1. Valuing Customers Sunil Gupta Donald R. Lehmann Jennifer A. Stuart All rights are reserved. Members of MSI and academic researchers may make limited copies of this presentation, electronically or in print, solely for their internal, non-commercial use. Any other use of this presentation—including reproduction for purposes other than those noted above, modification, distribution, or republication—without prior written permission of the Author is strictly prohibited.

2. © 2002 presented by Sunil Gupta at the Marketing Science Institute’s Conference on Customer Relationship Management: Customer Behavior, Organizational Challenges, and Econometric Models on January 31 – February 1, 2002. 2 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

3. © 2002 presented by Sunil Gupta at the Marketing Science Institute’s Conference on Customer Relationship Management: Customer Behavior, Organizational Challenges, and Econometric Models on January 31 – February 1, 2002. 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

4. © 2002 presented by Sunil Gupta at the Marketing Science Institute’s Conference on Customer Relationship Management: Customer Behavior, Organizational Challenges, and Econometric Models on January 31 – February 1, 2002. 4 Customer Lifetime Value Lifetime value of a customer Lifetime value with constant margins Margin Multiple

5. © 2002 presented by Sunil Gupta at the Marketing Science Institute’s Conference on Customer Relationship Management: Customer Behavior, Organizational Challenges, and Econometric Models on January 31 – February 1, 2002. 5 Model Time 0n 0 1n 0 r n 1 2 n 0 r 2 n 1 rn 2 3n 0 r 3 n 1 r 2 n 2 r n 3 4n 0 r 4 n 1 r 3 n 2 r 2 n 3 r n 4......

6. © 2002 presented by Sunil Gupta at the Marketing Science Institute’s Conference on Customer Relationship Management: Customer Behavior, Organizational Challenges, and Econometric Models on January 31 – February 1, 2002. 6 Value of Customer Base In discrete time In continuous time

7. © 2002 presented by Sunil Gupta at the Marketing Science Institute’s Conference on Customer Relationship Management: Customer Behavior, Organizational Challenges, and Econometric Models on January 31 – February 1, 2002. 7 Data Source: Annual Reports, 10K and 10Q Statements

8. © 2002 presented by Sunil Gupta at the Marketing Science Institute’s Conference on Customer Relationship Management: Customer Behavior, Organizational Challenges, and Econometric Models on January 31 – February 1, 2002. 8 Number of Customers

9. © 2002 presented by Sunil Gupta at the Marketing Science Institute’s Conference on Customer Relationship Management: Customer Behavior, Organizational Challenges, and Econometric Models on January 31 – February 1, 2002. 9 Modeling Number of Customers Cumulative number of customers Number of customers acquired

10. © 2002 presented by Sunil Gupta at the Marketing Science Institute’s Conference on Customer Relationship Management: Customer Behavior, Organizational Challenges, and Econometric Models on January 31 – February 1, 2002. 10 Parameter Estimates for Number of Customers (millions) Peak of customer acquisition = -  /  or 15-20 quarters

11. © 2002 presented by Sunil Gupta at the Marketing Science Institute’s Conference on Customer Relationship Management: Customer Behavior, Organizational Challenges, and Econometric Models on January 31 – February 1, 2002. 11 Quarterly Margin per Customer

12. © 2002 presented by Sunil Gupta at the Marketing Science Institute’s Conference on Customer Relationship Management: Customer Behavior, Organizational Challenges, and Econometric Models on January 31 – February 1, 2002. 12 Acquisition Cost per Customer

13. © 2002 presented by Sunil Gupta at the Marketing Science Institute’s Conference on Customer Relationship Management: Customer Behavior, Organizational Challenges, and Econometric Models on January 31 – February 1, 2002. 13 Value of Customers & Market Cap

14. © 2002 presented by Sunil Gupta at the Marketing Science Institute’s Conference on Customer Relationship Management: Customer Behavior, Organizational Challenges, and Econometric Models on January 31 – February 1, 2002. 14 Changes in Value over Time Market Value Customer Value

15. © 2002 presented by Sunil Gupta at the Marketing Science Institute’s Conference on Customer Relationship Management: Customer Behavior, Organizational Challenges, and Econometric Models on January 31 – February 1, 2002. 15 Managing Customer Value Impact of Acquisition Cost, Margin and Retention Rate Base Case: 70% customer retention

16. © 2002 presented by Sunil Gupta at the Marketing Science Institute’s Conference on Customer Relationship Management: Customer Behavior, Organizational Challenges, and Econometric Models on January 31 – February 1, 2002. 16 Value of Marketing and Finance Actions Impact of Retention Rate and Discount Rate Customer Value Of Amazon ($b)

17. © 2002 presented by Sunil Gupta at the Marketing Science Institute’s Conference on Customer Relationship Management: Customer Behavior, Organizational Challenges, and Econometric Models on January 31 – February 1, 2002. 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%