Wharton School Publishing
Managing Customers as Investments

Although every company knows its customers are valuable, the important question is just how valuable they are. While companies are pouring millions or even billions into measuring customer satisfaction and building customer relationship management (CRM) systems and other initiatives, many executives would be hard pressed to clearly demonstrate that the payoff is worth the price. To effectively allocate marketing resources, executives need to be able to answer questions such as: Is it worth spending $10 million to move customer satisfaction from 3.5 to 4.5 on a 5-point scale?

"The difficulties in showing the tangible impact of most marketing investments often lead firms to resort to proven short-term strategies, such as promotions, cost cutting, or financial re-engineering, that show quick and measurable results," write Sunil Gupta and Donald R. Lehmann in Managing Customers as Investments: The Strategic Value of Customers in the Long Run (Wharton School Publishing, 2005).

In their book, Gupta and Lehmann offer straightforward approaches to bridge the gap between marketing initiatives and their financial impact for the firm. The approach is remarkably straightforward, beginning with an assessment of the lifetime value of the customer and then relating the firm’s current and future customers to the overall value of the company. For example, if the average value of a customer to a firm is $100, and the company currently has 30 million customers, the value of its current customer base is $3 billion. The firm’s predicted future customer acquisition rate and the present value of those future customers might add another $1 billion to the value. This results in a total value of present and future customers of $4 billion. With suitable adjustments (such as for taxes), this total customer value would be pretty good proxy for the value of the firm.

While they address the complexity of research and practice, the authors offer simplified approaches that managers can apply directly. For example, in assessing the lifetime value of the customer, the authors show how managers can use a rigorous yet simple formula to estimate the lifetime value of a customer for a publicly traded firm. While much has been written about assessing lifetime value of the customer, many approaches become very complex or give the illusion of precision. Gupta and Lehmann point out that, in most instances, the lifetime value is equal to 1 to 4.5 times the annual dollar margin (profit) generated by a given customer. This provides a very quick and easy way to estimate lifetime value that can form the basis for more thorough analysis.

They go on to examine three key drivers of customer profitability (acquisition, retention, and margin) and how these drivers are linked to firm value. They present a process for "customer-based planning" to increase the value of customers. Finally, they explore the organizational requirements for creating a "customer-based organization."

In this book, Sunil and Gupta offer a much-needed bridge between marketing, "where customers are king," and finance, "where cash is king." It is often hard for managers to gauge the impact of marketing expenditures because the payoffs are intangible or too far in the future. On the other hand, some important marketing investments may not be made because their impact cannot be clearly demonstrated. The approaches offered in this book allow a more rigorous assessment of marketing expenditures that can help support managers in treating marketing as an investment rather than an expense.

   

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