Valuing Customers

Sunil Gupta
Donald R. Lehmann
Jennifer A. Stuart

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republicationwithout prior written permission of the Author is strictly prohibited.

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Customers as Assets
Intangible assets are hard to see and even harder to fix a
precise value for. But a widening consensus is growing
that the importance of (intangible) assets from brand
names and customer lists means that investors need to
know more about them. A task force appointed by SEC
will encourage companies to provide more information
regarding those assets.

- New York Times, May 22, 2001

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3
Valuing High Growth Businesses
Traditional finance approach
DCF
P/E ratio
The Wall Street approach
Henry Blodget (1999)
Desmet et al. (2000)
Accounting approach
Trueman, Wong and Zhang (2001)
Demers and Lev (2001)
Our approach

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4
Customer Lifetime Value
Lifetime value of a
customer




Lifetime value with
constant margins

=
+
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) 1 (
t
t
t
t
i
r m
LV
|
.
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=
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m LV
1
Retention
Rate (r ) 10% 12% 14% 16%
60% 1.20 1.15 1.11 1.07
70% 1.75 1.67 1.59 1.52
80% 2.67 2.50 2.35 2.22
90% 4.50 4.09 3.75 3.46
Discount Rate (i)
Margin Multiple
|
.
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+ r i
r
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Model
Time 0 n
0

1 n
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r n
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2 n
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r
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n
1
r n
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3 n
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r
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n
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r n
3


4 n
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r n
4



. . . .

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+ +

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6
Value of Customer Base
In discrete time



In continuous time



=

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7
Data
From To
Jun 1997 Jun 2001 35,100,000 6.23 $ 8.41 $
Dec 1997 Jun 2001 1,545,000 83.79 $ 229.25 $
Mar 1997 Jun 2001 34,100,000 4.30 $ 9.40 $
Mar 1998 Jun 2001 3,828,610 52.91 $ 162.30 $
Acquisition
Cost Company
Data Period
No. of
Customers
Quarterly
Margin
Source: Annual Reports, 10K and 10Q Statements

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8
Number of Customers
AMAZON
-
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
30,000,000
35,000,000
40,000,000
M
a
r
-
9
7
J
u
n
-
9
7
S
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p
-
9
7
D
e
c
-
9
7
M
a
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-
9
8
J
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-
9
8
S
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-
9
8
D
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c
-
9
8
M
a
r
-
9
9
J
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-
9
9
S
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-
9
9
D
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c
-
9
9
M
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r
-
0
0
J
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-
0
0
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0
D
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c
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1
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-
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1
Time
N
o
.

o
f

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r
s
E-BAY
-
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
30,000,000
35,000,000
D
e
c
-
9
6
M
a
r
-
9
7
J
u
n
-
9
7
S
e
p
-
9
7
D
e
c
-
9
7
M
a
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-
9
8
J
u
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-
9
8
S
e
p
-
9
8
D
e
c
-
9
8
M
a
r
-
9
9
J
u
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-
9
9
S
e
p
-
9
9
D
e
c
-
9
9
M
a
r
-
0
0
J
u
n
-
0
0
S
e
p
-
0
0
D
e
c
-
0
0
M
a
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-
0
1
J
u
n
-
0
1
Time
N
o
.

o
f

C
u
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t
o
m
e
r
s
AMERITRADE
-
200,000
400,000
600,000
800,000
1,000,000
1,200,000
1,400,000
1,600,000
1,800,000
S
e
p
-
9
7
D
e
c
-
9
7
M
a
r
-
9
8
J
u
n
-
9
8
S
e
p
-
9
8
D
e
c
-
9
8
M
a
r
-
9
9
J
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-
9
9
S
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p
-
9
9
D
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c
-
9
9
M
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r
-
0
0
J
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-
0
0
S
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p
-
0
0
D
e
c
-
0
0
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1
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n
-
0
1
Time
N
o
.

o
f

C
u
s
t
o
m
e
r
s
E-TRADE
-
500,000
1,000,000
1,500,000
2,000,000
2,500,000
3,000,000
3,500,000
4,000,000
4,500,000
D
e
c
-
9
7
M
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-
9
8
J
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-
9
8
S
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p
-
9
8
D
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c
-
9
8
M
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-
9
9
J
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-
9
9
S
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p
-
9
9
D
e
c
-
9
9
M
a
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-
0
0
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0
0
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p
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0
0
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e
c
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0
0
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1
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1
Time
N
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.

