Using Salesforce

I'm in process of migrating to Salesforce.com for our company's CRM. Here's what I know so far:

1. Salespeople there are meticulous during the sales process. I'm hoping this is because they're using Salesforce for their CRM.

2. You can get a user "seat" for about $65/month, and set up billing quarterly, semi-annually, annually, or bi-annually. Bi-annual prepayment gets you a discount.

3. I posted a "user case" on my profile, and received a call from a tech guy within a couple of days. He left me a voicemail because I couldn't take his call. I called him back and left him a voicemail. Another tech guy called me back about an hour later and walked me through the answer to my question. He was clear and thorough.

4. If you are using a contant/registration form on your website and you want to fully integrate Salesforce into your sales processes, you'll need to pull out the contact/webform on your website that exists and replace it with the Salesforce "web-to-lead" form.

That's all for now. Still haven't migrated our contact data over because of the day-t0-day fires, but I'm cautiously optimistic. Would be nice to be able to employ a consultant to handle the migration for us. But seeing that we're paying less that $1500/year, I'm not about to pay $2-3K to have someone come in and do this for us. (Though maybe I should, but cash flow is always the challenge in start-up land...)

No Revenue, Profit or Free Cash Flow? Now what?

In my recent post, I discussed how a firm's value could be determined simply by discounting the total revenue of the firm over a reasonable time period using an appropriate discount rate - the "Discounted Revenue Valuation Model" (DRVM)- because a firm's revenue represents the total benefit received by its customers.

DVRM focuses more on the economic, or intrinsic, value of a firm, not the market value of a firm. Financial markets and investors have shown a propensity to ignore economic valuations, instead valuing firms at artifically higher levels, creating a "market value" that exceeds true "economic value." This is the fundamental issue that I am addressing in these series of posts.

While I think DVRM a good starting point to begin to alter the way we think about firm valuation, practical challenges emerge with using this approach.

From a financial and accounting standpoint, it is possible for a firm's expenses to exceed its revenues. If a firm under evaluation has this condition, then the firm would not be a sustainable enterprise over the long run (assuming no change in the growth rates of revenues relative to expenses over time). So it seems that revenue alone cannot serve as the only indicator or proxy for determining firm value.

Arguably, it would be more responsible to take into account what's left from a firm's revenue after deducting all expenses. This is commonly known as "income" or "profit." Instead of using revenue, one could project a firm's annual income over a reasonable time horizon, determine a discount rate that fairly represents the risk level or opporunity cost of capital for the firm, and reach a new value for the firm. Using this method, there is the implicit correction for expenses incurred by the firm to achieve their revenue.

Even so, there are still problems with using a "Discounted Income Valuation Model." Primarily, accounting rules allow for a firm to claim expenses and revenues that are non-cash events, such as Depreciaton and Amortization on the expense side of things and Accounts Receivable on the revenue side. Therefore, accounting rules show that a firm may show an accounting profit, but may not have positive cash flows.

Cash is king, and anyone who's every been without money when they need will certainly attest to this. This leads us to using annual Free Cash Flows (FCF) to determine a firm's value. Just as we did with our Revenue Valuation Model and Income Valuation Model, we just forecast FCFs through a reasonable time period, discount them back using an appropriate discount rate, and now we have the true "value" of a firm.

Every textbook in basic finance espouses this method for properly determining a firm's value. This line of reasoning - starting with revenues, then using profits, and then using FCF to determine a firm's value - is exactly why textbooks and academics argue that the Discounted FCF Method is the proper technique to value an asset (or firm in this case).

But, here's the big problem -

Most start-ups generally have no FCF, Revenue, or Profit. And if this is the case with Facebook (which does have some revenue, though very little relatively speaking), how can you logically use some variation of the Revenue or FCF Valuation Models to accurately determine the true intrinsic or economic value of a firm?

I would argue that you can't. Throwing out valuations such as 10x revenues or 100x revenues to determine a firm's valuation is an economically unsound practice. There must be a better way to calculate firm valuation outside of some variation from the Revenue or FCF Models.

Company Value = Benefit to Customers

A common way to value a company is to look at the company’s total revenues and then take a some multiple such as “1x” or “2x” in conservative industries, with “10x” as an acceptable standard in the technology industry, and an incredible “100x” as witnessed in Microsoft’s valuation of Facebook. We’ll call this the “Revenue Multiple Approach” (RMA).

