Sometimes, a bidder on a work contract may bid lower than what would maximize his/her profit from the contract and the reason for that is to create goodwill (to increase expected future business from the buyer). How would you value the goodwill that is obtained in this way?
Valuing goodwill obtained through underbidding in order to increase future business can be a complex task. There is no straightforward formula to determine its precise value, as goodwill is an intangible asset that depends on various factors. However, here are some steps you can take to estimate its value:
1. Gather data: Start by collecting relevant information, such as the total revenue generated from the initial contract, the cost of delivering the contract, and any subsequent business secured from the buyer.
2. Calculate profit: Determine the profit earned from the initial contract by subtracting the costs from the revenue. This will help you identify the immediate financial impact of underbidding.
3. Analyze future business: Assess the potential future business secured from the buyer as a direct result of your underbidding. Consider factors such as the probability of winning future contracts, the expected revenue from those contracts, and the projected costs of delivering them.
4. Compare scenarios: To estimate the value of goodwill, compare two scenarios: underbidding to create goodwill and bidding at the maximum profit level. Calculate the total profit in each scenario, taking into account the immediate and future business generated.
5. Assign a value: Quantify the difference in profit between the two scenarios as the potential value of the goodwill obtained. This value represents the additional profit that could be generated from future business due to the underbidding strategy.
It's important to note that valuing goodwill is subjective, and results may vary based on market conditions, industry norms, and other external factors. Furthermore, estimating future business can be uncertain, making the valuation process challenging. Therefore, it's recommended to refine the analysis with the help of financial professionals or experts familiar with your industry.