Marketing Theory 2010 - Customer Asset & Equity

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2010 10: 417Marketing TheoryAndreas Persson and Lynette Ryals

Customer assets and customer equity: Management and measurement issues

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Article

Customer assets andcustomer equity: Managementand measurement issues

Andreas PerssonHanken School of Economics, Finland

Lynette RyalsCranfield School of Management, UK

AbstractIn spite of the current focus on marketing accountability and the growing body of research intocustomer equity and customer lifetime value, the finance community has not shown any noticeableinterest in these increasingly well established marketing metrics and, in fact, few companies haveadopted them. There is a problem here: marketing has failed to find credibility in the very field itintends to address, which is the accountability of marketing and its contribution to shareholdervalue. A root cause of this failure is the prevailing confusion among marketing academics about thedifference between customer assets and customer equity. In this paper, we argue for a cleardistinction between the management of customer assets and the measurement of customer equity.We demonstrate the advantages for external stakeholders of including the drivers of and com-ponents of customer equity in management commentaries to financial reporting; and show howthis could be done using a Customer Equity Scorecard.

Keywordscustomer assets, customer equity, customer lifetime value, marketing accountability, marketingmetrics

Introduction

A much needed narrowing of the gap between marketing, and finance and accounting is currently

under way, as evidenced by the publication of several special issues on topics such as the marketing/

finance interface (Journal of Business Research, 2000; Journal of the Academy of Marketing

Science, 2005); linking marketing to financial performance and firm value (Journal of Marketing,

Corresponding author:

Andreas Persson, Centre for Relationship Marketing and Service Management (CERS), Hanken School of Economics, P.O.

Box 479, 00101 Helsinki, Finland

Email: [email protected]

Marketing Theory10(4) 417–436

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2004); return on marketing investment (Journal of Strategic Marketing, 2007); the marketing/

accounting interface (Journal of Marketing Management, 2008); intangibles (Accounting and

Business Research, 2008); and ‘Marketing Strategy Meets Wall Street’ (Journal of Marketing,

2009). Worryingly, however, we find evidence that marketing academics and finance academics are

taking divergent perspectives on the appropriate metrics for marketing accountability. In this paper,

we argue that marketing academics need to appreciate the difference between customer assets and

customer equity, and we propose a scorecard that sets out the drivers and components of customer

equity and shows their implication for the future earnings potential of the firm.

From a marketing perspective, the burgeoning interest in finance and accounting stems from a

need to demonstrate marketing accountability. Marketing academics have taken the route of

aiming to connect marketing investments in customer relationships, brands, and other off-balance

sheet intangible assets to the generation of shareholder value (Gronroos, 2003; Kumar and Shah,

2009; Lukas et al., 2005; Rust et al., 2004a; Ryals, 2008a; Stahl et al., 2003). For example

Gronroos (2003: 172) introduces the notion of ‘investing in customers’, arguing that the relation-

ship paradigm has the potential to make marketing more relevant for shareholders, top manage-

ment, customers and customer management. In line with these ideas, there has been a rapid

growth in the number of studies on customer equity-related issues over the past few years (cf.

Kumar et al., 2006), tackling the issues of measuring the value of customer relationships and of

managing these relationships in order to maximize their value. However, much marketing research

on customer equity conspicuously lacks references to research on intangible assets that has been

conducted within the areas of, for example intellectual capital, accounting, and strategic manage-

ment. This state of affairs is particularly alarming since there have recently been calls for market-

ing to take a leading role in disseminating the usefulness of customer equity and other marketing

metrics to our sister disciplines, finance and accounting (e.g. Wiesel et al., 2008), in the hope that

these metrics will be adopted by firms in their financial reporting.

From a finance perspective, meanwhile, there have been numerous calls for more transparency

in financial reporting of intangible assets in order to assist investors’ decision making (e.g.

Canibano et al., 2000; IASB, 2005; Lev, 2001; Whitwell et al., 2007). Issues concerning the

valuation of intangible assets were once again brought into the limelight with the International

Accounting Standards Board’s (IASB) 2004 publication of the IFRS 3 statement on business

combinations. IFRS 3 requires that, in the case of corporate acquisitions, both tangible and

intangible assets be restated at their market values when accounting for the acquisition. However,

although customer-related intangibles are one of the five categories of intangible assets recognized

by IFRS 3, the well established marketing metrics, customer equity (Blattberg and Deighton, 1996)

and customer lifetime value (CLV)1 (Dwyer, 1989; Kotler, 1974: 24), have not sparked any notice-

able attention within the finance community (Gleaves et al., 2008); nor has the take-up among mar-

keting practitioners been widespread. This indicates that marketing theory may be off track when

attempting to promulgate financially-oriented customer metrics to the finance community. Indeed,

it is sobering to note that some parts of the finance community even appear to prefer qualitative

customer information to quantitative customer metrics (AFRAC, 2006). We argue that, to address

this problem, customer equity research needs to incorporate theories of direct marketing, brand

equity, service quality and relationship marketing (cf. Hogan et al., 2002b). These theories focus

on customer perceptions and behaviour, i.e. the drivers of customer equity, which are also of inter-

est from a finance perspective. For example, Wyatt (2008: 244) states that ‘understanding how cus-

tomer loyalty is generated and destroyed in different industries is a pre-requisite for identifying

value-relevant information on customer loyalty’.

418 Marketing Theory 10(4)



This paper takes the form of a literature review and makes two contributions to the field of

marketing accountability. First, based on a review of the customer equity-related literature, we

argue the case for a clear distinction between, on the one hand, customer assets; and on the other

hand, customer equity. We thereby contribute to marketing theory by clarifying the conceptual

foundation of customer equity and addressing the confusion that has arisen over the distinction

between the underlying customer asset, and customer equity as a measure of the value of that asset

(cf. Brodie et al., 2006: 367; Rust et al., 2004a: 78). The second contribution is that we demonstrate

the advantages for external stakeholders of including the actual drivers of customer equity in man-

agement commentaries to financial reporting, rather than simply reporting customer equity and its

components, and show how this could be done using a Customer Equity Scorecard. This Customer

Equity Scorecard could serve as a basis for an enhanced conversation between marketing theory

and financial theory with regard to the management of customer assets and the measurement of

customer equity. The paper is structured as follows. First, we review previous research on customer

equity. Next, we describe in more detail the development of customer equity as a concept, includ-

ing its drivers, components, and limitations. After that, we explore the potential role of customer

equity in financial reporting. We conclude with a discussion and suggestions for further research.

