CUSTOMER LIFE TIME VALUE AND EQUITY
The case for maximizing long-term customer profitability is captured in the concept of the customer lifetime value. Customer lifetime value (CLV) describes the net present value of the stream of future profits expected over the customerâ€™s lifetime purchases. The company must subtract from the expected costs of attracting, selling, and servicing that customer, applying the appropriate discount rate (e.g. 10%-20%, depending on cost of capital and risk attitudes). Various CLV estimates have been made for different products and services.
This is an underestimate because we are omitting the cost of advertising and promotion, plus the fact that only a fraction of all pursued prospects end up being converted into customers.
Now suppose the company estimates average customer lifetime value as follows:
* Annual customer revenue: $500
* Average number of loyal year:20
* Company profit margin:10
* Customer lifetime value:$1,000
This company is spending more to attract new customers than they are worth. Unless the company can sign up customers with fewer sales calls, spend less per sales call, stimulate higher new-customer annual spending, retain customers longer, or sell them higher-profit product, it is headed for bankruptcy. Of course, in addition to an average customer estimate, a company needs a way of estimating CLV for each individual customer to decide how much to invest in each customer.
CLV calculations provide a formal quantitative framework for planning customer investment and help marketers to adopt a long-term perspective. One challenge in applying CLV concepts, however, is to arrive at reliable cost and revenue estimates. Marketers who use CLV concepts must also be careful not to forget the importance of short-term, brand â€“building marketing activities that will help to increase customer loyalty.
The aim of customer relationship management (CRM) is to produce high customer equity. Customer equity is the total of the discounted lifetime values of all firmâ€™s customers. The more loyal the customer the higher is the customer equity. Rust, Zeithaml, and Lemon distinguish three drivers of customer equity: value equity, brand equity, and relationship equity.
It is the customerâ€™s objective assessment of the utility of an offering based on perceptions of its benefits relative to its costs. The sub-drivers of value equity are quality price, and convenience. Each industry has to define the specific factors underlying each sub-diver in order to find programs to improve value equity. An airline passenger might define quality as seat width; a hotel guest might define quality as room size. Value equity makes the biggest contribution to customer equity when products are differentiated and when they are more complex and need to be evaluated. Value equity especially drives customer equity in business markets.
It is the customerâ€™s subjective and intangible assessment of the brand, above and beyond its objectively perceived. The sub-drivers of brand equity are customer brand awareness, customer attitude towards the brand and customer perception of brand ethics. Companies use advertising, public relations, and other communication tools to affect these sub-drivers. Brand is more important than the other drivers of customer equity where products are less differentiated and have more emotional impact.
It is the customerâ€™s tendency to stick with the brand, above and beyond objective and subjective assessments of its worth. Sub-drivers of relationship equity include loyalty programs, special recognition and treatment programs, community-building programs, and knowledgeâ€“building programs. Relationship equity is especially important where personal relationships count for a lot and where customers tend to continue with suppliers out of habit or inertia.
This formulation integrates value management, brand management, and relationship management within a customer-centered focus. Companies can decide which driver(s) to strengthen for the best payoff. The researchers believe they can measure and compare the financial return of alternative investment to help choose strategies and actions based on which would provide the best return on marketing investments.
An alternative formulation to customer equity is provided by Blattberg, Getz, and Thomas. They view customer equity as driven by three components: acquisition, retention, and add on selling. Acquisition is affected by the number of prospects, the acquisition probability of a prospect, and a acquisition spending per prospect. Retention is influenced by the retention rate and retention spending level. Add-on spending is a function of the efficiency of add-on selling, the number of add-on selling offers given to existing customers, and the response rate to the new offers. Marketing activities can than be judged by how they affect these three components.
Customer equity represents a promising approach to marketing management.
Marketing Insight: Progress and Priorities in Customer Equity Management highlights some recent academics thinking on the subject. Note that the customer equity notions can be extended. The relational equity of the firm is the cumulative value of frameâ€™s network of relationship with its customers, partners, suppliers, employees, and investors. Relational equity depends on the companyâ€™s ability to attract and retain talent, customers, investors, and partners.