Luca Pacioli, a Fifteen Century Venetian monk, is widely credited as the first person to document the principles of double-entry bookkeeping and is even thought by some historians to have actually invented it. If true, Pacioli can hardly be faulted for thinking only about measuring physical assets. After all, the basic economic resources of Fifteenth Century Italy were materials, labor and capital. These same resources would serve as the basis for wealth creation for centuries to come, until the end of the industrial age.
Nowadays resources can be divided into four broad categories: resources that exist in physical form, also known as structural capital; resources that exist as cash and cash equivalents, also known as financial capital; resources that reside in people, also known as intellectual capital; and, lastly, resources that take the form of relationships, also known as relationship capital.
Over the past few decades, the most valuable resources of a typical company have shifted from structural capital to intellectual and relationship capital. The shift has led to a mismatch between accounting rules and market capitalizations. For some, the mismatch has become problematic.
The problem is that commonly-used accounting principles insist on treating physical resources such as smoke-billowing factories and inventory-filled warehouses as assets while treating intangible assets, including investments in customer service and satisfaction, as expenses, no matter that the latter may create far more economic value than the former. Perhaps the reason has to do with financial reporting’s originally intended audience: bankers, who naturally preferred to lend money against resources that could be repossessed, if necessary. Bankers would be hard pressed to repossess a relationship.
Invisible beans are hard to count. Can a company place a monetary value on the strength of its customer relationships? Can it impute a value for customer satisfaction or loyalty or advocacy — which, after all, drive customer profitability and overall brand equity? What, for example, is the value of a Facebook fan or a brand advocate actively tweeting and blogging about the benefits of a product or service?
The fact that companies commonly trade at several times book value is, at its core, a function of the level of perceived customer satisfaction, which—along with various external factors—naturally informs investor’s expectations about future profitability. Clearly, a decline in customer satisfaction and a lower propensity to recommend (commonly measured using the Net Promoter Score) could foretell an erosion in future profitability, if only investors had this type of information at their disposal.
It’s clear that investors would have a better understanding of the relationship between a company’s current condition and its future capacity to create wealth if accounting could somehow incorporate a cumulative score that reflects the value of its customer satisfaction, loyalty and advocacy as an asset on the balance sheet. Perhaps someday that will be the case.
Meanwhile, the challenge of placing a value on a company’s relationship capital is being partially addressed by various players in the social media space. A primary focus area has been Facebook fan valuations. Unfortunately, there’s no universal agreement of which metrics should be applied or how they should be weighted, leading to a wide range of estimates regarding the average annualized value of a fan.
Vitrue, now part of Oracle Social Relationship Management, was among the first to devise a valuation method for Facebook fans, emphasizing five contributors to the long term business value of a fan: product spending, brand loyalty, propensity to recommend, brand affinity and earned media value. Rob Fuggetta, CEO of Zuberance and author of Brand Advocates, has long contended that brand advocates are worth at least 5-times more than average customers. Last month, Syncapse published a report stating that the average value of a Facebook fan is $174.17. CEO Michael Scissons explained the methodology that allowed his firm to impute such a precise number in a New York Times interview aptly called Putting a Dollar Value on a Facebook Fan.
It’s understandable that the need to calculate a value for such intangible assets as “the media and messaging value that is inherent with fan membership,” “the propensity for fans to organically lure more fans” and “the emotional draw felt by brands” may not have occurred to a Fifteen Century Italian monk. But the need is one that modern-day accountants, investors and analysts, as well as marketers themselves, would be wise to consider.