Customer equity

Customer equity was originally conceptualized by Blattberg and Deighton (1996) as a way for

firms to determine the optimal balance of customer acquisition and retention spending. They state

that:

to measure that equity, we first measure each customer’s expected contribution toward offsetting the

company’s fixed costs over the expected life of that customer. Then we discount the expected con-

tributions to a net present value at the company’s target rate of return for marketing investments.

Finally, we add together the discounted, expected contributions of all current customers. (Blattberg and

Deighton, 1996: 137–8)

Blattberg and Deighton note that valuing customer relationships has many analogies with the

valuation of tangible assets, arguing that the appraisal of customer equity is conceptually similar to

the appraisal of the value of a portfolio of income-producing real estate.

Their ideas were further extended by Blattberg et al. (2001), who conceptualize customer equity

as follows: ‘the customer is a financial asset that companies and organizations should measure,

manage, and maximize just like any other asset’ (Blattberg et al., 2001: 3). Thus, they integrated

aspects of customer relationship management, database marketing, and customer satisfaction

within a customer equity framework. They advocated a number of key changes to marketing

strategy, such as managing customer lifecycles; organizing around customer acquisition, retention,

and add-on selling; and balancing marketing costs against financial returns.

Whereas Blattberg and Deighton (1996) only included current customers in their calculation of

customer equity, Rust et al. (2004b: 110) emphasized the importance of future potential from a

marketing perspective by incorporating the discounted lifetime values of prospective future cus-

tomers into their definition of customer equity. This is in line with Hogan et al.’s (2002b: 7)

contention that customer equity is a combination of the value of a firm’s current and potential

customer assets.

Persson and Ryals 419



Rust et al. (2000) argued for the existence of three key drivers of customer equity: value equity,

brand equity and retention/relationship equity. Value equity is defined as ‘the customer’s objective

assessment of the utility of a brand, based on perceptions of what is given up for what is received’;

brand equity is ‘the customer’s subjective and intangible assessment of the brand, above and

beyond its objectively perceived value’; and retention equity is defined as ‘the tendency of the

customer to stick with the brand, above and beyond the customer’s objective and subjective

assessments of the brand’ (Rust et al., 2000: 56–7). We thus see that value, brand, and retention/

relationship equity are conceptualized by Rust et al. (2000) as value that a customer perceives in

different aspects of the supplier’s offering. So the marketer’s task would be to identify which of

these drivers are most critical for different customers in order to increase their financial value to the

supplier, i.e. the customer equity.

Since the development of the original customer equity model (Blattberg and Deighton, 1996),

various other models have been proposed, taking different aspects into account, such as brand

switching (Rust et al., 2004b); the customer acquisition process (Villanueva et al., 2008); or using

only publicly available data (Gupta et al., 2004). A number of studies have applied Rust et al.’s

(2004b) customer equity models in different contexts, such as retailing (Vogel et al., 2008) and the

cell phone operator market (Sublaban and Aranha, 2009). Kumar and George (2007) discuss

different distinguishing features with regard to the measurement and maximization of customer

equity using various aggregate- and disaggregate-level approaches. They also propose a hybrid

approach, which allows firms to select an appropriate approach or different combinations, based

on the objectives of customer valuation and the consequent data requirements.

To date, the financial valuation of customer relationships has primarily been of importance to

marketing as a foundation for optimally selecting customers for marketing campaigns and mea-

suring the effectiveness of marketing actions after implementation (Petersen et al., 2009). This has,

however, given rise to some confusion over the distinction between the underlying customer asset,

and customer equity as a measure of the value of that asset (cf. Brodie et al., 2006: 367; Rust et al.,

2004a: 78). Because this confusion endangers acceptance of the customer equity concept by the

finance community, we explore it in detail in the following section.

Customer assets and customer equity

The idea that customers or customer relationships are valuable firm assets is by no means new (e.g.

Anderson et al., 1994; Bursk, 1966; Levitt; 1983; Wayland and Cole, 1994). Cravens et al. (1997:

497) declare that ‘satisfied customers are assets who represent long term value to an organization’.

The theoretical basis of the management of customers as assets or equity of a firm may thus

seem straightforward, but the two concepts ‘customer asset management’ (e.g. Berger et al., 2002;

Bolton et al., 2004; Hogan et al., 2002a; Storbacka, 2006) and ‘customer equity management’ (e.g.

Bell et al., 2002; Blattberg et al., 2001; Hogan et al., 2002b; Kumar and George, 2007; Rust et al.,

2005) are used by different authors when referring to the same underlying ideas. For example

Hogan et al. (2002b) and Kumar and George (2007) discuss the management of customer equity as

a practice that seeks to maximize customer equity by managing the customer asset. In the

framework proposed by Srivastava et al. (1998), customer relationships are included as one type of

market-based asset that should be developed and managed to increase shareholder value.

Buyer–seller relationships have also been identified as an example of a firm’s strategic assets

(Amit and Schoemaker, 1993). Hence, it follows that with regard to customer management, cus-

tomer relationships are the assets that marketing is concerned with managing.




Customer equity, meanwhile, is simply a measure of the value of the customer relationship

assets that are managed (Blattberg and Deighton, 1996; Hogan et al., 2002b; Kumar and George,

2007; Rust et al., 2004b). The use of the terms ‘asset’ and ‘equity’ in the fields of accounting and

finance can help to clarify their use in marketing. Assets traditionally appear on the left-hand side

of the balance sheet and are related to the investment decision, i.e. how funds should be allocated

over time in order to increase shareholder wealth. Equity, alongside liabilities, appears on the right-

hand side of the balance sheet and is related to the financing decision, i.e. how to generate funds.

