Listening to a lecture on the sales of commodities or glancing through at an article in recent economic theory might leave you with the impression that valuing a product is all about numbers and statistics. Of course, the final valuation of a commodity will be monetized but that does not mean that non-quantitative factors can be ignored in the valuation process. In fact, it is only because of certain qualitative factors that a commodity will be valued above or below another virtually similar commodity.
The same is true of websites in which qualitative factors are used in conjunction with quantitative factors and traditional valuation methods to determine its value.
WidgetWeb and Web’s Widget
When discussing monetary value, it is often helpful to have a template with which to work. We build this template with two fictional websties: WidgetWeb and Web’s Widget.
WidgetWeb has been running for five years, and its owner is ready to take it to market. He assembles this graph to account for Revenue, Expenses (Loss) and Profit:
Now let’s take a second fictional website: Web’s Widget. It has only been running one year and has generated a similar chart using the same statistics as WidgetWeb.
The Importance of Time, Revenue and Profit
It is readily held that a website that has been online longer than another is automatically worth more to a buyer. Thus before we look at any other statistics, WidgetWeb is already a more desirable asset. As well, though there have been arguments to the contrary, it is readily held that profit is considered more important than revenue in the valuation of a website. As can be seen, both WidgetWeb and Web’s Widget profit in year one was negative. In other words, both businesses lost money. For this, a potential investor is likely to be uninterested in acquiring either.
However, we can see that there was a capital expenditure of $1,100 for both sites. Taken purely as a quantitative factor, it is immediately included in the buyer’s calculation. But let’s look at the quality of this expense. If this was a computer the founder of the website purchased for the purpose of running this site, it might be entirely removed from the considerations of the buyer. After all, this is not likely to be a recurring expense after acquisition. When removed from the equation, WidgetWeb profit is $0; Web’s Widget’s is $200. In this situation, Web’s Widget is more desirable for a potential buyer when the first year’s profit minus capital expenses is examined.
Now let us look at the full five year life of WidgetWeb, including and then excluding capital expenditures. WidgetWeb’s founder purchases a new computer for the business every two years. The average profit per year in the former instance is $920 and, in the latter, $1,560. In either case, WidgetWeb now becomes more desirable than Web’s Widget for two reasons: 1) the average profit for WidgetWeb is higher than Web’s Widget ($920 or $1,560 compared to $200) and 2) Widget Web has a longer history of existence.
In addition, the longer a business has been alive, the more eyes have seen its brand. And a brand can be an important market for future earnings. Some businesses with recognizable brands have sold for millions. Thus, we see how looking at the qualitative analysis of capital expenditure and qualities such as brand can add value to businesses in surprising ways beyond what mere quantitative statistics can illustrate.
One of the most popular methods for determining the value of a website is by taking profit and applying a determined multiple. There are many different types of websites however, and multiples can differ accordingly with some types of sites being subject to higher multiples than others. The application of qualitative factors such as brand can also help to increase the multiple. In short, a qualitative and quantitative examination of a website can generated a higher value than merely looking at statistics alone. Nonetheless, the average multiple is 2.56. Taking average profit minus capital expenditure, we arrive at a figure for WidgetWeb of nearly $4,000 and Web’s Widget of $512. Taking only last year’s profit into consideration, Widget Web’s value remains stable while WidgetWeb’s soars to $10,496.