Apr

24

I would like to compute the present value of a client to a financial services firm. The question is, "How much is this relationship worth to the firm?"

Here is the situation: The business has high fixed costs but low variable or service costs. About $5m in fees the past year. The client has been at the firm for 30 years and is one of the top five individual revenue generators. The client is "at risk" and threatening to find a better service provider.

What I am unsure of is how to determine the cash flow to discount. Would it be the $5m revenue, would it be revenue minus service cost, or would it be revenue minus service cost minus percentage allocation of the fixed costs?

It reminds me of the statement, "Each student costs $20k a year to educate," yet if you look at the marginal cost of a student, it is practically nothing, which leaves me unsure how to think about the issue I presented.

I am wondering, would it be best to present this as "keeping this client for X years would be worth Y to the firm," or would some other method be more insightful?

Gordon Haave replies:

You need to be more specific about the fixed costs. That is, will the fixed costs travel with him to the new firm? If yes, then you value it at revenue minus the various costs. If not, then revenue minus service costs. Although it is conceivable that the competitor can lower the service costs somehow, so you should take that into consideration. 

Nat Stewart responds:

The fixed cost is that this is a large financial services firm with hundreds of pension fund clients, with all the infrastructure that that implies.

The low variable or service cost is that no single customer creates a large additional marginal cost to service. Which perspective (or a hybrid?) would create greater insight when valuing cash flows? This situation is not as extreme as the "educating a child" example, but the same idea.

Once this was determined, I had a notion of projecting the value for finite periods (value of retaining an additional 5, 10, 15 years) and also doing a simulation using an estimate of the probability of leaving each year. Still not sure what gives the greatest insights in terms of "This client is worth Y to the firm."


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3 Comments so far

  1. rajat hooja on April 24, 2007 12:32 pm

    “How much is this relationship worth to the firm?”

    In most cases letting a client who has been at the firm for 30 years and is also among the top five indivual revenue generators go to another firm is usually a bad idea.

    Here you also need to look at potnetial growth in business with this client as well as other clients who may come to your firm due to a positive reference by this client. This would be very fuzzy to quantify with any degree of accuracy.

    Rajat Hooja

  2. Stephen Halderman on April 24, 2007 10:27 pm

    Yes, there is a cost/benefit in dollar terms, but what if the effect of one client leaving makes others think there is better value elsewhere? The service costs are marginal until enough clients leave. Then, the costs become much larger on an incremental basis. A better question may be why the client wants to leave in the first place? This could open up an issue that may have other clients getting closer to leaving the firm.

  3. Nemo on April 25, 2007 1:20 pm

    I would agree with the general comments here but I would add that replacing a client will cost on average 10x what it would take to keep the client. Additionally I would warn about losing “top 5 clients” to anyone. By defenition your new “top 5 clients” will include someone with lesser revenue/profitability.

    Sit down with them. Summarize the relationship and ask what they want to be going forward and then determine if the service goals of your firm (do they want to be in that market) are aligned with where your client wants to go.

    I realize that is not a quantative approach to determining the PV of a client stream; but it is nonetheless an important one.

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