For marketing to get a seat at the corporate valuation table, we need to move from customer equity to customer-based corporate valuation

It is increasingly clear that customers deserve a more prominent role in the process through which firms are valued. Traditional financial information is getting less and less relevant as more and more of company valuations are coming from intangible sources.  Other measures such as same store sales have also lost relevance as more business is being done online instead of in-store. Investors currently have a blind spot – just ask early investors in Blue Apron, Lyft, Uber, and WeWork.

While these other data sources are becoming less relevant, customer-related data sources are becoming a lot more relevant. Visibility into individual-level customer behavior has significantly improved, as has our ability to convert that data into forward-looking insight. And at the end of the day, every dollar of revenue must come from a customer making a purchase. Better insight into future customer behavior could help investors see underlying “unit economic truth” and significantly reduce the incidence of Wile E. Coyote moments in financial markets:

The solution: customer equity?

We in marketing saw this coming decades ago. Robert Blattberg and John Deighton, professors at Carnegie Mellon and Harvard, respectively, invented the term “customer equity” (CE) back in 1996 to show how customer activity could help measure (and manage) shareholder value (SHV). Loosely speaking, CE represents the sum of the customer lifetime values (CLVs) of a company’s customers. Blattberg and Deighton’s work kicked off a veritable flood of articles in marketing refining the notion. Many scholars wrote articles and books heralding CE as a quantity that would become a regular, everyday part of the financial lexicon.

Blattberg and Deighton were prescient, and something like CE is sorely needed by financial market participants and company executives alike. This would also be a very welcome paradigm shift for marketers everywhere, to put it lightly, as a host of powerful new stakeholders come to realize the importance of managing the value of the customer base (i.e., what the CMO is traditionally in charge of). Marketers may hypothesize about the value of marketing assets, but in some sense, it is investors who actually determine the valuation of those assets. I genuinely believe this has the potential to be a game changer for the field of marketing. I can’t think of any other opportunity that could expand the role of marketing anywhere close to the extent that this could. A lot is at stake here and we can’t afford to let this opportunity slip through our collective fingertips. It’s why I wrote this paper, even though I am first and foremost a quant marketer.

Unfortunately, while the flooding continues, by and large, within academic marketing, traction outside of the ivory tower has remained a small trickle. CE isn’t in any corporate valuation textbooks or classes. A systematic review shows that CE is also virtually absent from company conference calls and popular media. Despite CE’s intuitive appeal, it remains for all intents and purposes unused by financial professionals and executives. 

Issues with customer equity

Given how many years it has been since CE first came onto the scene, it seems fair to say by this point that something is up. Do financial professionals and company executives just not “get it”? C’mon, of course not. Investors are highly intelligent and paid unreal sums of money to understand anything that will give them even a small edge.

In a recent paper I wrote with Fernando Pereda, available here, I analyze why, challenging conventional thinking by arguing that we as marketing academics are to blame for not “challenging our boundaries” enough, to borrow a phrase from Duke professor Chris Moorman and her colleagues. If we want finance to adopt marketing’s ideas, marketing will need to better adopt finance’s ideas – and after all, finance (and accounting) have spent a lot more time than we have perfecting the theory and practice of corporate valuation. Broadly speaking, I identify two issues that have stymied CE’s progress outside of marketing academia:

1.      There is considerable disagreement among top marketing academics over how CE should actually be defined. Most papers who talk about CE do not actually define it, and definitions vary widely for those who do. If we can’t agree on a definition for CE, how can people follow our lead? In the paper, I propose a series of guiding principles for what CE should be, then comb through the CE literature with these principles in mind to arrive at a “best” definition for it.

2.      Using this single best definition for CE, I show that while it can be very relevant and useful as a marketing metric, it does not score highly as a corporate valuation measure – as an estimate of the overall dollar valuation of companies – for two reasons:

• CE is a highly incomplete proxy for the operating asset value of a firm, and an even more incomplete proxy for shareholder value (SHV). As a result, decisions that are best from a CE standpoint may be far from optimal from a SHV standpoint. I identify a number of situations in which CE will systematically favor the wrong solution – and that these issues will hound not just CEOs and CFOs but also CMOs and marketing managers. Executives could easily get sued for disregarding their fiduciary duties following a CE maximization strategy. These issues obviously carry over directly to the investment community – I show that the valuation estimates are off, making CE not usable for absolute or relative valuation purposes.