What’s interesting to me is that you never read about why we use "revenue" (or a multiple of revenue) to establish a firm’s valuation.

I was considering company valuations last week from an economic perspective - thinking more about how and why companies are valuable and how they fit into the broader economy and less about the plug-and-chug, back-of-the-envelope modeling that is common in finance. It made sense that a firm’s value solely should be based on the benefit that its customers receive from purchasing the firm’s products and services.

The outcome of this explanation is to show how we can generate the value of a firm (“Supplier") based on its sales to its customer(s) (“Purchasing Firm”)

In general economic theory, we know that consumers will consume a good as long as price of good is less than (or equal to) the benefit received by the firm. Consumers consume based on personal utility and firms consume production inputs to minimize cost (or maximize profit). It is possible to calculate the contribution of consuming this input to total profit.

Mathematically, this is means that a transaction to purchase a good or service will occur only if:

Price of a Good ≤ Value

So, if the value of a good is expressed in its price, then the value of a product is equal to the maximum price that the good’s consumer is willing and able to pay.

Total Value of a Good = Max Price Paid by Purchaser

(This sort of reinforces what we said above about a transaction taking place only if the price of a good is less than or equal to its value to the consumer.)

In a perfectly competitive market, firms produce to a point where their marginal cost of producing a product is equal to the marginal benefit gained from its sale. This is represented by the marginal cost/marginal benefit curves, also more commonly known as “Supply” (marginal cost curve) and “Demand” (marginal benefit curve).

If a firm produces to the point where MC = MB, then the costs to the Purchasing Firm for the good will be equal to the revenue of the Supplier. Conversely, the revenue of the Supplier will be equal to the marginal costs of the Purchasing Firm, which happens to be equal to the marginal benefit received by the purchasing firm.

So if we want to determine the Supplier’s value, then we can assume that its value is equal to the total marginal benefit experienced by all Purchasing Firms, which we’ve said happens to be equal to our Supplier firm's revenue.

Simply put:

Value of a Firm = Total Marginal Benefit Received by its customers = Total Revenue of Firm

Instead of using the Revenue Multiple Approach, we could call our company valuation model method the “Marginal Benefit Valuation” (MBV) because when we’re using revenues to determine a firm’s value, we’re really just calculating the firm’s total marginal benefit to its customers.

Finally, the last step in this process would be to take some reasonable time period, project revenues each year over that time horizon, use a discount rate that correctly assumes risk level or opportunity cost, and calculate a firm's value based on the discounted revenue streams during this time. And there's the basis for firm valuation using revenues to make the determination.

As an extension to the discussion ---

Which multiple to use (1x, 2x, 10x, 100x…)?

Much of that decision is subjective based on brand recognition, future company growth, the industry, and pure subjectivity. (We all remember the dotcoms where business valuations were based on which venture capital firm was willing to bid the highest.) This is another article in itself….

Why use multiples of revenues?

Well, as a part-time academic (I teach Finance at the University of San Francisco), I’ve personally never been able to get my head around using the RMA. If revenues are the choice for determining a company’s value (because they represent the Marginal Benefit received by their customers), it seems that it is far more logical to calculate the present value of future revenues. If one is particularly bullish on a company’s future prospects and would like to reflect this attitude in a company’s value, just adjust the discount rate downward and adjust the growth rate upward to yield higher present value (or higher company value). But of course, then you’re infusing significant subjectivity to the equation, but this approach offers a more sound theoretical modeling technique.

Market Value vs. Intrinsic Value

I'd like to tackle the issue of firm valuation. Determining a firm's value is especially important for start-up firms under consideration for venture funding. Establishing, maintaining, and increasing a start-up's value is central to the reason the firm was founded and for utilizing venture capital and investment provided to it.

This introduces an item that requires further clarification - the definition of "value." Value can be generally defined as "a fair price" or as "utility" or "worth" (courtesy of the American Heritage Dictionary...).

In the financial world, it's common to differentiate among types of "value." Specifically, there is a difference between an asset's "market value" and its "intrinsic value." Market value is the value that someone else places on an asset - what that asset is worth to some other market participant. Intrinsic value is the actual value or worth of a firm.