Using the analogy of customer relationships as assets, it can be said that firms need to invest in

these relationships through marketing activities, personnel training, product/service development,

etc. This need to invest is an intangible liability, whereas the customer relationships themselves are

intangible assets that are invested in and managed. Meanwhile, the potential value created by the

investments in all of the firm’s customer relationships (the sum of the customer lifetime values) is

customer equity, which contributes to shareholder value (cf. Berger et al., 2006; Bick, 2009; Hogan

et al., 2002a; Kumar and Shah, 2009).

Hence, it is more accurate to refer to the management of customer assets (in order to maximize

customer equity) rather than to refer to the management of customer equity itself. This distinction

enables us to avoid the confusion that may occur when the term ‘customer equity’ is used to refer

both to the customer asset and to the value of that asset (cf. Brodie et al., 2006: 367; Rust et al.,

2004a: 78).

Thus, we propose the following definitions:

Customer assets are the relationships that a firm has with its customers.

Customer equity is the value of those customer assets.

Therefore, the function of marketing and of customer relationship management as a process is to

manage the customer assets so as to maximize their value (customer equity).

The notion of the management of customer assets as a process is illustrated by Rust et al. (2000),

who use the word ‘equity’ when what they are in fact doing is conceptualizing the drivers of

customer equity, namely value equity, brand equity and retention equity. These three types of

equity are viewed as the customer’s evaluation of value, and as such are not directly concerned

with the equity created for the supplier (cf. Brodie et al., 2002). Rather, they are connected to the

concept of customer-perceived value of a product/service, brand, or relationship, or in other words

value that a customer gains from an exchange relationship with a supplier. It is important to recog-

nize that value, brand, and relationship equity, as conceptualized by Rust et al. (2000), are not

actual components of customer equity, but rather drivers of customer equity, i.e. drivers of the

value of customer assets. In the next section, we examine the drivers and the components of cus-

tomer equity.

Drivers and components of customer equity

Using the distinction between customer assets and customer equity allows us to clarify the drivers

and components of customer equity. These drivers and components fit into a customer equity

framework, as illustrated in Figure 1. Customer relationships – the assets – are on the left-hand side

of the diagram. These customer assets are managed by the firm by engaging in marketing activities

that affect customer perceptions and behaviour, which are the drivers of customer equity. Cus-

tomer equity – the measure of value – is on the right-hand side of the diagram. The components




of customer equity and CLV are affected by the firm’s management of its customer assets and the

subsequent changes in the drivers of customer equity. In order to increase its customer equity, a

firm naturally needs to continuously measure its customer equity.

Drivers of customer equity

A review of the customer management literature suggests that the drivers of customer equity fall

into two categories – customer perceptions and customer behaviour – which Gupta and Zeithaml

(2006) classify as unobservable and observable constructs respectively. Marketing activities can be

used to drive profitable customer behaviour directly or indirectly by enhancing customer per-

ceptions. The most widely discussed customer perceptions that have been found to drive profitable

customer behaviour are satisfaction and attitudinal loyalty. For example the service–profit chain

(e.g. Heskett et al., 1994; Kamakura et al., 2002) links service quality to customer satisfaction,

loyalty and profitability. Fornell et al. (2006) show a positive correlation between firms’ scores on

the American Customer Satisfaction Index (ACSI) and their stock prices. Furthermore, Reinartz

and Kumar (2002) find that the attitudinal element of customer loyalty (a subjective measure), in

addition to the behavioural one, is a crucial determinant of customer profitability. Rust et al.’s

(2000) categorization of customer perceptions into value equity, brand equity and relationship

equity overlap the concepts of customer satisfaction and attitudinal loyalty to a great extent. Value

equity resembles objective satisfaction with the firm’s offering; brand equity is comparative

to subjective satisfaction with various aspects of the brand; and relationship equity is very similar

MEASUREMENT

Customer EquityCLV

balance

Components of Customer Equity

New customeracquisition

Additionalpotential

Customerprofitabilitydistribution

Discount rate(e.g. WACC)

Cash flows,profits or

contribution toprofit (revenues -

costs)

Projectedcustomer

lifetime (e.g.retention rate)

MANAGEMENT

Drivers of Customer Equity

Customer Assets

(customer relationships)

Perceptions

Value equity

Brand equity

Relationshipequity

Customersatisfaction

Attitudinalloyalty

Length (duration) /behavioural loyalty

Depth (purchase frequency,upgrades) and patronage

concentration

Breadth (cross-buying)

Intensity and channelsof interaction

Referral behaviour

Risk

Behaviour

Contribution to learningand innovation

Customerportfolio

diversification

Figure 1. Drivers and components of customer equity




to attitudinal loyalty. Rust et al. (2004b) provide a framework that allows firms to evaluate the

effect of various marketing activities on value, brand and relationship equity, the subsequent effect

on customer switching behaviour, and finally the impact on customer equity.

Customer behaviour can be affected either by actions aimed at improving customer perceptions,

or by marketing activities that aim at changing customer behaviour. Bolton et al. (2004: 274)

classify customer behaviour that affects the value of the customer asset into three categories:

relationship length (duration), depth (increased usage/upgrading) and breadth (cross-buying).

Another aspect is the customer’s patronage concentration (Storbacka, 1994, 1997; Storbacka et al.,

1994) or share-of-spending (Keiningham et al., 2005) with the firm.

