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Placing a dollar value on network technology

Jan 27, 20033 mins

One of the best questions I’ve been asked recently is “How do you value this company?”

The context was a venture capitalist asking whether the traditional formula for valuing companies made sense in a particular case. But it got me thinking about the broader question of how to value technology in general and network technology in particular.

Some background: The typical shorthand formula for measuring a high-tech start-up’s “value” is based on revenue. As any veteran of the Internet bubble knows, a start-up’s value is its subsector multiple (I’ll spare you the explanation) times its expected revenue in the anticipated “exit” year, meaning the year the company is expected to be sold.

This handy formula lets you look like a financial wizard without the time and trouble of a Wharton degree.

When asked, you simply squint knowingly, stare off into space and mumble something like, “Ah yes . . . the multiple for these types of firms is 3.5. . . . What was the revenue run-rate last quarter? And the growth? Ah, yes . . . the company is worth about $107 million.” (Make sure to throw in lots of jargon like “run rate” to create the right wizardly impression.)

Trouble is, we really are in the realm of black magic and arcane arts. This formula, while useful for general benchmarking purposes, has no particular justification. Why should a company be valued in terms of revenue rather than (as my venture capitalist friend asked) a more traditional measure, such as, say, profitability?

Let’s expand the question slightly, and maybe make it more relevant (at least for those of us lacking Wharton degrees and investment funds). How do you decide how much money a company should be spending on IT? That’s another way of asking the question, “How much is technology worth?” Several models have been proposed; most IT executives are familiar with the concepts of return on investment and total cost of ownership.

My firm uses something called the total cost of service delivery (TCSD), which is similar to the idea of horsepower. TCSD is predicated on the assumption that you don’t just deploy technology for technology’s sake. You’re putting it in place to help accomplish something – to make accounting more efficient, for example.

So you evaluate the effect of technology by comparing it with other approaches, such as hiring more accountants. If two accountants plus a new technology are as efficient as 50 accountants without the new technology, the value of that technology is 48 accountants.

The problem with this approach is that it doesn’t fit into a handy formula. And it often makes those of us who deploy it look less than wizardlike, because we don’t get to use snazzy jargon. Instead, we ask silly questions such as, “What, exactly, are you trying to accomplish here?”

Forcing people to re-examine their basic premises is never comfortable. One participant in a recent research study of ours informed us that he “didn’t answer silly questions.” But you know, sometimes the silly questions have the greatest value.