Importance of Valuation of Digital Initiatives Against Other...

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Importance of Valuation of Digital Initiatives Against Other Investment

Sarah Dawson, CFO Tech Outlook | Saturday, April 03, 2021

By developing a strategy and a full range of cash-flow scenarios, businesses can more meaningfully compare digital initiatives against other investments.

FREMONT, CA: Today's accounting guidance rules do not accurately gather the value drivers of digital firms. At least not as well as they do for conventional, physical goods types of firms. Valuing assets for a physical goods firm is arguably quite simple -. Ideally, every investment decision should be assessed against an alternative course of action. For digital projects, the alternative may be to do nothing. By developing an honest base case and full cash-flow scenarios, leaders can more meaningfully compare digital initiatives and strategies against investments that may be competing for scarce resources. This method may also prompt firms to think more strategically about how, when, and how much to capitalize on digital projects, given how rapidly customers' expectations are changing.

 

Developing a realistic base case can offer the data required to vet a digital strategy or initiative's potential impact. It is also essential to identify the impact that digital strategies and initiatives may have on investment discussions. There can be some overlap, but firms' digital initiatives usually fall into one of two categories. The first is applying digital tools and technologies to disrupt an industry, needing a major revamp of a firm's business model or a spooling up of new businesses, some of which may even cannibalize the core strengths. The second category is when firms use digital to simply do the things they already do—in service to, for instance, cost reduction, enhanced customer experience, new sources of revenue, and improved decision making.

The introduction of video-streaming services has changed the economics of conventional broadcast and cable TV channels. And the rise of cloud computing has also reshaped how firms are transforming themselves and has disrupted two other sectors, man­u­fac­turers of mainframe and server computers, and firms that ran companies' data centers. Cloud computing has become an enormous business: $150 billion was invested in cloud technology and infrastructure over the first half of 2020. To value these opportunities, business leaders should utilize the standard discounted cash flow method. These firms often grow fast and do not earn profits early on should not impact the valuation approach.

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