Several other facets of customer behaviour that affect the value of the customer asset are

mentioned in other studies. For example Storbacka (1994) identifies two different ways in which

firms can seek to change customer behaviour in order to decrease customer-related costs: decreas-

ing the intensity of a customer’s interactions with the firm; and moving the customer to cheaper

interaction channels. The issue of customer-related risk has also been discussed in connection with

the value of customers. For example the risk in revenue streams and the costs to serve a customer

(Ryals and Knox, 2005), as well as the risk of a total or partial loss of the customer relationship

(Ryals and Knox, 2007) have been highlighted. The volatility of cash flows from customers has

also been found to affect the relative value of customers at a customer base (or portfolio) level

(Dhar and Glazer, 2003; Ryals et al., 2007). Furthermore, Kumar and Shah (2009) demonstrated

that the relationship between a firm’s customer equity and market capitalization is moderated by

the volatility and vulnerability of cash flows from customers. Finally, behaviour driving the indi-

rect value of customers has recently been receiving increasing attention. Kumar et al. (2007) found

that the referral value of customers is often higher than their lifetime value. Similarly, Ryals

(2008a) demonstrated substantial indirect benefits from customer referrals and references, as well

as customers’ contribution to a firm’s learning and innovation.

The relative importance of the various drivers of customer equity, both customer perceptions

and behaviour, will vary depending on the industry and on the company. When referring to the

value of customer relationships, it is thus important to consider which aspects of the relationships

are actually creating value for the firm, and how (cf. Rust et al., 2004b). In the following section,

we will move on to consider the components of customer equity in more detail.

Components of customer equity

Customer equity measures the total value of customer assets, usually defined as the sum of the

lifetime values of a firm’s customer relationships. The CLV of an individual customer is typically

comprised of the projected lifetime of the customer’s relationship with the firm, often expressed as

a retention rate; the cash flows the firm expects to receive from the customer in each future period;

and a discount rate (Berger and Nasr, 1998; Jain and Singh, 2002). Although these are the core

components of CLV, numerous variations and extensions appear in the marketing literature. For

example common alternatives to cash flows are profits (e.g. Gupta and Lehmann, 2005) or con-

tribution to profit (e.g. Rust et al., 2000). Furthermore, the importance of using a firm’s weighted

average cost of capital (WACC) for the discount rate, as well as taking individual customer risk

into account, is highlighted by Ryals and Knox (2007). Useful reviews of different types of CLV

models are provided by Gupta et al. (2006) and Jain and Singh (2002).

CLV and, by extension, customer equity draws on the discounted cash flow (DCF) approach

used in finance. Gupta et al. (2006) point out, however, that there are two key differences between




CLV and traditional DCF. First, CLV is usually estimated at an individual customer or segment

level, allowing differentiation between customers based on profitability. Second, CLV explicitly

incorporates the possibility for future customer defection, typically through a retention rate. If

customer relationships are considered to be assets that firms invest in, adopting a version of the

DCF asset valuation technique from finance appears logical, since a value can then be derived that

estimates the present value of the cash flows generated by the customer relationship over its

lifetime, discounted at the appropriate required rate of return. This fits well with Rust et al.’s

(2004a: 78) contention that marketing expenditures are investments and that ‘marketing assets

represent a reservoir of cash flow that has accumulated from marketing activities but has not yet

translated into revenue’. In effect then, firms invest their limited resources in marketing as well as

other activities to establish, maintain and enhance relationships with customers, in order to

maximize the return on these investments in the form of maximized customer lifetime values and

customer equity.

With regard to customer equity calculations, Ryals (2008b) emphasizes the need to include

additional potential that could be obtained through changes in specific customer segments, or

through the way they are managed. The costs and likely success rates of acquiring different types

of new customers also need to be taken into account. Moreover, the balance between customer

acquisition and retention is a key determinant of customer equity (Blattberg and Deighton, 1996;

Reinartz et al., 2005). In addition, although not generally considered as a component of customer

equity, the profitability distribution across the customer base (Ryals and Knox, 2007; Storbacka,

1994, 1997; van Raaij, 2005) could serve as a useful indicator of customer base risk, as could the

volatility and vulnerability of cash flows from customers (Dhar and Glazer, 2003; Kumar and

Shah, 2009; Ryals et al., 2007; Stahl et al., 2003).

Impact of customer equity drivers on customer equity components

There are numerous ways in which the components of customer equity can be impacted by its

drivers. Two of the main components, the projected lifetime of a customer relationship and the

cash flows that the firm expects to receive from the customer, are clearly affected by customer

relationship management efforts. Indeed, two of the key tasks in the management of customer

relationships are to extend the lifetimes of customers and to increase the cumulative cash flows

from customers during their lifetimes (cf. Bolton et al., 2004). Much marketing effort is aimed both

at lengthening customer relationships and at increasing cash flow. For example it is widely

recognized that cross-selling increases behavioural loyalty by increasing switching costs while at

the same time enhancing cash flows from customers as they purchase/use a wider range of prod-

ucts/services (Reinartz and Kumar, 2003; Venkatesan and Kumar, 2004). The success of a firm’s

efforts to increase customer lifetimes and cash flows, meanwhile, is manifested through changes in

the perceptual and behavioural drivers of customer equity.

The third main component of customer equity, the discount rate, can also be affected by

management of the customer equity drivers. Specifically, increases in customer satisfaction,

loyalty and retention lead to a reduction in the volatility of sales and earnings, as the cash flow from

customers becomes less susceptible to competitive activity (Anderson et al., 2004; Srivastava

et al., 1998). This in turn reduces the firm’s cost of equity capital (Harrison-Walker and Perdue,

2007) and the discount rate.

With regard to the components of customer equity, a firm’s success in customer acquisition is

affected by the perceptions and referral behaviour of its current customers (Villanueva et al.,




2008). Furthermore, the profitability distribution and diversification of the customer base (viewed

as a portfolio) can also be affected by changing perceptions of the firm among existing

and potential customers that will influence the acquisition and retention of customers (cf. Dhar and

Glazer, 2003). Finally, additional potential, as conceptualized by Ryals (2008b), is by definition

achieved through changes in the management of customer relationships, which in turn affects the

drivers of customer equity.

