Research Archive

Valuing Customers

Donald Lehmann, Sunil Gupta, Sunil Gupta, Jennifer Stuart

Publication type: Journal article

Research Archive Topic: Marketing


It is increasingly apparent that the financial value of a firm depends on intangible assets (e.g., brands, customers, employees, knowledge) that are not on the balance sheet. In this paper we focus on the most critical aspect of a firm - its customers. Specifically, we demonstrate how valuing customers makes it feasible to value firms, including high growth firms with negative earnings.

We begin by defining the value of a customer to a firm as the expected sum of discounted future earnings based on key assumptions concerning retention rate and profit margin. The value of all customers is determined by the acquisition rate and cost of acquiring new customers. We demonstrate this method by using publicly available data for five firms - one well-established firm (Capital One) where traditional financial valuation models work well, and four Internet firms (Amazon, Ameritrade, Ebay and E*Trade) where traditional financial models have difficulty.

Our results show a close relation between customer value and market value for Capital One, Ameritrade and E*Trade, as of March 31, 2002. By contrast, we find that Amazon and Ebay are either overvalued or have high option value that is not captured in our model. We also compare the relative impact of improving retention (e.g., by better service), margins (e.g., by cross selling), and acquisition costs (e.g., by efficient marketing). Our results show that retention elasticity is in the range of 3-7. In other words, improving customer retention by 1% is likely to improve customer and firm value by 3-7%. In comparison, margin elasticity is about 1 and acquisition elasticity is only 0.02-0.3. We also find that 1% improvement in retention has almost five times greater impact on customer value compared to 1% improvement in discount rate or cost of capital. Our results suggest that the linking of marketing concepts to shareholder value is both possible and insightful.

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Donald R. Lehmann, Sunil Gupta, and Jennifer Ames Stuart. "Valuing Customers." Journal of Marketing Research 41, no. 1 (February 2004): 7-18.

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