Customer Equity
Wiesel, Skiera, and Villanueva (see article Customer Equity: An Integral Part of Financial Reporting in the March 2008 issue) make an eloquent case that firms should report new forward-looking metrics about customer assets in a manner helpful to investors. Their assertion appears consistent with the spirit of IASB and FASB requirements. More important, the authors argue that the widespread adoption of such metrics may facilitate “marketing’s reentry into the boardroom because it aligns customer management with corporate goals and the investor’s perspective" (p. 2).
The approach advocated in the article is rather simple. It involves two elements: customer equity statement and customer equity flow statement. Furthermore, the authors identify five critical criteria for customer equity-based financial reporting: future orientation/decomposition, objectivity, comparability, simplicity, and cost effectiveness.
As a discipline, a criticism often leveled at marketing is that it has developed far too many metrics whose financial implications are either weak or not obvious. A key contribution of this article is to advocate for and to demonstrate the potential of an idea that appears timely and relevant.
In general, blog threads for the Journal of Marketing have attracted spirited discussion among JM readers and others. I look forward to your responses to the profound questions raised by Wiesel, Skiera, and Villanueva in their recent article. Please take a few moments to contribute your thoughts to this blog thread now.
By Siva K. Balasubramanian, Journal of Marketing Web Site Editor
Comments
You can also find a survey on customer equity by Mike Hanssens and Julian Villanueva published in Foundations and Trends in Marketing at http://dx.doi.org/10.1561/1700000002. In this paper, the authors (a) discuss the academic and strategic importance of CE, (b) provide an extensive literature review, and (c) prioritize future research.
Posted by: Zac Rolnik | June 13, 2008 3:53 PM
Btw, it's by "Dominique M. Hanssens", not Mike Hanssens
Posted by: Adeline Chua | June 16, 2008 1:23 AM
The authors are to be congratulated on an important contribution to performance reporting. They are correct that company directors are now being asked to provide forward looking information, and notably metrics or KPIs, in annual corporate reports.
This can be interpreted in two ways: predicting future performance or providing current metrics from which future forecasts can be built.
This paper assumes the former without considering the key issues which will lead company directors to opt for the second. Some of these key issues are:
1. Contrary to popular imagination, boards do not know the future performance of their companies. Yes, they have plans and forecasts but experience tells them how error-prone those are.
2. Making public forecasts which do not work out, even with safe harbour protections, is at least bad for reputation and can lead to prosecution.
3. Making private forecasts public tells their competitors more than the directors want them to know. Competitive confidentiality is a real issue.
4. These forecasting models are fine in theory but not tested in practice. And even if they would have worked in the past (where we have the data)where is the guarantee they will work in the future (where we don't)?
In my view, we should cease regarding Customer Equity (or any similar DCF technique) as a Silver Metric and get back to advising directors on how to select the key metrics for their dashboards.
Tim Ambler
Posted by: Tim Ambler | June 17, 2008 3:54 PM
We appreciate Tim's comments on our paper and would like to take the opportunity to respond to them. We all agree on the fact that company directors are now being asked to provide forward looking information, including metrics or KPIs, in annual corporate reports or any other way of financial communication.
The fact that managers may prefer to keep some key information hidden due to competitive reasons may go against the desire of investors to have information. Investors have the right to get metrics that could help them better assess the value of the firm. If firms provide that information on an aggregate level (even though a more disaggregated level would be preferred) the value of this information for competitors is questionable. Many times, competitors will also be asked to disclose the same metrics. For a privately-owned company, there is hardly any to disclose this information, but when companies go public, they are forced to be more transparent.
Tim's point regarding the risk of making forecasts and not meeting them is valid and firms need to be careful in doing so. But, how much trust would someone have into a firm's management if they do not have any idea about the future? Many public firms make forecasts and share these forecasts with investment bank analysts. In addition, the financial community does not take companies' projections for granted and do their own valuations, many times using the DCF method.
As such, firms can discuss their projections/assumptions as well as the analysts' projections/assumptions in their meetings and incorporate any unforeseen events.
Summing up, we are very much in line with some of Tim's comments (for example, the need of internal metrics and management dashboards), but we believe companies should help analysts and investors in their understanding of the sources (and risks) of the future business performance.
Posted by: Thorsten Wiesel, Bernd Skiera and Julian Villanueva | June 30, 2008 7:58 PM
I like the approach of this paper a great deal, particularly the notion of breaking down a measure into its underlying components and looking at a statement of changes over time. My reservation here is philosophical: I'm not sure CLV is a workable measure. It may not pass the reliability test the authors mention in Table 2. There are so many different ways to measure CLV, and any measure simple enough for a manager to use tends to have simplifying assumptions as here (e.g., 10% discount rate, constant cash flow and retention rates over time), so that I'm not sure I believe the result. I know two firms who have decided their lifetime is 3 years, because they can't imagine projecting revenue and cost assumptions beyond that timeframe, and I recall reading that other firms use 4 or 5.
That said, I think this kind of aggregate analysis can be useful to an investor, but I also agree with Tim that no firm is likely to produce this kind of analysis unless forced by regulation or investor demand. The fact that Netflix and a number of other providers do release the kind of information is very helpful and interesting, though. I wish regulators/investors did demand this more.
You could set a doctoral student to work calculating this for more than Netflix and start thinking about relating the results to other measures, particularly financial.
Posted by: Bruce Clark | July 9, 2008 2:24 AM