Impact of growth rate on lost profits
When calculating lost profits, damages experts need to determine the growth rate carefully.
Failure to properly analyze the factors that drive a company’s expected revenue growth is sure to result in a challenge.
The first step in calculating lost profits is to determine the company’s lost revenues.
A key component of this step is to estimate the rate at which revenues would have grown, absent the defendant’s alleged wrongful conduct.
By necessity, this growth rate is an estimate, but an expert can take a scientific approach to determining it. As the following cases demonstrate, failure to do so may jeopardize the admissibility of the expert’s testimony in a Daubert challenge.
Chemipal Ltd. v. Slim-Fast Nutritional Foods International, Inc.
The plaintiff, a distributor, sued a manufacturer of weight-loss products for breaching its obligation to provide advertising and promotional support under their distribution agreement. The U.S. District Court for the District of Delaware granted defendant’s motion to preclude the testimony of the plaintiff’s damages expert as unreliable.
The expert had failed to make any calculations in arriving at a growth rate. Rather, he’d made a “‘ballpark’ estimate of growth rates based on his own recollection of growth rates of other products he had worked with in the past...”
The expert’s testimony was inadmissible under Daubert because he’d failed to:
- Verify the accuracy of his growth estimates, or
- Demonstrate how those estimates translate into the potential growth rate for the defendant’s products.
Because the plaintiff’s damages case rested entirely on the expert’s opinion, the court granted summary judgment for the defendant.
Celebrity Cruises Inc. v. Essef Corp.
A cruise line sued the manufacturer of the defective spa filter responsible for a Legionnaires’ disease outbreak. The plaintiff sought several types of damages, including lost profits from the time of the Legionnaires’ outbreak in 1994 until it was acquired by another cruise line in 1997.
The U.S. District Court for the Southern District of New York excluded one of the plaintiff’s damages experts in part because she’d used an inappropriate growth rate. To determine the rate, she’d used two other cruise operators as proxies.
The problem was that the proxy companies hadn’t achieved projected growth levels. In fact, they’d experienced negative growth for most of the relevant time period. The expert claimed she hadn’t known actual performance data was available when she conducted her analysis. But even after becoming aware of the proxy companies’ poor performance, she declined to incorporate the data into her methodology.
This sort of “forward-looking” approach, the court said, may be appropriate when valuing a company as of a specific point in time. But it’s “inadequate to measure damages attributable to an event occurring after the point in time when the projections are made.”
Manpower, Inc. v. Insurance Company of the State of Pennsylvania
This case concerned a dispute between a staffing and recruiting firm and its insurance provider over a business interruption claim. The claim involved the collapse of a building containing the offices of one of the plaintiff’s subsidiaries. The subsidiary sought to recover its lost profits and additional expenses while it was unable to operate its business at the insured premises. The U.S. District Court for the Eastern District of Wisconsin granted the insurer’s motion to exclude testimony by the plaintiff’s lost profits expert.
The expert determined that the subsidiary’s revenues for the five-month period immediately preceding the collapse were 7.76% higher than revenues for the same period in the previous year. He used that growth rate, without considering growth rates for other periods, under the assumption that the subsidiary’s growth spurt just before the collapse was attributable to new management and would continue. But he failed to support that assumption with economic analysis of the factors affecting its revenues.
On appeal, the 7th U.S. Circuit Court of Appeals reversed the district court’s ruling, finding that the weaknesses in the expert’s testimony went to the expert’s conclusions rather than the reliability of his methods, which was a question for the jury.
Importance of growth rates
In cases involving lost profits, be sure that your experts give their growth rates sufficient attention. Failure to support the growth rate with reasonable assumptions and detailed analysis based on objective market evidence can derail your entire damages claim.
Calculating lost revenues
Experts typically use the following proven methods — either alone or in combination — to calculate lost revenues:
- Before-and-after method. The expert compares the company’s sales before and after the alleged wrongdoing.
- Yardstick method. The expert compares the company’s post injury sales to those of comparable companies, industry averages, unaffected portions of the company’s business or some other benchmark.
- Sales projection method. The expert compares the company’s actual sales after the injury with its preinjury sales projections based on reasonable assumptions.
- Market share method. The expert estimates the company’s sales under the assumption that it would have achieved or maintained a certain market share but for the defendant’s alleged wrongdoing.