The Proper Price for a Domain, Part 3: Working the Numbers Wrong | #15 in Series: What Businesses Need to Know about Domaining

In this series I address people running a business or organization of any size, from entrepreneurs to the whole C-Suite, as well as Business Development, Marketing, Sales, Finance and IT. But I welcome all readers, including of course domainers. ?Series Table of Contents

In my last article, we continued our analysis of what a specific domain can do for you, by generating projected performance numbers for it — basic numbers, on which to base further calculations. We covered the steps 3, 4 & 5 in our evaluation process.

So now you have projected performance numbers for the domain. But what should you do with them? How should you translate them into the worth of the domain for your business, or a price you should be prepared to pay for it?

The answer may be obvious to you, and you may well be right. But the right answer is not obvious to everyone, since what some people are advising is obviously wrong. It's important to understand why what's wrong is wrong, because without that you can't understand why what's right is right — and then you're at risk of miscalculating and getting it wrong yourself.

So far, we've done steps 1 to 5. Next is step 6. In the next article, we'll do step 6 right (step 6b) — but here (step 6a), we'll do it wrong!

6a) Translate the numbers from step 5 into an interim money-based price cap, the maximum you should be prepared to pay for the domain based solely on the narrowly conceived and time-limited potential financial value of the domain for your company.

That's the objective. Now let's apply a rule of thumb to your numbers without proper understanding, as at least one domaining site, which is out there as I write, is advising you to do. We'll arrive at a dangerously wrong result.

I recently came across the advice that a domain is worth 10% of the annual revenues you expect it to generate.* I found this fascinating, because it's in the right direction and yet so wrong. It's in the right direction, because it's applying our principle that the value of a domain is what it can do for you.

But it's wrong because it's using the wrong numbers to measure what the domain can do for you. Specifically, it's using projected annual revenue. But revenue comes with associated costs, such as payroll and shipping costs. Those costs must be paid first, so the part of revenue that pays them can't pay for the domain, or for anything else.

Breakeven is the point where an investment has paid for itself.** The payback period is the time between making an investment and reaching breakeven.

The opportunity cost of an investment is what you can't do with the money you spent on the investment, instead of spending it on the investment, because you spent it on the investment.?The opportunity cost is initially equal to the price of the investment, then shrinks to zero at breakeven.***

Even if a investment is adding to revenue, that part of the additional revenue that's needed to pay for other costs can't contribute to reaching breakeven. During the payback period, until breakeven, the investment is in the red.

The implications of this are huge. Consider this example.

• Company A is a software business. Profit = 10% of revenue.
• Company B is a grocery business. Profit = 1% of revenue.
• Both companies estimate that a particular domain (a different one in each case, of course) would generate $1 million annual revenue.
• The 10% guideline advised by the domaining site I mentioned says they should both be willing to pay up to $100,000 for the domain.****
• On that basis — paying $100,000 for the domain and then actualizing its revenue projection — Company A, with its 10% profit margin, ?will reach breakeven in 1 year, and the investment will be profitable beginning in year 2. The opportunity cost of the acquisition will evaporate in just one year, and by the second year the domain will be generating new opportunity. The domain quickly becomes a powerful asset.
• On the same basis, Company B, with a 1% margin, ?will reach breakeven in 10 years, and the investment will be profitable beginning in year 11 (assuming its annual revenue projection holds true for that long). The opportunity cost will linger for a decade, as the acquisition remains in the red. For ten years the domain will drain badly-needed limited resources from other sectors, dragging the company down.

See the problem? The right reference number is not revenue but profit.

• For Company A, 10% of the revenue generated by the domain can be used to pay for the domain; the rest goes to pay other costs.
• For Company B, only 1% of the revenue generated by the domain can be used to pay for the domain; 99% is eaten by other costs.

?A domain can only pay for itself from the profit it generates.

The 10%-of-annual-revenue advice was so bad, I wondered where it could have come from. Fortunately, it doesn't seem to be widespread — either on domaining sites or elsewhere — but I did find a 3/23/2021 statement online, "B2B product industries allocate, on average, roughly?10% of?revenue?to marketing, which is similar to B2C Services (10.1%)."*****

Now, that's not a recommendation or even a rule-of-thumb. It's just a statistic. There are some investment rules of thumb out there, but they generally give a broad percent-of-revenue range with significant qualifiers, or else don't use revenue at all.