Given the considerable body of marketing literature, it is puzzling why customer equity has

not already gained wider acceptance among marketing managers or, indeed, among share-

holders, as a key performance metric. We have argued the need for greater clarity in marketing

theory between customer assets and customer equity as one issue. However, there are also

certain limitations relating to the practical application of customer equity which we will now

examine.

Limitations of CLV and customer equity

Several limitations of customer lifetime value/customer equity metrics have been suggested; we

review these from the perspective of marketing academics and managers, and then from the

perspective of those academics working on the marketing/finance interface.

Marketing management perspective

Most of the previous research related to customer equity has been concerned with measuring

customer equity for internal management purposes (e.g. Berger et al., 2002; Blattberg and

Deighton, 1996; Bolton et al., 2004; Reinartz et al., 2005; Rust et al, 2004b; Ryals, 2005;

Venkatesan and Kumar, 2004). The focus of customer equity calculations in this context is

to facilitate decision making with regard to optimal resource allocation in the management of

different customer relationships.

Several studies have provided empirical support for the successful use of CLV (e.g. Dhar

and Glazer, 2003; Donkers et al., 2007; Kumar et al., 2008; Reinartz and Kumar, 2003;

Reinartz et al., 2005; Ryals, 2005, 2006; Venkatesan and Kumar, 2004) and customer equity

(e.g. Hanssens et al., 2008; Rust et al., 2004b; Ryals, 2005; Sublaban and Aranha, 2009;

Tirenni et al., 2007). Nevertheless, a few studies also raise concerns regarding their accuracy

and practical usability. For example Malthouse and Blattberg (2005) found in a study of four

firms that allocated resources based on CLV, that of the top 20 per cent of customers,

approximately 55 per cent were misclassified (and did not receive special treatment) while

approximately 15 per cent of the future bottom 80 per cent were misclassified (and received

special treatment). These findings demonstrate that historical customer behaviour and value

are not very accurate predictors of future value, highlighting the uncertainty inherent in CLV

calculations. Campbell and Frei (2004) similarly found that a substantial amount of variation

in the future profitability of customers of a financial services firm was left unexplained by

current profitability. Ambler (2006: 27) has also addressed several weaknesses associated with

DCF-based techniques such as customer lifetime value and, although conceding that they may

be useful for planning and could be included in a set of multiple performance metrics forming

a dashboard, Ambler and Roberts (2008) maintain that no variant of DCF should be used as

the sole ‘silver metric’.




Marketing/finance interface perspective

From a finance perspective, the measurement of customer equity, rather than the management of

customer assets (i.e. customer relationships) is the key issue. Hence, it is critical to clearly define

the elements to be included in the measures, and to agree upon a consistent usage of terms.

Unfortunately, in the marketing literature, as pointed out by Jain and Singh (2002), customer

profitability (CP), customer lifetime value (CLV), and customer equity (CE) are often not

recognized as distinct concepts. Pfeifer et al. (2005: 13) argue that ‘many people use these terms

interchangeably and loosely. ‘Customer value’ becomes ‘‘profit’’, which becomes ‘‘company’s

profit’’’. Gleaves et al. (2008: 836) concur, stating that

the actual usage of the term CP varies considerably and, especially in the marketing literature, there are

additional terms, which can become blurred with CP including the terms CLV and CE which should

have very specific meanings. There is also some vague use of costing terms in the marketing literature

where collaboration with management accounting (MA) specialists should lead to greater clarity.

Thus, terminological confusion in the marketing field has hindered the acceptability of some of

these key metrics as far as finance academics and practitioners are concerned (Gleaves et al.,

2008). With regard to the terms CP, CLV and CE, and their calculation, Gleaves et al. (2008: 839)

claim that ‘the marketing literature suggests, from an accountant’s perspective, a lack of under-

standing and clear use of such terms’.

Although the concept of customer profitability has received some attention in the management

accounting literature (Bellis-Jones, 1989; Foster and Gupta, 1994; Foster et al., 1996; Guilding and

McManus, 2002), the lack of finance interest in CLV and customer equity appears to be due to

reservations regarding the reliability of these measures. For example Weir (2008: 805) states that

‘what can readily be seen from this is that it becomes increasingly complicated to determine a CLV

figure, and that the metric itself becomes ‘‘messier’’ as it becomes more steeped in financial cal-

culus’. Without the called-for collaboration with the accounting and finance disciplines (Gleaves

et al., 2008; Weir, 2008), marketing is unlikely to develop customer valuation measures that will be

accepted as reliable enough for financial reporting purposes.

Customer equity in financial reporting

This lack of credibility is all the more concerning because customer equity has demonstrable

potential as a financial metric and could be of great interest to potential shareholders. Customer

equity is not only of interest for customer relationship management purposes within the firm, but

also for firm valuation purposes by an external audience consisting of financial analysts, investors

and possibly other stakeholders (Gupta et al., 2006). Wiesel et al. (2008) make a case for including

customer equity statements in the management commentaries of firms’ financial reports. They

propose that customer equity statements should include the value of the customer base, including

the components of customer equity and changes in value over time (cf. Blattberg et al., 2001). The

reported aim of including these statements is to answer the calls from the finance community (e.g.

Canibano et al., 2000; IASB, 2005; Lev, 2001; Whitwell et al., 2007) for more transparency in

financial reporting of intangible assets in order to assist investors’ decision making.

However, the use of ‘silver metrics’ is arguably as questionable for external financial reporting

as it is for internal customer management purposes. Although customer equity and its components

are useful indicators of the success of a firm’s marketing and customer management, they provide




an incomplete view. Investors are likely to gain a more meaningful insight into a firm’s future

potential if management commentaries of financial reports also contain information on the drivers

of customer equity (see Figure 1). In fact, the reporting of both the drivers and the components of

customer equity is implicitly supported by the finance community. The IASB discussion paper on

management commentaries published in 2005 specifically mentions many of the recognized

drivers and components of customer equity as measures that could be included in management

commentaries:

� customer satisfaction levels (§§ 121, 130 and 135)

� risks related to customers (§ 128)

� customer loyalty (§ 138)

� penetration (number of products purchased per customer) (§ 138)

� customer churn rates (§ 146)

� acquisition costs (§ 146)

� average revenue per user (§ 146).