This fundamental difference in values supports the argument that the true value of a company is not necessarily reflected in the market valuations given to them by other market participants. The case I referred to was Microsoft's $15 billion valuation of Facebook. Valuations generated by venture capitalists or other related suitors nearly always tend to be market values, and not a reflection of a firm's intrinsic value.

If a VC values a company at $100 mln, and makes a $10 mln investment, that means that they have purchased 10% of the company. That initial $10 mln investment may be (or at least should be) entirely necessary for the target company to propel itself for product development, sales, and eventually profit. However, given that VCs are wrong on their company valuations 90% of the time, the $100 mln valuation is solely based on the market value - what the VCs are willing and able to pay for some asset.

In this case, they are willing and able to pay $10 mln for 10% of the company. Surely they would be willing to pay less that $10 mlm for 10% of the company, and alternately, the company owner would surely be willing to sell less than 10% of the company for $10 mln. But assuming that the VC and the company operate in a competitive market, this $10 mln investment for 10% of the company represents the market equilibrium price for the asset (the asset being 10% of the start-up).

This market price doesn't necessarily mean, and in most cases, does not mean that the intrinsic value of the start-up is $100 mln, only that the market value of the start-up is $100 mln. In fact, with the 90% failure rate of the VC industry, it stands to reason that the market valuation of the company is quite overpriced, but because there is a willing buyer and seller, a market for the 10% of the company is created.

With a couple of fundamentals definitions, we can begin to see how the market valuations for start-ups and new media companies may be incorrect a high percentage of the time, with these errors tending to overvalue a firm rather than undervalue a firm.

It's a point of frustration to see artificially high market values placed on firms (whether they be start-ups or publicly-traded) when it is clear the economic or intrinsic value of a firm can be clearly argued to be much lower.

Free Information for sale...

Working with Altos Research over the past six months, it's been fascinating to not just have a front row seat in the theater, but be up on stage as one of the main cast members. Sales and subscribers and growing every month, and the use cases of the residential real estate market data that we collect and provide to our subscribers are becoming more and more diverse.

The Altos Market Reports and AltosCharts compose the crux of our product line for real estate professionals (agents, mortgage lenders, title reps, etc.). The reports are updated weekly, providing our subscribers with local market information to share with their clients about the constantly changing real market dynamics.

Our CEO, Mike Simonsen, passed along a link to a blog post by Kevin Kelly from Wired Magazine titled "Better Than Free" that discusses how free data on the Internet is valuable and can be sold if packaged correctly. It's a striking post and motivated me to do a quick analysis of the Altos Market Reports and AltosCharts to see if we meet the criteria in Kevin's article. Turned out to be a remarkably pleasant experience. Seems we're doing things pretty well here at Altos Research....

Immediacy - Check! The Altos Market Reports are updated every week and available for download on Monday of each week, reflecting market data collected from the Friday before.

Personalization - Check! Market Reports include the contact information, photo, and logo of each subscriber. This enables our clients to utilize the reports for outbound marketing and impress the heck out of their clients and potential clients in listing and update meetings.

Interpretation - Check! Subscribers receive a training session over the phone regarding the market stats in our reports and how to use them effectively with their clients. In addition, we're launching a User Forum this week where subscribers will be able to collaborate on use cases.

Authenticity - Check! There is a branding aspect to the Altos Market Report and the AltosCharts. The reports are copyrighted to Altos Research, and our clients like that we're a third-party, objective source data. Being able to rely on our data collection reliability and accuracy enables clients to support their argument with their clients.

Accessibility - Check! All subscriber reports are hosted at Altos Research - just log in, download the report(s) needed, and off you go. Additionally, we're launching a CRM application that enables real estate professionals to auto-send copies of the market reports directly to their clients are part of their drip marketing campaigns.

Embodiment - Check! All of the market data/stats published in the Market Reports is available for display using AltosCharts - a "widget" that is posted to a website, updates itself automatically every week with new data, and can be utilized as a web conversion tool.

Patronage - Check! From the early days of availability, our clients have been enthusiastic subsribers. With a retention rate over 90%, there's no doubt the Altos Research clients see the value for their subscription fee.

Findability - Check! Clients continuously share stories about how our Market Reports and specific data within has helped them with their clients and getting the next listing. This is often the same data found in alternative sources, but not with the clear packaging and presentation necessary to communicate the key ideas.

Fun stuff - sometimes its okay to give yourself a little pat on the back....