Customer equity is the total value of all relationships with a company’s customers throughout a given period of time and is one of the most important metrics in strategic marketing.
What is Customer Equity?
Customer equity is calculated by multiplying the number of new customers acquired by the customer lifetime value (CLV) of those customers, which can be estimated based on past buying habits and is usually a fairly stable number. Customer equity is essentially a company’s “index fund” – a single “share” can go up and down, but ideally the value of the global “stock market” always increases gradually.
Customer Equity – a Definition
The concept of customer equity is best understood by comparing it to a related concept, brand equity. Both are similar in some respects, as they attempt to measure the intangible value of marketing assets and include customer loyalty as a fundamental consideration. But there are serious differences.
One is the basic unit of analysis, as brand value focuses on the product, while customer value is directly related to the product. And second, customer value measures observable customer behavior rather than analyzing less tangible attitudes, as is the case with brand value.
Because customer behavior and purchasing decisions are directly related, customer equity provides a more accurate understanding of the cause-and-effect relationships that ultimately drive revenue. When combined with financial metrics, such as net present value, revenue generation over the customer’s lifetime can be compressed into a single customer value.
For all those benefits, the value of the brand is better known than that of the customer. But not because brand equity is a more popular or effective measurement, but because customer equity generally does not have enough time to reveal itself. In contrast, the more data is disclosed, the greater is the benefit to the customer.
What drives customer equity
There are three drivers of customer equity – brand equity, value equity and relationship equity (also known as retention equity). These factors both work independently as well as together.
Brand Equity: refers to the overall value of the brand as an asset. Brand Equity is reflected in the way customers respond to the brand.
Value Equity: is defined as the customer’s objective assessment of the benefits of a brand, based on their perception of what they give up for what they receive. Three key levers influence Value Equity: quality, price and convenience.
Relationship Equity: is what makes a customer stay with the preferred brand and not switch to another.
How to calculate customer equity?
Customer’s equity is the sum of all the life values of a company. In other words, you calculate the value of each customer’s life (CLV) and sum all these values to determine the metric. Customer equity is therefore the total profitability expected from a customer base over time. It is calculated using a composite discount rate that allows us to take into account the expected total monetary profitability of our customer base.
To calculate customer equity, it is necessary to apply the following formula:
Customer Equity = Sum of Current and Future Customer Lifetime Value (CLV)
Notice: Since the lifetime value of the customer should always be calculated using a discount rate, the above sum provides the expected total profitability of current and future customers also based on the discount.
An example of customer equity?
“In one year, a company had 1,000 customers, each of whom turned over 100 euros per year. The following year, the number of customers dropped to 900, but the forecast is that each will turn over 120 euros that year – so the company increases its sales to 108,000 euros while the number of customers drops, making the business sustainable.
With these figures, it is possible to develop strategies on how to attract more customers, which customers limit consumption, marketing plans to reactivate them and many other actions that help increase the company’s revenue.
Customer equity gives a complete picture of the company’s performance
One could say that customer equity is the pulse of corporate health. It is a metric that can be a trigger for strategic change. It provides a complete picture of business performance. It can also be used to estimate future return on marketing investment (marketing ROI). A marketing strategy based on customer equity means planning for the long term and bringing the most valuable customers together with the company.
Customer equity provides information about which types of customers are most valuable, where their value comes from, and how to cultivate long-term relationships. In each of these cases, it’s about determining the optimal level of total marketing spend and the most effective way to allocate the budget with a view to maximizing long-term benefits.