Furthermore, the appendix to the discussion paper (IASB, 2005: § A42) states that ‘manage-

ment should include information about key relationships the business has in place, how they are

likely to affect the performance and value of the business and how they are managed’.

Thus, the finance community is calling for the inclusion of a diverse set of customer metrics in

management commentaries on financial reports. To date, the most prolific response from the

marketing community has proposed customer equity as the most suitable candidate for inclusion in

financial reports (Wiesel et al., 2008). However, some parts of the finance community may actually

prefer qualitative customer information rather than quantitative customer metrics. For example in a

response to IASB 2005, the Austrian Financial Reporting and Auditing Committee (AFRAC) state

that:

companies should not be obliged to present quantitative forecasts or give projections, but they should

present information about those aspects and events for the year under review that could be relevant in

assessing future prospects. Forward-looking information should focus on qualitative information.

(AFRAC, 2006: 3)

In summary, some academics are starting to recognize that CLV and customer equity, although

valuable, are insufficient measures for marketing managers who aim to manage customer rela-

tionships to maximize long-term cash flows. At the same time, the finance community is calling for

more meaningful disclosure of customer-related information. Sidhu and Roberts (2008: 682)

emphasize that ‘from a financial analyst perspective, intermediate constructs must be related to

value downstream and marketing activity upstream’; the drivers and components of customer

equity clearly fit this description. In the next section, we propose how companies could develop

a Customer Equity Scorecard that would provide this information to shareholders and potential

investors.

The Customer Equity Scorecard

Based on the discussion above, it appears that the inclusion of a section in financial reports where

customer relationships and their management are discussed would be useful for investors. A range

of customer metrics related to customer equity should be reported for the sake of objectivity and




maximum provision of useful information. Based on the drivers and components of customer

equity (Figure 1), we propose a Customer Equity Scorecard (Table 1). For each item on the

scorecard, we have listed the data source and identified how it is related to the future earnings

potential of the firm. Depending on the market situation, industry characteristics, and the current

position of the firm, different metrics will be of varying importance. Naturally, management can

provide guidance in the commentary regarding its view of the currently crucial measures, but

financial analysts and investors should be capable of determining which weights they assign to the

different metrics when undertaking their assessment of the value of the firm’s customer base. If

the firm provides all the necessary information, the external audiences can, if they wish, even make

their own customer equity calculations of the firm. Once a standardized system of measures is in

place, it would also be possible to report the various customer equity drivers and components over

several time periods, including future projections.

The scorecard in its current form is not a standardized solution. However, it aims to illustrate the

usefulness of including the two categories of customer equity drivers — customer perceptions and

behaviour — as valuable items that complement the components of customer equity. For example

components of customer equity (and changes in these), such as average customer revenue, costs,

and acquisition and retention rates, will provide stakeholders with information on the effects of a

firm’s efforts to increase customer equity, as well as the data required to actually calculate cus-

tomer equity. However, these data will not give stakeholders any insight regarding why certain

components increased or decreased, or what future developments may be expected. The beha-

vioural drivers, on the other hand, potentially shed some light on these issues. For example changes

in revenues and costs may be explained by changes in customers’ buying behaviour. Improvements

in customer acquisition could be explained by a greater number of referrals. Data on the average

length of customer relationships would show whether the firm’s current customer base consists of

mainly long-term or short-term customers. A change in the risk profiles of customers, meanwhile,

could be an indicator of future expectations with regard to revenues, costs and customer retention.

Finally, greater insight into the behavioural drivers of customer equity can also be conveyed by

reporting the perceptual drivers of customer equity. For example higher satisfaction scores may

explain positive changes in buying and referral behaviour. Improvements in attitudinal loyalty,

meanwhile, would signify greater potential for behavioural loyalty, as the firm would not have to

rely solely on inertia or high switching costs to retain customers. Finally, changes in value, brand

and relationship equity would indicate the firm’s success in improving different aspects of its

offering, which should be reflected in changes in customer behaviour.

The Customer Equity Scorecard has a number of limitations, which affect its applicability in

practice. First, there is a risk that bias is introduced in the measurement of various items on the

scorecard. For example in the case of using surveys to measure customer perceptions, non-

response bias is definitely an issue for which researchers are still attempting to develop remedies

(Kreuter et al., 2010). Nevertheless, various methods to account for biases are available; for exam-

ple non-response weighting is commonly used in order to correct for variations in the probability of

selection (cf. Rust et al., 2004b). Second, where companies have long sales cycles or a small cus-

tomer base, it may be difficult for them to measure certain of the drivers and components of cus-

tomer equity on an annual basis. That said, even in industries with long sales cycles for goods, such

as heavy machinery or automobiles, companies often maintain ongoing relationships with custom-

ers through the provision of services. Finally, it is possible that the data in the proposed scorecard

could lead stakeholders to different conclusions; and due to lagged effects, it might be necessary to

compare scorecards over time to gain deeper insights regarding the firm’s ongoing and potential




Tab

le1.

