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Customer Equity: Nice Idea, Bit Of A Mess In Execution

In the 1990’s/early 2000s great interest arose in how to understand marketing strategy and its financial impact in terms of customers. This was an extremely welcome occurrence. The concept of customer equity (CE) was developed. It is an interesting story, full of insightful comments. Sadly in some ways the whole thing became a bit of a debacle showing marketer hubris and lack of knowledge beyond marketing. The basic idea was to show how marketing could be valuable and constructed around customers. Yet, sadly marketers failed to pay attention to key concepts in other disciplines, especially accounting. As such I personally think the term CE probably needs to be retired. It is a penny farthing of an idea. An important stage in development but a bit rickety when you look at it.

Defining Customer Equity

In some ways this is the simplest bit of CE. You can look many places and they will give you the standard marketing line. This goes something like: CE is sum of the customer lifetime values of the firm.

Sadly this isn’t really meaningful unless you have a definition of customer lifetime value and such definitions are all over the place. (For more on CLV see here). You can’t define something as the sum of something else unless you have a clear definition of the first thing.

Is CE An Asset Measure? Not Really

The idea is often stated that CE is an asset. Why then was it called customer equity and not customer asset? Equity in accounting is specifically something that is not an asset. The ‘accounting equation’ is Assets – Liabilities = Equity. If something is equity it isn’t an asset and vice versa.

I feel sorry for those who first used the term, e.g., Blattberg, Getz and Thomas see here and Rust, Zeithaml and Lemon see here. They did pioneering work. Equity sounded like a great term but it was absolutely the wrong term to use.

Does it matter? After all, we all use terms a bit loosely at times. The problem is that we really need accountants to buy into the idea to apply notions related to customer equity broadly. Using their terms incorrectly just makes them dismiss your idea right at the start of the conversation.

Another problem is that equity by its nature is a remainder. It is something you can’t show evidence of, it just emerges from other measured items. Yet what point do marketers really want to make in this literature? The point is that the value of customers is something that should be directly measured. You directly measure assets, you do not directly measure equity. Yet marketers want people to believe us that we can show the value of customers, i.e. we can directly measure the value. Why then do we use a term that implies that the value of customers isn’t measurable? It is just a really unfortunate choice.

What Do You Want It to Do?

The challenge is that marketers seem to be a bit confused as to what we want CE to do.

Is it a term for marketers to use? Maybe, but it isn’t tied well into marketing decisions.

Do we want accountants to use it? Maybe, but beyond the problem of the terminology sunk costs in the form of acquisition costs fly around in customer equity thinking like dementors at Harry Potter’s 18th birthday party. The sunk costs just mess everything up in an evil way. Leaving it unclear what we are saying.

Do We Have Finance Envy?

Why did we do this? It may be because marketers want to be taken seriously by finance people who deal with shares. Rather than accountants who deal with reporting. (Marketers you have met Wall Street. You should have found out by now that many of them are arseholes. Your mum would love you to settle down with a nice accountant). Marketers want to speak to firm valuation. They see this as sexier. As such, they want to add in future customers. Thus, they shoehorn future customers — otherwise known as ‘not really customers’ — into measures of customer equity (see here). This makes the whole thing very confusing.

Future customers will need to be acquired. This means the acquisition costs of these non-customers have to be considered if you are valuing a firm. I agree they need to be considered but why do they have to be included in customer lifetime value? (Probably because we have defined CE as the sum of CLVs and want to include future customers in it). Messing with CLV allows us to still call customer equity the sum of customer lifetime values. Sadly, we then need at least two different definitions of customer lifetime value. It is a complete mess, which is totally self-inflicted by marketers. (Much that we all like to blame accountants for all bad reporting choices).

How Do Marketers Cope With The Mess

Some marketers, sensibly I think, reserve customer lifetime value for current customers. You often see this done by people who want their models to actually work and be understood. For this see work by Bernd Skiera and Phil Pfeifer. To be clear you can still value a firm’s future customers without throwing sunk costs into CLV. Having a single clear definition allows us to build credibility around CLV. Having only one definition of CLV will make it seem less like the standard marketer BS that accountants always worried it was.

Another approach is to be very explicit that there is current- and future-customer equity. This makes sense. Sadly as though we were worried that the terminology was too easy we have decided to call current-customer equity — static customer equity. We then call future-customer equity (plus its current form) dynamic customer equity. Now static is mostly applied to valuations of current customers over the long-term at a given point in time. Dynamic is mostly applied to valuations of total customers over the long-term at a given point in time. Both static and dynamic could be described as static or dynamic depending upon how you squint. The opaque terminology seems almost designed to prevent the uninitiated from using the idea. What is the main hope for CE? That it will gain widespread usage. Once you call things static and dynamic I think that boat has already sailed. (Or maybe sunk?)

I just find this confusing. Current customer equity changes every time you look at it so it isn’t really static. Why are future customers dynamic? This value changes over time which is good but then so does static customer equity.

How do marketers cope with the mess? They like to make it messier.

The Customer Equity Statement

Blattberg, Getz, and Thomas in an inspired book introduced the idea of the customer equity statement. That was a brilliant idea. Sadly the way they did it undermined their brave attempt. It was a brilliant mistake, see here. The customer equity statement outlined didn’t take off. I think that may be because it is very confusing and doesn’t conform to any current financial reporting practice. Accountants could never use it and it isn’t clear who else would.

Drivers Of Customer Equity

Work has dug into the drivers of customer equity. I will note that there is much that I admire in the work of Rust, Zeithaml and Lemon (here). Yet, I think they made a mistake by focusing on a survey to understand drivers of customer equity. It becomes a bit too ‘standard marketing strategy’. I would argue the hope behind customer measurement is that we can get to something that will impress those who don’t normally buy marketing ideas. Customer equity was a crossover idea and I don’t think the work on drivers of customer equity crossed over enough. (‘Go towards the light customer equity. The accountants on the other side are friendly’). I think we need to concentrate on drivers of customer value actually in the equations we use to make the idea clear. E.g., increasing retention by x% will increase the firm’s customer asset by $y.

What Drives Customer Equity?

A Unified Theory Of Marketing

I think the general idea of viewing customers as assets is a powerful one. As such, I do genuinely value the work in this area. (Sorry if, as ever, I seem grumpy — it is just a personality flaw of mine). I see the potential for a unified theory of marketing. Let’s do it.

But maybe let us not use the term customer equity. Customer asset anyone? If there are no sunk costs and only current customers are valued maybe accountants might actually buy it.

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