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What is the customer worth?

Aresh Shirali | July 14, 2005

Objectivity in marketing has been compared to a Rorschach ink-blot test: those who see it, see it. The rest frown, and get back to the serious business of crunching numbers. "If you can't measure it," they scoff, "you can't manage it."

Every now and then, however, somebody tries to shake this idyllic state of mutual quasi-tolerance between marketing and finance executives, and that's a good time for an overview.

image Now, this book, Managing Customers As Investments: The Strategic Value Of Customers In The Long Run from Wharton School Publishing, is not that overview. Nor is it about inter-disciplinary tension, really.

It is, rather, a marketing incursion made by a couple of professors at New York's Columbia Business School, Sunil Gupta and Donald R Lehmann, into classic finance territory. Armed with statistical tools, Gupta and Lehmann hardsell the concept of 'Customer Lifetime Value'.

To their credit, they go about it in the meticulous manner of academics who have done their research with care, whether on the subject of their exertions or the attitudes of the target audience.

They equate 'customers' with 'investments' in the book's title, and that too without falling for any wise-guy formulations (no 'assets' on cafe seats for sure). Further, they pose a big enticing question right on the cover: 'Are you spending more on your customers than they are worth?'

If that doesn't get this book a peek-in, maybe nothing will -- short of a shock demand for a multifold increase in the marketing budget to buy 'mindspace' or something suitably surreal. Anyhow, lest marketers suffer visions of hapless customers being made to walk the plank, the book's very first line signals the authors' basic outlook on what is worth how much. They quote Peter Drucker, against whom managers dare not blaspheme, as saying this: 'Innovation and marketing are the only two valuable activities of a firm. The rest are costs.'

That's a neat way to start a book bursting with numerical tabulations, bar charts, exponential curves and the like. Thankfully, none of it detracts from the text narrative. The book is easily accessible to readers who might balk at the sight of big fat multivariate functions and big fat Greek notations to indicate the summation of an infinite series.

So what does the part in plain English say? Marketers need not fear. Customers are not to be put through case-by-case inquisitions to determine just how worthy they are to the business. They are, nonetheless, to be 'codified' if you will, into a cash figure.

There's a reason this must be done, say the authors, winking an apology. The Internet bubble burst of April 2000 dealt a brutal blow to the notion of customers being assets, you see. Having spent a year whetting their hopes on the promise of cyberspatial eyeballs, investors turned into 'show me the money' grouches almost overnight.

'Intangible value' began to sound like one big con played by whizkids who just wanted investors to sign blank cheques for their cyber-fantasies. Suddenly, marketing was guilty -- unless numerically proven innocent -- on Wall Street and in its dominions.

Time to set the record straight, say Gupta and Lehmann. For the simple reason that the value of a business firm is still a function of the value of its customers.

The link, they assert, holds good. Business is still business. To demonstrate what they're talking about, they present an elaborate mathematical formula to calculate CLV in hard currency. The idea is to quantify how much profit customers deliver over their lives.

In brief, CLV is depicted as a function of two factors, the annual margin and retention rate, discounted to current value.

Of course, anyone engaged in the actual hurly-burly of business is bound to see the formula as a gross oversimplification. It is. Gross enough, perhaps, to render it worthless in practical terms. Market conditions change frequently.

Margins are not constant. Nor can the calculation of the second factor be done with any reliability, depending as it does on cost of capital and other business dynamics. Still, the authors don't intend this to be a hard-and-fast depiction of the truth. It is, as many such formulae are, at best a broad approximation to make things simple for those who think notationally.

The point is to show how much money customers could give you over the years. Shunt money down the formula, and -- boy-oh-boy -- it coughs up even more tempting money. To that extent, it works. Objectively speaking, it's better to be 'vaguely correct', as Gupta and Lehmann muse, than 'precisely wrong'.

Managing Customers As Investments, Sunil Gupta & Donald R Lehmann, Wharton School Publishing, Rs 450.

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