A Theory of Customer Valuation: Concepts, Metrics, Strategy, and Implementation

V. Kumar
 

 

 
Theory of Customer Valuation
Key Takeaways

​What? This study proposes the CVT to value future customer contributions based on the nature and scope  of the contributions.

So What? By focusing on a CVT-based approach, firms can (1) acquire/retain profitable customers, (2) employ resources productively, and (3) nurture profitable customers, resulting in higher firm value. 

Now What? Firms should (re)organize their structure and operations to facilitate the implementation of CVT-based strategies. 

​Value Exchange in Customer Relationships

Firms routinely operate in a cycle of creating value to and deriving value from its customers. This value exchange ultimately characterizes the firm–customer relationship from a value standpoint. The value exchange is also impacted by other relationship factors. For instance, while determining resource allocation rules, firms are often challenged to dynamically align resources directed towards customers and products to simultaneously generate value to customers and value from customers. In addition, the volatility and vulnerability in customer cash flows (arising due to both customer and firm actions) differentially affects overall firm profitability. Further, customer life events (e.g., getting divorced, becoming empty nesters) can also affect future cash flows. Therefore, firms look for ways to better manage customer cash flows, and thereby build better customer relationships.

Issues in Valuing Customer Contributions

Since customers are considered as assets of the firm, several attempts have been made to use the principles guiding the valuation of stocks (also assets of the firm) to value customer contributions. However, firms typically face the following three key issues while valuing customer contributions. First, adopting a metric that can most accurately identify customers who offer the highest future value potential is critical in order to invest in the “right” customers. Second, configuring a portfolio of the most valuable customers for the firm is complicated. For instance, dynamics in customer characteristics over time, and industry regulations often prevent firms in building the ideal portfolio of customers. Finally, firms cannot frequently ‘hire’ and ‘fire’ their customers in an effort to rebalance their customer portfolios. The above reasons make the financial theories inappropriate for valuing customers. 

A Novel Approach to Valuing Customer Contributions

This study introduces the customer valuation theory (CVT) as a reliable approach for firms to better understand and manage the value creation and cash flow management process. The CVT focuses on two aspects of customer financial contributions: their nature (i.e., direct and indirect) and their scope (i.e., breadth and depth). Incorporating these two aspects, the CVT can be defined as a mechanism to measure the future value of each customer on the basis of (1) the customer’s direct economic value contribution, (2) the depth of the direct economic value contribution, and (3) the breadth of the indirect economic value contribution by accounting for volatility and vulnerability of customer cash flows. In proposing this theory, this study shows that how the CVT informs firms about (1) the conceptualization of value generation from customers, and (2) the ways and means available to maximize value from customers.

Components of the Customer Valuation Theory

The CVT, as captured by the definition, has three components. First, the direct economic value contribution refers to the economic value of the customer relationship to the firm, expressed as a contribution margin or net profit. Here, the CVT recognizes customer lifetime value (CLV) as the metric that can most accurately capture a customer’s future value potential to the firm. Second, the depth of direct economic value contribution refers to the intensity and inclusiveness of customers’ direct value contributions to the firm through their own purchases. Finally, the breadth of the indirect economic value contribution refers to customers’ indirect value contributions to the firm through their referral behavior, their online influence on prospects’, and their feedback on the firm offerings. This indirect contribution can also be extended to accommodate other contexts that guide salesperson value, donor value (in the case of nonprofit firms), and business reference value. Developing further on these components, this study identifies the “Wheel of Fortune” strategies to maximize the depth of direct economic value contribution by the customers, along with other strategies to maximize the breadth of the indirect economic value contribution by the customers that can guide firms in the implementation of the CVT. In implementing these strategies, this study provides evidence of multi-million dollar gains experienced by firms across several industries over the past 2 decades.

Role of Customer Valuation Theory in Managerial Decision-Making

Because CVT enables managers to actively manage customer relationships on the basis of future customer contributions through specialized customer strategies, it creates a positive impact on firm performance. Specifically, the implementation of the CVT can help firms improve their marketing productivity and realize higher firm value through (1) valuing customers as assets, (2) managing a portfolio of customers, and (3) nurturing profitable customers.


 
ABOUT THE AUTHOR:
V. Kumar

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