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9
Modeling Number of Customers
Cumulative number of customers



Number of customers acquired
) exp( 1 t
N
t
|
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+
=
2
)] exp( 1 [
) exp(
t
t
dt
dN
n
t
t
|
| o
+

= =

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2

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10
Parameter Estimates
for Number of Customers (millions)
60% 70% 80%
o 82.20 70.53 60.21
| -4.77 -4.67 -4.57
0.31 0.31 0.32
MAD 0.84 0.75 0.63
MSE 0.97 0.79 0.68
o 4.09 3.49 2.96
| -3.73 -3.63 -3.52
0.28 0.28 0.28
MAD 0.04 0.04 0.04
MSE 0.003 0.003 0.003
o 95.02 84.68 75.24
| -6.27 -6.17 -6.07
0.34 0.33 0.33
MAD 0.98 0.71 0.62
MSE 1.77 0.79 0.73
o 8.51 7.24 6.15
| -3.75 -3.66 -3.57
0.34 0.34 0.35
MAD 0.29 0.24 0.28
MSE 0.09 0.06 0.08
E*Trade
Ameritrade
E-Bay
Retention
Company Parameter
Amazon
Peak of customer
acquisition = -|/
or 15-20 quarters

2
0
0
2

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2
0
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2
.

11
Quarterly Margin per Customer
AMAZON
$0
$3
$6
$9
$12
$15
$18
$21
M
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-
9
7
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Time
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AMERITRADE
$0
$30
$60
$90
$120
$150
$180
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E-BAY
$2
$3
$4
$5
$6
$7
$8
$9
$10
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-
9
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E-TRADE
$30
$40
$50
$60
$70
$80
$90
$100
$110
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12
Acquisition Cost per Customer
AMAZON
$0
$3
$6
$9
$12
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$18
J
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-
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$60
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$360
$420
$480
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-
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0
40
80
120
160
200
240
280
320
360
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3
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1
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2
0
0
2
.

13
Value of Customers & Market Cap
r=60% r=70% r=80%
Amazon 2.00 2.54 3.29 5.13 3.58
Ameritrade 1.13 1.45 1.94 1.51 1.29
Ebay 1.56 2.11 2.87 18.72 17.00
E*Trade 1.44 1.89 2.56 2.10 3.98
Value of Customers ($ billion) Market Cap ($ billion)
As of June
30, 2001
As of Jan
16,2002
Retehtion Rate

2
0
0
2

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2
0
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2
.

14
Changes in Value over Time
Amazon
23.45
12.91
13.69
5.56
3.67
5.13
2.21 2.16
2.41
3.14 3.31 3.29
-
5.00
10.00
15.00
20.00
25.00
Mar-00 Jun-00 Sep-00 Dec-00 Mar-01 Jun-01
Time
$

b
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s
Market Value

Customer Value

2
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2

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1
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2
0
0
2
.

15
Managing Customer Value
Impact of Acquisition Cost, Margin and Retention Rate
Customer
Value ($b)
Base Case Retention Acquisition Cost Margin
Amazon 2.54 28.34% 0.51% 10.51%
Ameritrade 1.45 30.18% 1.19% 11.19%
Ebay 2.11 30.80% 1.42% 11.42%
E*Trade 1.89 29.96% 1.11% 11.11%
% Increase in Customer Value for a
10% improvement in
Base Case: 70% customer retention

2
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2

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b
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a
r
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1
,

2
0
0
2
.

16
Value of Marketing and Finance Actions
Impact of Retention Rate and Discount Rate
Customer
Value ($b)
Base Case Retention Rate Discount Rate
Amazon 2.54 28.34% 2.91%
Ameritrade 1.45 30.18% 4.17%
Ebay 2.11 30.80% 2.91%
E*Trade 1.89 29.96% 3.12%
% Increase in Customer Value
for a 10% improvement in
60% 70% 80%
8% 2.17 2.80 3.75
12% 2.00 2.54 3.29
16% 1.85 2.32 2.93
Retention Rate Discount
Rate Customer Value
Of Amazon ($b)

2
0
0
2

p
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d

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b
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a
r
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1
,

2
0
0
2
.

17
Conclusions
Measuring intangible assets customers

Customer value as a proxy for firm value

Increase in customer value for a 10% improvement in
Acquisition cost = 1%
Margins = 11%
Retention = 30%
Discount Rate = 3%