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Custmer Value Essay

3163 words - 13 pages

What Are Your Customers Worth?
Not all customers are created equal. You need to know their lifetime value, then compare the cost of acquiring, serving, and keeping them. By Sunil Gupta and Donald R. Lehmann

Most senior executives say their companies should be customer-focused. Yet in times like these, when budgets are tight, some of the first expenditures to be cut are for marketing and IT, both of which are supposed to help companies better understand and serve customers. Professors Elizabeth Demers of the University of Rochester and Baruch Lev of New York University confirmed these conclusions in a study last year. They found that while investors implicitly capitalize ...view middle of the document...

The same can be said of almost any traditional measure of marketing effectiveness, such as brand awareness or image. We argue that there are ways to show the value of these investments if you use the concept of customer "lifetime value" to design customer-based strategies and to measure their ROI. The lifetime value of a customer is the present value of all future profits generated from that customer. In a simple theoretical example, if the customer-retention rate is 100%, that customer generates a certain profit margin for each period measured. In this case, the lifetime value of this customer is simply the present value of the future income stream. This is identical to the finance approach of valuing perpetuity.

But there are two opposing forces that affect margins over time. On one hand, customers buy more when they stay longer with a company and become more comfortable doing business with it. However, increased competition over time, as well as a changing customer mix, combine to reduce margins. The customer mix changes because a company starts by attracting profitable customers and later adds less-profitable customers. Although it's possible to build sophisticated models for estimating customer lifetime value, a useful simple estimate is the annual profit margin of a customer multiplied by a margin multiple. This multiple typically ranges from 1 to 5, and in most cases, an optimistic estimate for this multiple is 4. In other words, if a customer provides a margin of, say, $100 per year, the lifetime value of this customer is roughly $400. This simple idea can lead to significant insights for decision-making, such as how much to invest in customerdata collection and analytics (see sidebar, "Relevance, Not Abundance, Makes Data Valuable"). Lifetime value differs from the traditional present-value or discounted-cash-flow approach by focusing on individual customers and recognizing that customers don't stay with a company forever. It, therefore, accounts for customer retention and defection. Acquiring customers Because growth is critical for most companies, consistent gains in customers, market share, and revenue are typically the yardsticks for success. But if the value of a customer over his or her entire life is, say, $400, it doesn't make sense to spend more than that to acquire this customer. Yet this simple, intuitive notion is commonly ignored in the pursuit of growth. This was most evident during the height of the Internet bubble, when companies were acquiring customers regardless of the cost. CDnow Online, for example, spent an average of about $40 to acquire a customer even though our estimates suggest that the lifetime value of its typical customer was roughly $25. Such disparity has been even more dramatic in the telecommunications industry, where the potential convergence of broadband, cable, and telephone enticed several companies to spend enormous amounts of money to acquire other companies. AT&T spent a staggering $110...

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