, order backlog, customer contracts and non-contractual customer relationships.
For the purposes of database valuation, “customer lists” and “non-contractual customer relationships” are the most pertinent. Within the accountancy profession, however, there is a degree of dispute about how this class of intangible asset should be valued and the robustness of the methods typically used. Each of these (cost-based, market-based, income-based) is considered to have flaws and will produce widely-varying results.
In most cases where a valuation has been undertaken, it has tended to be for reasons other than to place an asset on the balance sheet. According to Kelvin King, managing director of Valuation Consulting and a leading expert on the subject, “over the years it has been a significant area of work for us and continues to be in commercial negotiations, intellectual property off-shoring and general efficient tax planning and commercial strategies, including licensing and transfer pricing re these most valuable of customer intangible assets.”
However, the real point of valuing a database ought to be to support a company’s overall valuation, especially during a merger or acquisition process. King points out that the broader economic climate has suppressed M&A activity to such an extent that there have been no database valuations for purchase price allocation in recent years.
That is remarkable given the rise to prominence of data in the years since the crash. Data has entered the mainstream consciousness for both businesses and consumers and is widely looked to as a provider of value and innovation, not least as part of the new digital economy.
Without a robust valuation process to underpin it, however, data risks looking like another asset bubble - over-priced and lacking a sound basis. It is a problem that is starting to attract serious attention, as reflected in the report, “Data on the balance sheet”, produced in June by the Centre for Economics and Business Research on behalf of SAS.
As the report says: “It is increasingly important that firms are able to account for their data. Firstly, regulatory and compliance initiatives are putting greater emphasis on the quality of data and resulting decision-making in the aftermath of the financial crisis. Secondly, for financial reasons, data that play an increasingly important role in value creation must be recognised if they are to be accorded appropriate priority by company decision-makers.”
But as the authors note, the intrinsic nature of data makes it difficult to value in traditional balance-sheet accountancy terms. Cost and depreciation are an issue, together with difficulties in estimating a return on investment, while external factors like competitor activity or regulatory changes also have an impact.
Data also has paradoxical qualities that affect the ability to value it. “Data does not have a physical presence and therefore may be considered to have an infinite life when compared alongside physical assets. However, data can depreciate quickly if it is readily outdated (eg, unstructured social media and financial trading data),” says the report.
Such problems are not entirely limited to data - other intangible assets can also present difficulties around valuation. One source in financial services, talking to DataIQ off-the-record, recalls the challenge of dealing with the valuation of software that had been created in-house. “It was held as an asset, which there were good financial reasons for doing, but that create a mini-industry in its own right to manage and value that asset,” said the source.
Reviewing the software and whether it had been impaired over the course of a year was combined with a three-year amortisation of the cost of its creation. Difficult as that process proved, it was still easier than trying to value data, which the company also attempted. “We did try to put a value on specific items of data, such as a phone number or a date of birth. They were very valuable to us, but how you determine that value is difficult,” the source said.
In that example, the issue of taking quality into account proved to be a stumbling block, since this is constantly in motion. Internally, the importance of key pieces of data to the CRM process was not in doubt. Creating a model to prove it was. “It became too theoretical,” the source told DataIQ.
The solution to this problem proposed in the CEBR report, however, amounts to just four paragraphs on proposals by the International Integrated Reporting Council. As CEBR notes: “They propose that each firm should report all the inputs it uses and the business model it relies upon in transforming those inputs into outputs in order to present a clearer picture of the firm’s ability to create value in the short, medium and long term. This means firms must refer not only to financial and physical capital in their reporting, but also to human, social and relationship capital and knowledge capital.”
It is argued that this approach would encourage companies to show how much they rely on data and how they create value from it, together reporting on any risks that may depress that value. A pilot programme is in place, but there are as yet few obvious outputs from the IIRC initiative.
McKinsey also weighed into the same territory with its own report, “Measuring the full impact of digital capital”. Rolling big data and analytics up into the broader set of intangible assets which a company like Facebook represents, the management consultancy identifies the same serious problems for senior management that is caused by the failure to value data as an asset.
“Conventional accounting treats these capabilities not as company investments but as expenses, which means that their funding isn’t reflected as capital. Since the amounts spent aren’t amortised, they take a large bite out of reported income,” write Jacques Bughin and James Manyika.”Spending on those capabilities sometimes should be treated as capital, though, since they can be long-lived.”
They note that “behavioural data and user participation can be monetised”, which argues for a new way of valuing these assets. McKinsey also presents an academic take on how a different approach to valuation of intangible assets such as data would change the price put on different businesses in quite a striking way. But as with other reports, there is no attempt to show how this shift in thinking should be brought about.
If the existing methods of valuing data are defective, something will have to change. Among organisations which rely on the use of data there is an obvious desire to realise some financial value on their books out of that investment. Since some of those companies are among the largest in the world, it is only to be expected that things will eventually change.
“There is more than just an appetite to value data,” points out Iain Lovatt, chairman of Blue Sheep. “As of July, research and development will be represented as a fixed investment in gross domestic product reports produced by the US Bureau of Economic Analysis. It will go onto the country’s ‘balance sheet’ and the UK is expected to follow suit in 2014,” he says.
A new asset category is being recognised by the BEA as “intellectual property products” and expenditue on R&D will be considered an investment for GDP reporting purposes. “The recognition of R&D as investment will improve BEA’s measures of fixed investment, allowing users to better measure the effects of innovation and intangible assets on the economy,” says the bureau.
This is no small development. Private companies spending money to create new products and services have not had that included as an expenditure within GDP figures, but simply included as a cost of production. That has not shown any creation of a separate commodity as a result of the R&D. Now, the US will treat it as an investment and model its output value, as well as depreciation of that activity.
Lovatt believes this will begin a process within which intangible assets, especially data, will come to be valued more effectively. “Data suffers, as new businesses do, from being easy to grow. There is no old business which has created a $100 billion valuation in five years as Facebook did. But that value is also easy to destroy - Facebook only has assets on its balance sheet worth $6.3 billion,” he points out.
“Accountants will become more interested in data and how it is collected, used and moved inside the business. They have never been interested in that before - if you spend money on it, they get interested,” he says.
Governments, too, have started to focus on this activity, not least as part of a focus on new sources of revenue through taxation. In France, for example, the Colin-Collin report published in January considered how the state might begin to tax data collection. It is not implausible to consider that a form of Tobin tax could be proposed, just as it has been for financial transactions. With the G20 keen to tackle global corporations which pay relatively little tax, data might prove to be one of the new entry points into those money pots.
Everywhere, the digital economy is proving to be a driver of growth, but also to be elusive when it comes to booking its real value. Few of these new activities can happen without data and most are yielding vast new sources of raw material for analytics. That is where competitive advantage is being won. When the owners of those digital businesses decide they want to cash in, valuing the data asset will suddenly become a whole lot more important.