October 1, 2005

Valuing Customers

Customer lifetime value helps you value a firm and changes what numbers you track on your financial dashboard.

The Idea

Customer lifetime value helps you value a firm and changes what numbers you track on your financial dashboard.

The Research

Sunil Gupta, Donald Lehmann and Jennifer Stuart studied customer data in 2003 from five companies: a traditional company, Capital One, and four successful Internet firms, Amazon, Ameritrade, eBay and ETrade. They estimated the long-term value of a single customer and forecast growth in the number of customers, and they used these results to arrive at a value for a company’s current and future customer base. That value yielded a proxy for overall firm value.

This method is especially useful for valuing high-growth firms with a limited history and low or negative earnings, firms for which traditional financial methods do not work well. And the method uses information in the public domain — annual reports and other published financial statements — rather than data that only the company can see.

The research results also show that key customer measures have a significant impact on firm value; for example, a 1 percent improvement in retaining customers raises the value of your firm five times more than a 1 percent improvement in the cost of capital. That means your financial “dashboard” — the numbers you track at the highest level — should include measures of customer value too.

Practical Applications

CEOs, CFOs and marketing managers

You can use CLV to add key customer indicators to the financial measures you track on your balance sheet. These indicators allow you to project future cash flows from customers and assess how different uses of money and staff can yield the best future return. CLV also helps marketing managers make the case that activities to improve customer retention count as investment rather than current expense.

Investors, financial analysts and acquiring companies

The valuation of high-growth, new or knowledge-intensive businesses calls for intangible measures beyond traditional methods of discounted cash flow, using data available outside the company. This research offers a customer-based model very different from the eyeballs and page views that led investors astray during the dot-com bubble. The model does not replace traditional financial methods of valuation but rather adds in powerful customer components.

Read the Research

Donald Lehmann, Sunil Gupta, Sunil Gupta, Jennifer Stuart

"Valuing Customers"

View abstract/citation  Download PDF  

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