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    Managing Customers as Investments

     
    1/23/2006

    “The ‘atomic’ level of a business is its relationships with a customer,” write Sunil Gupta and Donald R. Lehman, professors at Columbia University’s School of Business. “Figure out where those relationships are headed and you have a strong start on understanding a firm’s value and long-run stock price.”

    According to the authors, a valuation approach based on customers can help senior managers in two critical areas: mergers and acquisitions, and firm valuation and stock price. This book clearly explains the rationale behind customer-based valuation, describes measurement tools for important but intangible sources of earnings such as innovation and customer loyalty, and also presents Gupta and Lehman’s own measurement tool for “customer lifetime value.” It concludes by explaining how to incorporate these ideas into your company’s marketing and valuation strategy to evaluate, manage, and enhance strategic decisions.

    As Gupta and Lehman observe, most companies collect customer data that provides only a snapshot in time. A measurement of customer lifetime value, on the other hand, represents the current and future profits that customer cohorts generate over their lifetime with the firm, including profit patterns and defection rates. To estimate customer lifetime value, managers must forecast five key inputs: “acquisition rate (new customers acquired over time), retention rate, change in margin per customer over time, and acquisition cost and retention cost (to the extent these are not included in the margin estimate).”

    Marketing expenditures used to acquire customers should be represented on financial statements and treated as investments, not expenses. Such a model may significantly change how marketers approach their jobs: Market share might emerge as a less appropriate metric for analyzing market strategy than a customer-based metric.

    Throughout the book Gupta and Lehman offer plentiful examples of how organizations have either succeeded by following various customer-focused practices or stumbled badly by not doing so. They illustrate their CLV model with a valuation of Netflix using public information.

    It is refreshing that a book on valuation is structured so that simple and actionable ideas are in the text, unburdening the reader of the supporting mathematical and background details, which are left for the appendices. All in all, it's a good look at a provocative topic.

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