I think of Sunil Gupta and Don Lehmann’s 2005 book, Managing Customers As Investments, as the third of the valuing customers books. (After Rust and colleagues Driving Customer Equity and Blattberg and colleagues, Customer Equity). It was written a few years after the others and I think that probably helps it read more cleanly. It has more measurement and that, to my mind at least, is a good thing. The authors are making good progress filling in the details. They give us a relatively clear way of valuing customers as investments.
The Efficient Market And Marketing
It is only sixteen years ago but I would say that the discipline has lost something since this book was published. The authors clearly are aware of the challenges of efficient market thinking for marketers. They are cautious in their discussions of what market value actually means. Few scholars are so thoughtful nowadays. The book is so much the better for the authors’ caution to my mind. You don’t need to have extreme views of market efficiency to find value in what they say. They know that life is complex and are happy to treat the reader like a serious person rather than state something dubious and add a couple of citations to published papers to ‘prove’ it.
Formula And CLV Calculations
While some will dispute the use of formula in CLV calculations I think those complaints are often over-blown. Formulas give you a clear idea of what is expected to happen/what was done. The fact that formulas require assumptions can be seen to be helpful. Using formula makes the assumptions clear upfront. The assumptions may be wrong, but the formula has been useful at clarifying your thought. I really appreciate how this book laid out its math. You can (mostly) see what they do and what they mean.
They even give us a formula for what happens when margins are growing at a constant rate. Who knows if these assumptions will ever apply in the real-world but it is wonderfully clear.
You See Hints Of Later Problems
If you have read the later literature you will see how this work fits in that tradition. There is more confusion over several points than I would like. The confusion over acquisition costs that we see in this literature is there in this book. The authors saw the problem of acquisition costs but didn’t quite know how to resolve it while staying true to prior conceptions. They make some clear points:
Considering that acquisition cost of $32 per customer has already been incurred for current customers and is therefore sunk cost the lifetime value of a current subscriber is $157.Gupta and Lehmann, 2005, page 105
Yet many of the ideas detailed seem to work against the correct treatment (or lack of treatment) of sunk costs. Soon after acquisition cost is said to be required for forecasts of customer lifetime value (page 107). Why? An example they give, Figure 3.11 page 63, suggests ‘customer value’ is stated net of acquisition.
This attempt to please everyone is somewhat hidden somewhat because the authors want to know the value of current and future customers. Acquisition costs for future customers are not yet sunk so these costs appear in the calculations they show in appendix C. This makes it read to me like the formula they outline only applies to firms with no current customers. To be clear I believe the authors knew what they were doing. I’m just not sure less sophisticated readers understood it from the confusing way things were written. To be honest things have been a mess in the field ever since.
I also worry that finance and accounting is not well enough separated. Valuing a firm can be a pretty rough and ready thing. Lots of multiples and general rules of thumb that mostly work. There is no true value so a number within a few billion dollars is often fine. Indeed if your model had entirely theoretically wrong inputs, but through luck turned out to be highly predictive of firm value, some finance people might celebrate. If you valued all the elements wrong in a set of accounts, even if your errors netted out it wouldn’t be okay. Casualness with what we mean isn’t good enough if we need to establish accounting practice. I would have liked to see more thought to the accounting, rather than finance, side of valuation. (Okay that mostly just says I’m an accountant by training).
One of the reasons to be clearer on what accountants need is that the authors have lots of ideas of how to structure firms. You need to get broad buy-in to do this sort of re-structuring. The sort of back of the envelope valuation ideas that might work for investing won’t work for accountants and they won’t be convinced by this work.
Valuing Customers As Investments
Despite my quibbles this book is focused and a very useful approach to understanding the point of valuing customers as investments. It has a more encompassing view than most work that came after it. I like this book and wish we had more like it.
Read: Sunil Gupta and Don Lehmann (2005) Managing Customers As Investments: The Strategic Value Of Customers In The Long Run, Wharton School Publishing