Still, I get the logic behind the bad advice — which makes me think the error was unintentional. A domain is for marketing, so someone must have thought that the same percentage of revenue that's earmarked for marketing for the company as a whole (for the average B2B product company), should be applied also to the acquisition of marketing assets (for every company).

But that's not right. It's wrong in two ways:

1. A statistical average for B2B product companies should not be used as a prescriptive standard for any particular company (such as yours).
2. Overall budget allocations are made to ensure that within available resources, all departments get what they need to keep the boat afloat. But a purchase outside of that allocation can't be computed as just an extension of that allocation. It must be evaluated in terms of its impact on the whole company and all its parts, lest it suck money from other needs for years until breakeven, as with Company B in our example. ******

Why did I spend a whole article on an example of how to do work the numbers wrong? Because, as I said, I didn't make up the example. The bad advice (or 'guidance') is out there, ready to entrap the unwary, even if (fortunately) it's currently pretty obscure.

More to the point, if you don't really understand the numbers you're dealing with, you're likely to deal your company right into a deep black hole.

In my next article, I'll show how to work the numbers right.

(Like this article? 'Like' it! Have a question or comment? Comment! Think it's worth sharing? Share it! Thanks! - Keith)

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* On at least one site, it's even worse than bad advice. It's razzle-dazzle. The percent-of-projected-additional-annual-revenue principle isn't stated at all, it's just embedded in a handy online calculator that purports to tell a prospective buyer how much they "should offer" for a particular domain.

The calculator performs a simple multiplication anyone could do in their head — it moves the decimal point one notch to the left, knocking off a zero — unless the buyer changes a '0.1' default in a 'brand value' field (huh?), with no indication given as to what that is or why they might want to change it. And even then, the calculator ?just performs a one-step multiplication.

But this is presented as a sophisticated determination of what you "should offer" for the domain. The Wizard of Oz said, "Don't look behind the curtain." But I'm saying, you'd better look!

** Actually, 'breakeven' can refer either to ongoing revenue = costs, or cumulative revenue = costs. I'm using it here in the cumulative sense, which is appropriate in evaluating a proposed large initial investment.

*** That's if we ignore complications from all sorts of compounding effects.

**** Actually, the site says they should both offer $100,000! There's nothing about paying "up to" that amount. Maybe the domainer would accept a $20,000 offer, but the site is saying each company should offer $100,000. If the domainer would actually accept $20k and the companies do pay $100k, they'll be paying $80k more than they need to, which will be happily pocketed by the domainer.

***** I don't know if this statistic is actually the source of the idea for the 10% guideline on some domain sites, but it's the thing I found that makes the most sense of it. It doesn't matter, though, because regardless of the source, the sense it makes of the guideline is still nonsense. Here's the source for this statistic: https://blog.hubspot.com/marketing/marketing-budget-percentage

****** Company C sits by the sea. They spend 10% of their annual budget on marketing, and 15% on maintaining and developing the physical plant (buildings, etc.). Now they get a notice from their insurance company that to keep their insurance, they must build a seawall to protect their facilities from increased flood damage risk due to climate change.

How much should Company C be prepared to pay for the seawall? 10% of the projected additional annual revenue it will generate, because that's the percentage of the annual budget allocated to marketing? Or 15%, because that's the percentage allocated to the physical plant?

Tough question, easy answer, because in this case 10% = 15%. By either guideline, Company C should pay zero for the seawall — zero dollars, zero euros, zero yen, does it matter? — because the seawall is not expected to generate additional revenue.

So the company ought not to invest in the seawall at all. Instead they should lose their insurance (which actually will add to their bottom line!) and then sit there unprotected by the seashore until a big storm washes them away.

You could object that this example is silly, because the seawall isn't for marketing. But that's not the problem. The problem isn't with applying the percent-of-projected-additional-annual-revenue guideline to a physical plant investment, it's with applying it to a marketing investment, to any investment.

Redact the labels — 'marketing', 'physical plant', 'domain name', 'seawall' — read the examples with these labels blacked out — and you'll see that they don't really make any difference. Or they shouldn't. It's the principle that's wrong.

Any investment has its own costs and benefits. If these are relatively small, routine, and/or fall within the scope and budget of a particular department, that department can make the decision by its own criteria. But to the extent that the benefits, or especially the costs, push beyond those limits, the decision must be evaluated holistically from a broader perspective.