Using the Distributor Model to Value Customer Relationships

By: Edward Hamilton | PJ Patel

As seen in Business Valuation Update

A common framework when valuing intangible assets of a business—such as brands, trademarks, and technology—is to use the relief from royalty method, combined with the multi-period excess earnings method (MPEEM) to appraise customer relationships. This framework requires significant market evidence, especially at the asset level, because of the challenge of finding royalty indications that are directly comparable to the asset being valued. Therefore, in certain industries and situations this framework may be highly subjective and, if applied in a mechanical manner, may provide a value conclusion that is inconsistent with a qualitative assessment of the entity and its underlying assets. As an alternative, in certain situations, we replace the company-specific margin with a market-based margin, as a reasonable market proxy, in an MPEEM. This method is commonly referred to as the distributor method (DM). The name is derived from the initial use of distribution companies as the market proxy. Subsequently, extensions have been developed for other situations.

When a company has strong and unique intellectual property, such as a brand or technology, limited though material value to the customer
relationship may exist. A leading brand with strong recognition generates its own demand, and customers (retailers and distributors) carry
the brand due to consumer demand. The company benefits from having the customers in place as they enable the company to reach the
consumer. This situation, a relationship based on the ability to provide the desired product in a timely and efficient manner, is analogous to that of a distributor. A distributor’s relationships with its customers are contingent upon it providing a desired product in a timely manner. Additionally, the distributor’s operating margin is reflective of the relative importance of the IP vs. the customer relationship. The more unique or proprietary the distributor’s products, the lower the margin typically earned and the lower the value contributed by the customer relationship function. The less unique, and thus the relatively greater value added by the customer relationships, the higher the margin.

Exhibit 1 demonstrates this inverse relationship. A distributor carrying a unique product, e.g., a branded pharmaceutical, earns a lower
margin because the customer seeks a specific product. The relationship is merely a channel to the product.

An alternative example demonstrates the varying value drivers of two brands sold in a retail setting. Brand A is the leading brand with strong brand equity. It earns a margin that is above that of other products in the same space. Brand B is a secondary brand. Customers purchase it largely on price, and competitors with similar levels of brand equity exist. It earns a margin at the lower end of market observations. If a valuation practitioner applied the traditional framework using market observations of royalty rates to value the trademark, the incremental margin would largely accrue to the customer relationships, which is inconsistent with a qualitative assessment of the business drivers.

In fact, the opposite is likely appropriate; after appropriate charges for use of supporting assets such as customer relationships, fixed assets, and working capital, all economic value should accrue to the brand. This is demonstrated in Exhibit 2. As the total margin increases, the portion attributable to the brand increases as well.

Case study

A large consumer packaged goods company engaged us for a project related to its acquisition of a leading manufacturer and
distributor of snacks. The acquired brands were iconic in their region. Formal data and anecdotal evidence demonstrated the strength of the brand. Market research indicated strong brand equity, and anecdotal evidence abounded in support of the brands. There were tales of stores deciding not to carry the brand and losing customers. There were consumers who refused to go to stores that did not carry their favorite products.

Additionally, the company’s customers—retailers—carried the brand because of customer demand, not because of their relationship with
the company. As such, the company does benefit from having an assembled base of retailers and the related ability to reach consumers. Based on these factors as well as the similarity of the relationships the company holds with its customers and the relationships distributors hold with their customers, we decided to apply the distributor method (use of distributor inputs in the MPEEM) to value the customer relationships. In turn, we utilized the MPEEM using the prospective financial information (PFI) to value the brand. We determined that this method was less subjective than the traditional approach of trying to select an appropriate royalty rate from a list of royalty rates of limited comparability.

Calculation discussion

We estimate the value of the customer relationships by applying the fundamental data (margin and contributory asset charges) of a distributor to the revenue stream associated with the relationships being valued. In applying this calculation, the method disaggregates
the value added by specific business processes/IP. This method may also be viewed as a profit split. It’s important to note that the key
inputs, and in particular the margin and contributory asset charges, are based on those of the distributors. The margin is lower than the brand margin since any IP, including technology and brands, is captured within the distributor’s cost of goods sold.

Additionally, contributory asset charges (CACs) are consistent with a distributor—fixed assets are those used in distribution, not manufacturing—and are typically lower than that of a manufacturer. Working capital is that of the distributor, and may be higher or lower than that of a manufacturer, depending upon working capital practices within a given industry. The CAC for use of the workforce is likely lower than for the IP owner as it only includes individuals involved in sales and distribution, as opposed to IP-related functions including R&D and marketing. For a distributor, the workforce CAC may even be immaterial. In this example, the income stream was not adjusted for a CAC for the use of the distributor’s trade name, as we considered the importance of this factor immaterial. In other cases, it may be appropriate to apply a CAC for one or more of these assets. It is important however, that they be the assets of the distributor (distributor corporate name or logistical software), not the assets of the brand/subject entity (brand name or proprietary manufacturing processes).

We can capture the incremental value (in this case largely reflected in a brand margin that substantially exceeds the margin used to value
the customer relationships but also in differing contributory asset charges) via other valuation methodologies and ascribed it to the appropriate asset (in this case, the brand). It’s important to note that application of the distributor method without use of a brand/company level MPEEM would likely leave a substantial portion of the margin/economic profit unaccounted for and thus include it as goodwill. In practice, we have never used the distributor method to value the customer relationships if the MPEEM using the full PFI was not used to value another asset.

Other attributes of the DM are similar to the traditional MPEEM. Inputs such as revenue, growth rates and attrition rates are needed. These inputs are typically the same whether viewed from a distributor or brand-specific perspective. Exhibit 3 illustrates the use of the distributor method (use of distributor inputs in the MPEEM) to estimate the value of customer relationships for a transaction in the consumer products industry.


There may be additional situations where a selected group of companies provides an appropriate proxy for the customer relationship function. An example would be an industry in which certain companies have proprietary intellectual property and others do not. Those
that do not have proprietary IP would likely have lower margins and may, for purposes of valuing the customer relationships, provide reasonable inputs in the same manner as a distributor’s in the case study above. Similarly, the MPEEM using the PFI would then be used to value another asset, which would likely be the IP.

Acceptance of the method

VRC has been using the distributor method for a number of years. During this time we have found both interest and acceptance in terms of its use. Generally, it has been widely accepted when applied in the manner discussed. It is also in the Appraisal Foundation’s best practice document titled “The Valuation of Customer-Related Assets,” which is scheduled for publication in exposure draft form shortly.


The distributor method is a powerful tool for the valuation of customer relationships in situations where these relationships are a supporting asset and where there are appropriate market inputs—based on comparable companies—which have customer relationships that are analogous to those of the subject entity. This method also allows the use of the MPEEM using the PFI for the valuation of another asset including a primary asset or unique IP. In situations where its use is appropriate, it is nearly always a less subjective valuation methodology.