Customer-Based Corporate Valuation - Integrating the Concepts of Customer Equity and Shareholder Value

Abstract

Purpose - Synthesis of the customer lifetime value and the shareholder value (SHV) approach in order to develop an integrated, marketing-based method for corporate valuation. Design/methodology/approach - Discusses the limitations and assumptions of existing methods to estimate customer value components and examines the limitations of the SHV concept. By linking the customer equity (CE) and the SHV approach, a formal model to calculate corporate value is developed. The discounted cash flow method is used for modelling the profit streams. Findings - Provides formulas for the estimation of both the individual lifetime value of a customer and CE. Provides a comprehensive model to estimate corporate value based on customer-related cash flows and traditional financial metrics. Introduces typical cases, in which the use of a customer-based valuation seems beneficial. Illustrates how our approach can be applied by using a simple case study on M&A in the telecommunication industry. Gives suggestions on how to obtain the necessary data, partially even from publicly available sources. Research limitations/implications - Advancement of the quantitative techniques for modelling the customer value components would allow for relaxing some restrictive assumptions. The explicit modelling of the future growth of the customer base (the acquisition rate) would increase the applicability of the model. Additionally, taking into account heterogeneity within the customer cohorts is a task for future research. Finally, our model needs to be applied more extensively using real data for the input variables. Practical implications - A CE-based valuation approach can guide marketing investments and helps to avoid misallocation of resources. Based on an example in the field of M&A, we demonstrate the usefulness of the approach for obtaining a realistic indicator of firm value. It helps to assess whether an acquisition is economically sensible. We provide evidence for the superiority of a customer-based approach over traditional financial methods. Originality/value - While the traditional SHV method considers cash flows at a highly aggregated level, our approach employs disaggregated cash flows on the level of individual customers. Thereby we do incorporate the lifetime values of future customers by considering different cohorts. We do capture customer defection by incorporating retention rates. Our model enables a more detailed and valid estimation of corporate value by accounting for the single customer activities that drive marketing actions. This enables a better forecasting of the free cash flow. Incorporating customer-related drivers into financial valuation models makes easier to assess the return on marketing investments.