Cust

om

ereq

uity

score

card

for

finan

cial

report

ing

purp

ose

s

Cust

om

ereq

uity

(CE)

dri

ver/

com

ponen

tD

ata

sourc

eIm

plic

atio

ns

for

futu

reea

rnin

gspote

ntial

ofth

efir

m

Cus

tom

erpe

rcep

tions

Val

ue

equity

Bra

nd

equity

Rel

atio

nsh

ipeq

uity

Surv

eyPosi

tive

lyco

rrel

ated

with

beh

avio

ura

llo

yalty,

rete

ntion

and

acquis

itio

nof

new

cust

om

ers

(Dan

aher

and

Rust

,1996;R

ust

etal

.,2004b)

Neg

ativ

ely

corr

elat

edw

ith

risk

(Ander

son

etal

.,2004;Sr

ivas

tava

etal

.,1998)

and

dis

count

rate

(Har

riso

n-W

alke

ran

dPer

due,

2007)

Cust

om

ersa

tisf

action

Surv

eyPosi

tive

lyco

rrel

ated

with

beh

avio

ura

llo

yalty,

pat

ronag

eco

nce

ntr

atio

n,

cross

-buyi

ng,

rete

ntion

(Love

man

,1998)

and

refe

rral

beh

avio

ur

(Ver

hoef

etal

.,2002)

Neg

ativ

ely

corr

elat

edw

ith

risk

(Ander

son

etal

.,2004;Sr

ivas

tava

etal

.,1998)

and

dis

count

rate

(Har

riso

n-W

alke

ran

dPer

due,

2007)

Att

itudin

allo

yalty

Surv

eyPosi

tive

lyco

rrel

ated

with

beh

avio

ura

llo

yalty,

purc

has

efr

equen

cy,pat

ronag

eco

nce

ntr

atio

n,re

tention

(Kam

akura

etal

.,2002)

and

refe

rral

beh

avio

ur

(Rei

nar

tzan

dK

um

ar,2002)

Neg

ativ

ely

corr

elat

edw

ith

risk

(Ander

son

etal

.,2004;Sr

ivas

tava

etal

.,1998)

and

dis

count

rate

(Har

riso

n-W

alke

ran

dPer

due,

2007)

Cus

tom

erbe

haviou

rBeh

avio

ura

llo

yalty

(ave

rage

lengt

hofcu

stom

erre

lationsh

ips)

Dat

abas

ePosi

tive

lyco

rrel

ated

with

rete

ntion

(by

def

initio

n)

Neg

ativ

ely

corr

elat

edw

ith

risk

(Ander

son

etal

.,2004;Sr

ivas

tava

etal

.,1998)

and

dis

count

rate

(Har

riso

n-W

alke

ran

dPer

due,

2007)

Ave

rage

num

ber

ofpurc

has

esD

atab

ase

Posi

tive

lyco

rrel

ated

with

cust

om

erre

venues

(by

def

initio

n)

Ave

rage

pat

ronag

eco

nce

ntr

atio

n/s

har

e-of-

spen

din

gSu

rvey

/dat

abas

ePosi

tive

lyco

rrel

ated

with

cust

om

erre

venues

(by

def

initio

n)

and

rete

ntion

(Per

kins-

Munn

etal

.,2005)

Ave

rage

num

ber

ofdiff

eren

tpro

duct

s/se

rvic

esbough

t/hel

dD

atab

ase

Posi

tive

lyco

rrel

ated

with

cust

om

erre

venues

and

rete

ntion

(Rei

nar

tzan

dK

um

ar,2003;V

enka

tesa

nan

dK

um

ar,2004)

Ave

rage

cust

om

erri

sksc

ore

Dat

abas

ePosi

tive

lyco

rrel

ated

with

dis

count

rate

(by

def

initio

n)

Num

ber

ofcu

stom

ers

acquir

edby

refe

rral

Surv

ey/

dat

abas

ePosi

tive

lyco

rrel

ated

with

acquis

itio

nra

te(S

tahlet

al.,

2003),

cust

om

erre

venues

and

futu

rere

ferr

albeh

avio

ur

(Vill

anuev

aet

al.,

2008)

Neg

ativ

ely

corr

elat

edw

ith

acquis

itio

nex

pen

diture

s(S

tahlet

al.,

2003)

(con

tinue

d)

429



Tab

le1

(co

nti

nu

ed

)

Cust

om

ereq

uity

(CE)

dri

ver/

com

ponen

tD

ata

sourc

eIm

plic

atio

ns

for

futu

reea

rnin

gspote

ntial

ofth

efir

m

CE

com

pone

nts

Acq

uis

itio

nra

teD

atab

ase

Posi

tive

lyco

rrel

ated

with

cust

om

ereq

uity

(by

def

initio

n).

Acq

uis

itio

nex

pen

diture

sper

cust

om

erD

atab

ase

Neg

ativ

ely

corr

elat

edw

ith

CLV

and

cust

om

ereq

uity

(by

def

initio

n).

Ret

ention

rate

Dat

abas

ePosi

tive

lyco

rrel

ated

with

CLV

and

cust

om

ereq

uity

(by

def

initio

n)

Ret

ention

expen

diture

sper

cust

om

erD

atab

ase

Neg

ativ

ely

corr

elat

edw

ith

CLV

and

cust

om

ereq

uity

(by

def

initio

n)

Churn

rate

Dat

abas

eIn

vers

eofre

tention

rate

(by

def

initio

n)

Ave

rage

cust

om

erre

venues

Dat

abas

ePosi

tive

lyco

rrel

ated

with

CLV

and

cust

om

ereq

uity

(by

def

initio

n)

Ave

rage

cust

om

erco

sts

Dat

abas

eN

egat

ivel

yco

rrel

ated

with

CLV

and

cust

om

ereq

uity

(by

def

initio

n)

Dis

count

rate

(e.g

.W

AC

C)

Est

imat

edor

det

erm

ined

by

borr

ow

ing

cost

s

Neg

ativ

ely

corr

elat

edw

ith

CLV

and

cust

om

ereq

uity

(by

def

initio

n)

Cust

om

erbas

epro

fitab

ility

dis

trib

ution

Dat

abas

eH

igher

dep

enden

ceon

pro

fits

from

asm

alle

rnum

ber

ofcu

stom

ers

(¼hig

her

risk

)posi

tive

lyco

rrel

ated

with

dis

count

rate

(by

def

initio

n;cf

.St

orb

acka

,1994)

Neg

ativ

ely

corr

elat

edw

ith

cust

om

ereq

uity

(by

def

initio

n)

Cust

om

erport

folio

div

ersi

ficat

ion

Dat

abas

eO

ptim

izat

ion

ofi

nve

stm

ents

acro

ssth

ecu

stom

erbas

e(¼

hig

her

risk

-adju

sted

retu

rn)

posi

tive

lyco

rrel

ated

with

cust

om

ereq

uity

(by

def

initio

n;cf

.D

har

and

Gla

zer,

2003)

430



future performance. Qualitative descriptions by management to complement the data in the scor-

ecard could enhance the meaningfulness of the reported measures.