• CE is practically impossible for financial professionals and executives (e.g., PE investors, value-oriented hedge fund managers, and CFOs) to actually use on an ongoing basis from an operational standpoint. CE approaches are incompatible with standard valuation methods (e.g., there is no CE-based DCF valuation model). You can’t use CE for many highly relevant and prominent use cases even if you wanted to – for example, valuing bonds, doing financial planning and budgeting, and providing management guidance. You also can’t really validate and update forecasts as new data comes in (at least, the way that financial professionals would do so). You can, in contrast, do all of these things with a standard DCF-type model. 

As someone who spent a number of years on the buyside before “seeing the light” and becoming a marketing professor, I can personally attest to these issues. Having spoken with dozens of professional investors about these concerns, I am far from alone. We need to do a better job incorporating the theory and practice of corporate valuation into the measure. It is for this reason that I believe we haven’t challenged our boundaries enough.

Moving from CE to CBCV

I lay out these issues with CE not to put it down, but rather to diagnose the root cause of the issue so that we can figure out what we can do to fix it. I argue in the paper that a framework Wharton professor Peter Fader and I have endearingly called “customer-based corporate valuation” (CBCV) solves every single one of these issues, while retaining the underlying customer-driven spirit of CE.

CBCV is a framework that augments (instead of replaces) any traditional corporate valuation method by forecasting key financial line items (most notably revenue) within that method off period-by-period customer-base activity projections. The underlying model that we use to characterize customer behavior may actually be the same as the one driving the CE calculation, but instead of using it to get CLV’s that are then summed up, we insert it into your favorite traditional corporate valuation model to make that valuation model better (i.e., to make the financial projections more accurate).

We lay out the general framework in detail in the paper – give it a read. For a high-level overview of CBCV, see Pete and my recent article in January’s print edition of HBR. For a more in-depth look at specific examples, see our papers laying out the methodology for subscription and non-subscription businesses.

CBCV addresses all of the issues mentioned above:

1.      CBCV directly measures SHV – it is not a proxy.

2.      CBCV is compatible with all major traditional valuation models, so investors can continue using the methods they have come to know and love (and the resulting valuation method must be theoretically valid).

3.      CBCV can be used to value corporate bonds, assess dividend payment risk, and do financial planning, liquidity management, and management guidance.

4.      It is easy to validate and update CBCV model forecasts.

We are already starting to see the investment community wake up to the virtues of the CBCV framework:

• Dozens of investment firms and company executives are consumers of CBCV. The professional investment community – especially in private equity – are bringing these concepts to life within their firms.
• Over 40 investors and analysts at top hedge fund and private equity firms have written endorsements of the framework as a whole and of specific CBCV analyses that impacted them.
• Sell-side analysts are consumers of the work. Pete and I have been on multiple conference calls with Seth Basham at Wedbush Securities, Oliver Chen at Cowen and Company, and Fabienne Caron at Kepler Chevreux. These analysts have also cited our work in their reports.
• CBCV analyses are now regularly featured in popular financial media – at last count, over 60 times in outlets such as the WSJ, Economist, Inc Magazine, and Harvard Business Review.
• The Financial Accounting Standards Board (FASB) is listening – Bain partner Rob Markey has written a letter to them which, among other things, endorses a CBCV view of the world. Pete and I wrote a letter to them as well. There have been multiple conversations with FASB, with more to come.
• This work has made its way into top finance curricula – for example, Fernando and I co-taught a guest lecture in a highly popular corporate valuation course at Wharton taught by Kevin Kaiser.

CBCV is already changing the practice of valuation, despite the fact that the very first paper we wrote on the topic was published only three years ago. We are just getting started.

Where we go from here

So what comes next? I offer a few predictions in the paper: 

1.      Investors will push for heightened disclosure of informative, objective, historical customer-related data such as new customers acquired, and, hopefully, the C3. Firms will be reluctant at first, but will be forced into it because investors need the clarity that these disclosures will provide. For more on this, see here. We need your support! Contact us if this resonates with you.

2.      CE will get more popular, not less. But it won’t be used as an overall valuation measure, but rather a measure of unit economic health, complementing other measures that currently get well-earned airtime including CLV and the retention curve. A rising tide will lift all the customer-related ships.

3.      CMOs will get a lot more powerful but also a lot more accountable. CMOs will start sounding like CFOs and CFOs will starting sounding more like CMOs.

4.      The marketing science driving CBCV will continue to improve. Underexplored areas include moving from pure measurement of value to managing it, strategic disclosure issues, competition, network effects, and reconciliation with CAPM.

I hope that this work helps us start a broader discussion about the role that customers should play in corporate valuation, and what we as marketers can do to better capitalize on this once in a lifetime opportunity that is sitting at our doorstep. 

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McCarthy, Daniel; Pereda, Fernando (2020). "Assessing the Role of Customer Equity in Corporate Valuation: A Review and a Path Forward", available for download at SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3518772