Intangible Assets Plus Hard Numbers Equals Soft Finance

Discounting DCF

Nelson cut her teeth on asset valuation at Hewlett-Packard. She stayed at hp for eight years, the last four of which she spent evaluating acquisitions, equity investments, and strategic alliances. It was while working on mergers and acquisitions that she found the work that she loved.

"My interest is in the core drivers of value," she says. To find those core drivers, Nelson sorts the components of any deal or investment into four "buckets": market, product and technology, team, and financial. And to evaluate those components, she reaches back to a trusted tool in the CFO tool kit: discounted cash flow, a standard technique for projecting annual cash flow into the future and then discounting its value back to the present, taking into account the time value of money. "DCF analysis is still the touchstone," she says.

But using DCF at Macromedia is very different from using it at hp. Granted, Nelson still reduces every idea to revenue streams: How much will come in and when? And she uses her cash-flow projections to calculate present value with a discount factor that shrinks the value of future cash flows in proportion to increased risk. But that's where the similarities end. At Macromedia, Nelson uses this very traditional tool in very nontraditional ways, adapting DCF to the intangibles of the new economy.

Nelson takes the vagaries of intangible assets into account by conducting sensitivity, or "what if," analyses. After carefully and systematically running the DCF numbers for Plan A, Nelson runs dozens of scenarios, generating alternatives, asking questions based on a broad set of changing assumptions, and poking holes in those assumptions. "When I was in graduate school, I used to take comfort in using a discount factor," she says. "Isn't that a great notion? It gives you a number, and that number lets you feel confident. But if all you do is use that black box of a discount factor, you haven't addressed all the issues yet. They're out there, but you don't know what they are. They're all embedded in your discount rate."

What's the New Way Worth?

In early 1998, with the executives at Macromedia growing concerned about the dramatic business changes being ushered in by the Web, Nelson came face-to-face with her own set of dramatic challenges. "The old multitiered distribution methodology was broken and getting worse," says CEO Rob Burgess. To move all of the company's customer contacts onto the Web, Burgess hired Stephen Elop to serve as senior vice president of the company's Web division. Elop's job: to answer all of the "how" questions. How could Macromedia enhance the customer experience at every point in the sales cycle? How, for example, could the company help a Web designer who was struggling with a specific animation problem? In effect, how could the company offer just-in-time training? At the same time, how could the Web help Macromedia learn more about each customer?

Elop and the executive team came up with a plan to generate Web pages on the fly that would suit each customer's needs. A cartographer, for instance, would see cartographic content. The better the fit between content and customer, the longer the site would hold the customer. In developing the site, the company planned to use two key technologies: a "membership repository" that would profile each customer, and a BroadVision transaction engine that would allow Macromedia to target very specific customers.

All of which sounds smart and makes perfect Web sense, but it leaves one huge question unanswered: What is the New Way worth? To answer that question, Nelson and Elop agreed to measure the value of the project in three ways: marketing return on investment, the cost of sales, and share of customer loyalty.

The first measure, marketing ROI, shows the dollar return on money spent to acquire new customers. Marketing ROI increases with the ability to convert sales pitches into sales. It's easy to calculate the costs and returns of using traditional direct mail. What Elop had to show was that the return on a Web campaign was much better than the return on a traditional campaign. That wasn't hard to do, he says, because creating each additional electronic "piece" is incredibly cheap. What's more, by using the Web to customize pieces, Macromedia could increase the customer-response rate.

The second measure, the cost of sales, simply shows the revenue that Macromedia could reclaim from the two or three tiers in its channels of distribution. In the past, the company's costs would balloon as distributors took their share of sales margins. Costs also went up significantly as distributors held inventory in their pipelines. The New Way could slash those costs.