Expected attrition rate – How 2 best account it

The expected attrition rate is used in valuing customer-related assets using the Multi-period excess earnings method (MPEEM), a discounted cash flow model, the valuation expert should identify the portion of revenue expected to be generated through repeat customers existing as of the valuation date. The estimated future revenue is derived from the revenue per customer and the number of retained customers. Because customer relationship assets derive value within a finite period, the number of customers providing repeat business is expected to decrease over time.

Measurement instrument

Attrition is the measurement of the rate of decay or loss of existing customers. The valuation expert may have to conduct a statistical analysis of historical customer turnover and revenue growth rates to estimate the expected attrition. However, historical customer data may not be available and the valuation expert may have to rely on management estimates or industry data to develop customer attrition rates. Once estimated, the attrition rate or factor is then applied to the projected revenue stream in order to separate the revenue into existing and future customer revenue.

There are two factors that may affect attrition: inherent advantage and the nature of the business. Expected attrition rateExpected attrition rate

1. Inherent advantage

An inherent advantage exists when a customer gains a specific advantage in purchasing one company’s products or services over another (e.g., if a company has a unique product or there are high switching costs). Further, the company business model may be the principal driver of customer retention. For example, companies working on an engagement basis over long periods of time typically have lower attrition rates than companies without stable recurring revenue-generating customer relationships.

2. Nature of the business

In addition, geographical reach, expected competitive environment, and the state of the industry may have an impact on customer attrition. If the company operates in an industry that is moving toward obsolescence, customer retention could potentially decrease. If competition is expected to increase, but the number of customers in the industry is not expected to increase significantly, customer retention can potentially decrease as well. Expected attrition rate

Impact on valuation

The type of analysis used to estimate the attrition rate may have a significant impact on the indicated attrition factors and the customer relationship value. In a constant rate attrition analysis, an attrition rate is identified for each period for which prior period customer purchase information is available. The valuation expert then concludes a single rate based on the attrition rates indicated for each period that is held constant throughout the remaining useful life of the subject customer relationship asset. This analysis focuses on the attrition of relationships or the revenue attributable to the relationships. Expected attrition rate Expected attrition rate

Customer impactExpected attrition rate

Although the constant rate attrition analysis requires only limited information about whether a customer made a purchase during each period, no distinction is made between customer relationships based on the size of the purchase or the age of the relationship. Expected attrition rate Expected attrition rate

Frequently, this factor may have a direct impact on the expected attrition rate and a significant impact on the customer relationship value. This is because revenue may be concentrated in a certain group and may not necessarily be reflected in the number of relationships that have been lost. For example, a company may lose only 2 customers but 20 percent of revenue, or on the contrary, lose 100 customers but only 1 percent of revenue. Expected attrition rate Expected attrition rate Expected attrition rate

Variations/segmentation/scenario thinking

An actuarial attrition analysis or a variable attrition rate analysis considers variations in attrition rates based on the age of the customer relationship. This analysis results in an indicated attrition rate for each relationship age. The use of this analysis typically requires at least five to seven years of purchase information to ascertain the relationship between age and attrition. The variation in attrition rates based on customer size can be incorporated in both the actuarial attrition analysis and the constant rate attrition analysis by focusing on revenue rather than on the customer relationships. Expected attrition rate Expected attrition rate Expected attrition rate Expected attrition rate

Expected attrition rate

Expected attrition rate

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