Page 62 - DMGT308_CUSTOMER_RELATIONSHIP_MANAGEMENT

Unit 3: Analysing Profitability of Customers

Optimal allocation of resources and efforts across profitable customers and cost effective and Notes
customer specific communication channels (marketing contacts) is the key to the success of such
an approach. This calls for assessing the value of individual customers and employing customer
level strategies based on customers’ worth to the firm.
The assessment of the value of a firm’s customers is the key to this customer-centric approach.
But what is the value of a customer? Can customers be evaluated based only on their past
contribution to the firm? Which metric is better in identifying the future worth of the customer?
These are some of the questions for which a firm needs answers before assessing the value of its
customers. Many customer oriented firms realize that the customers are valued more than the
profit they bring in every transaction. Customers’ value has to be based on their contribution to
the firm across the duration of their relationship with the firm. In simple terms, the value of a
customer is the value the customer brings to the firm over his/her lifetime. Some recent studies
(Reinartz & Kumar, 2003) have shown that past contributions from a customer may not always
reflect his or her future worth to the firm. Hence, there is a need for a metric which will be an
objective measure of future profitability of the customer to the firm (Berger & Nasr, 1998).
Customer lifetime value takes into account the total financial contribution—i.e. revenues minus
costs—of a customer over his or her entire lifetime with the company and therefore reflects the
future profitability of the customer. Customer lifetime value (CLV) is defined as the sum of
cumulated cash flows—discounted using the Weighted Average Cost of Capital (WACC) — of
a customer over his or her entire lifetime with the company.
The shareholder value and the customer lifetime value approach are conceptually and
methodically analogous. Both concepts calculate the value of a particular decision unit by
discounting the forecasted net cash flows by the risk-adjusted cost of capital. However, virtually
no scholarly attention has been devoted to the question if any of the components of the
shareholder value could be determined in a more market-oriented way using individual customer
lifetime values. Therefore, the main objective of this unit is to systematically explore the
contribution of both concepts to the field of corporate valuation. At first we present a
comprehensive calculation method for estimating both the individual lifetime value of a
customer and the customer equity. After a critical examination of the shareholder value concept,
a synthesis of both value approaches allowing for a disaggregated and more realistic corporate
valuation will be presented.

The Significance of the Customer in Corporate Valuation

In recent years, the proliferation of value-based management has led to an increasing demand
for corporate valuation methods. This development is rooted in external factors, namely in the
capital market’s requirements. The fulfillment of the need to effectively assess companies is
particularly important at a time when a strongly merger-driven economy with a growing
monetary transaction volume fosters the danger of false evaluation and misinterpretation.
However, internal reasons also play a major role in this context, such as the support of efficient
resource allocation, which requires the measurement of the value contribution of functions or
business units (Srivastava/Shervani/Fahey 2000, pp.168 f.; Blattberg/Deighton 1996, pp. 136–
144).
These days, market orientation does not represent a company’s key success factor, market value
orientation does. In this context, market value orientation is usually interpreted as capital
market orientation; for this reason, the concept of shareholder value is frequently employed.
Resulting from the financial origins of the shareholder value concept as a predominant evaluation
method, marketing as a likewise value-creating area has long been neglected. It is an accepted
fact that the field of marketing and – within this broad area – the field of sales represents the
crucial company-customer interface, the customer being the most valuable resource of the
company (Srivastava/Shervani/Fahey 1999, p. 169). It is the customer who creates value – all

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