Shenehon Online: Technologoy's Contribution to Business Valuation

The Creation of Goodwill

By: Scot A. Torkelson

For most companies, prior to the 1980's, a good business valuation entailed hiring a good machinery and equipment appraiser and a good real estate appraiser. This explains, in part, why the Appraisal Institute, which serves real estate appraisers, originated in the 1930's, while its most prominent counterpart, the Institute of Business Appraisers, originated at a much more proximate 1978. Coincidence? Hardly. There was good reason for this. Historically, the market price of a business was quite close to its book value: note the nearly flat lines for stock price compared to book value from 1920 to 1950. But this changed in the 1980's. By 1985, the market value of a business began to outpace its book value. In 1990, $1.00 of book value was generating $4.00 of market value in the public markets. Market values jumped again, and by 2000, the same $1.00 of book value was generating about $10.00 of market value.

If market values are paired with book values, sequentially from 1920 to 2002, one can see that the increased 'intangible' market value emerges precisely at the same time as two landmark technological revolutions. The first occurred in 1984 when Apple introduced the Macintosh, followed by IBM's PC one year later. The second was the very public adoption of the Internet when Mozilla, and later Netscape, appeared on store shelves and PC's came equipped with telephone modems (remember those?). These two events transformed business valuation by embedding knowledge in every operating device of the factory floor, and on every desk of every employee: linking every worker, literally, with every other worker. The organizational structures within companies flattened, large production inventories could be more closely tracked, and purchases were recognized the moment they came off the shelf. The early adopters of technology were the clear winners, the resisters no longer exist.

Two comments about this contribution are in order. Goodwill has always existed, in varying degrees, but prior to the computer age there was no way to accurately measure it. Secondly, the competition allowed companies to install systems that run their businesses efficiently. This, in turn, makes them more profitable and produces higher rates of return.

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