Conclusions and future research directions

Marketing, in its quest for accountability, has recently afforded increasing attention to techniques

(such as DCF), and terms (such as assets and equity) from finance and accounting. However, in

marketing’s eagerness to demonstrate its impact on shareholder value and to grab a seat in the

boardroom, it has placed a misguided focus on aggregate financial metrics such as CLV and

customer equity, apparently assuming that ‘this is the only language that finance and accounting

speak’. In reality, accounting and finance are not such precise disciplines as might be imagined,

and they are also becoming increasingly qualitative, with the development of for example beha-

vioural finance and calls from accounting for further development of ‘narrative reporting’ (Ambler

and Neely, 2008; Roslender and Wilson, 2008).

Hence, rather than continuing on the quantitative path and attempting to value customer assets

and include customer equity in a firm’s financial reporting as suggested by Wiesel et al. (2008), a

more fruitful exercise would be to seek to determine how and to what extent various aspects of

customer relationships and their management can be reported, in order to provide information that

can be used by investors and other external audiences to predict the future earnings potential of the

firm. To this end, we have argued the case for a clear distinction between, on the one hand, the

management of customer assets and the drivers of customer equity; and, on the other hand,

the measurement of customer equity and its components. Identification of the drivers and com-

ponents of customer equity not only serves marketing managers in their efforts to manage customer

relationships profitably. The provision of these metrics in the management commentaries of

financial reports would also more directly answer the call from the finance community for more

transparency in financial reporting of intangible assets in order to assist investors’ decision

making. The potential positive implications of including customer equity drivers and components

in financial reporting are not only limited to more well informed firm valuations by an external

audience. The concretization of the intermediate and financial outcomes of customer relationship

management efforts in financial reports will also enable marketing to demonstrate accountability,

thereby preventing any further erosion of its influence within the firm.

Based on this analysis, we suggest two propositions that might guide future research into

customer lifetime value and customer equity:

P1: In practice, marketing managers make use of qualitative data and of heuristics rather than

detailed analyses of customer lifetime value or customer equity. These heuristics guide their

perceptions of the value of customer assets and are used to develop strategies to manage customer

relationships.

P2: In companies where marketing makes use of customer lifetime value or customer equity

calculations to determine customer management strategies, marketing is seen as more accountable

than in organizations that do not make use of such measures.

Many CEOs feel that their future potential, based particularly on their ability to leverage

various types of intangible assets, is not fairly reflected in their share prices. Such firms could

attempt to provide greater transparency to the investor community by including more detailed

information on the performance of the firm’s intangible assets in their financial reports.

However, a few issues should be considered here. First, there is a clear risk that companies

abuse this possibility by using creative methods of measuring the performance of their




customer relationships and other intangible assets. This risk could be neutralized by the

introduction of standardized, industry-wide measures (cf. Stewart, 2009). Second, rather than

attempting to include customer relationships and other intangible assets on the balance sheet,

the management commentary on financial reports appears to be a more useful place in which

to describe the underlying reasons for the gap between book value and market value and/or

the firm’s own assessment of what its market value should be, based on its potential to utilize

its capabilities to leverage its various tangible and intangible assets. Such supplemental

reporting should include both qualitative and quantitative data and could take the form of a

scorecard. We have in this paper suggested a set of customer metrics that could be included

on a customer dimension of such a scorecard. Brands and networks could be other dimensions

on such a scorecard, in line with Brodie et al.’s (2002, 2006) arguments for the integration of

the concepts of customer equity, brand equity, and network equity into a theory of market-

place equity. Further research could investigate the feasibility and usefulness of including

these and various other dimensions on a scorecard, in order to provide financial analysts and

investors with sufficient information to make decisions while at the same time allowing firms

to be held accountable for the management of their customer relationships. Thus, our third

and fourth propositions to guide future research:

P3: A customer equity scorecard would be a useful managerial tool for marketing.

P4: A customer equity scorecard would be a useful indicator of shareholder value for investors

and analysts.

In summary, this paper has offered a contribution to marketing theory by bringing added clarity

to the literature on customer assets and customer equity. It thereby also provides the foundation for

further meaningful theoretical development on the management of customer assets and the

measurement of customer equity. In addition, the proposed Customer Equity Scorecard contributes

to a bridging of the gap between marketing theory and financial theory with regard to customer

equity-related issues.

Acknowledgements

The first author, Andreas Persson, gratefully acknowledges the financial support provided by the Finnish

Center for Service and Relationship Management (FCSRM) and Liikesivistysrahasto – Foundation for

Economic Education. The authors also extend their thanks to the two anonymous reviewers for their valuable

comments, and to Liz Parsons for her editorial guidance.

Note

1. Customer equity can be regarded as the sum of the lifetime values of a firm’s customers, but may also

include potential customers.

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Andreas Persson is a doctoral student at the Centre for Relationship Marketing and Service Management

(CERS) at the Hanken School of Economics, Helsinki, Finland. His main research interests are customer

equity and the profitable management of customer relationships. His research has appeared in the

International Journal of Bank Marketing. Address: Centre for Relationship Marketing and Service

Management (CERS), Hanken School of Economics, P.O. Box 479, 00101 Helsinki, Finland. [email:

[email protected]]

Lynette Ryals is Professor of Strategic Sales and Account Management at Cranfield School of Management,

UK. She specialises in key account management and marketing portfolio management, particularly in service

businesses, and has a PhD in customer profitability. Her research has appeared in Journal of Marketing,

Journal of Service Research, Industrial Marketing Management and European Journal of Marketing. She

is the Director of Cranfield’s Key Account Management Best Practice Research Club.




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Marketing Theory 2010 - Customer Asset & Equity

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