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Customer assets and customer equity: Management and measurement issues

Andreas Persson and Lynette Ryals Marketing Theory 2010 10: 417 DOI: 10.1177/1470593110382828 The online version of this article can be found at: http://mtq.sagepub.com/content/10/4/417

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Article

Customer assets and customer equity: Management and measurement issues

Andreas Persson
Hanken School of Economics, Finland

Marketing Theory 10(4) 417436 The Author(s) 2010 Reprints and permission: sagepub.co.uk/journalsPermissions.nav DOI: 10.1177/1470593110382828 mtq.sagepub.com

Lynette Ryals
Cranfield School of Management, UK

Abstract In spite of the current focus on marketing accountability and the growing body of research into customer equity and customer lifetime value, the finance community has not shown any noticeable interest in these increasingly well established marketing metrics and, in fact, few companies have adopted them. There is a problem here: marketing has failed to find credibility in the very field it intends to address, which is the accountability of marketing and its contribution to shareholder value. A root cause of this failure is the prevailing confusion among marketing academics about the difference between customer assets and customer equity. In this paper, we argue for a clear distinction between the management of customer assets and the measurement of customer equity. We demonstrate the advantages for external stakeholders of including the drivers of and components of customer equity in management commentaries to financial reporting; and show how this could be done using a Customer Equity Scorecard. Keywords customer assets, customer equity, customer lifetime value, marketing accountability, marketing metrics

Introduction
A much needed narrowing of the gap between marketing, and finance and accounting is currently under way, as evidenced by the publication of several special issues on topics such as the marketing/ finance interface (Journal of Business Research, 2000; Journal of the Academy of Marketing Science, 2005); linking marketing to financial performance and firm value (Journal of Marketing,
Corresponding author: Andreas Persson, Centre for Relationship Marketing and Service Management (CERS), Hanken School of Economics, P.O. Box 479, 00101 Helsinki, Finland Email: andreas.persson@hanken.fi

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2004); return on marketing investment (Journal of Strategic Marketing, 2007); the marketing/ accounting interface (Journal of Marketing Management, 2008); intangibles (Accounting and Business Research, 2008); and Marketing Strategy Meets Wall Street (Journal of Marketing, 2009). Worryingly, however, we find evidence that marketing academics and finance academics are taking divergent perspectives on the appropriate metrics for marketing accountability. In this paper, we argue that marketing academics need to appreciate the difference between customer assets and customer equity, and we propose a scorecard that sets out the drivers and components of customer equity and shows their implication for the future earnings potential of the firm. From a marketing perspective, the burgeoning interest in finance and accounting stems from a need to demonstrate marketing accountability. Marketing academics have taken the route of aiming to connect marketing investments in customer relationships, brands, and other off-balance sheet intangible assets to the generation of shareholder value (Gronroos, 2003; Kumar and Shah, 2009; Lukas et al., 2005; Rust et al., 2004a; Ryals, 2008a; Stahl et al., 2003). For example Gronroos (2003: 172) introduces the notion of investing in customers, arguing that the relation ship paradigm has the potential to make marketing more relevant for shareholders, top management, customers and customer management. In line with these ideas, there has been a rapid growth in the number of studies on customer equity-related issues over the past few years (cf. Kumar et al., 2006), tackling the issues of measuring the value of customer relationships and of managing these relationships in order to maximize their value. However, much marketing research on customer equity conspicuously lacks references to research on intangible assets that has been conducted within the areas of, for example intellectual capital, accounting, and strategic management. This state of affairs is particularly alarming since there have recently been calls for marketing to take a leading role in disseminating the usefulness of customer equity and other marketing metrics to our sister disciplines, finance and accounting (e.g. Wiesel et al., 2008), in the hope that these metrics will be adopted by firms in their financial reporting. From a finance perspective, meanwhile, there have been numerous calls for more transparency in financial reporting of intangible assets in order to assist investors decision making (e.g. Canibano et al., 2000; IASB, 2005; Lev, 2001; Whitwell et al., 2007). Issues concerning the valuation of intangible assets were once again brought into the limelight with the International Accounting Standards Boards (IASB) 2004 publication of the IFRS 3 statement on business combinations. IFRS 3 requires that, in the case of corporate acquisitions, both tangible and intangible assets be restated at their market values when accounting for the acquisition. However, although customer-related intangibles are one of the five categories of intangible assets recognized by IFRS 3, the well established marketing metrics, customer equity (Blattberg and Deighton, 1996) and customer lifetime value (CLV)1 (Dwyer, 1989; Kotler, 1974: 24), have not sparked any noticeable attention within the finance community (Gleaves et al., 2008); nor has the take-up among marketing practitioners been widespread. This indicates that marketing theory may be off track when attempting to promulgate financially-oriented customer metrics to the finance community. Indeed, it is sobering to note that some parts of the finance community even appear to prefer qualitative customer information to quantitative customer metrics (AFRAC, 2006). We argue that, to address this problem, customer equity research needs to incorporate theories of direct marketing, brand equity, service quality and relationship marketing (cf. Hogan et al., 2002b). These theories focus on customer perceptions and behaviour, i.e. the drivers of customer equity, which are also of interest from a finance perspective. For example, Wyatt (2008: 244) states that understanding how customer loyalty is generated and destroyed in different industries is a pre-requisite for identifying value-relevant information on customer loyalty.

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This paper takes the form of a literature review and makes two contributions to the field of marketing accountability. First, based on a review of the customer equity-related literature, we argue the case for a clear distinction between, on the one hand, customer assets; and on the other hand, customer equity. We thereby contribute to marketing theory by clarifying the conceptual foundation of customer equity and addressing the confusion that has arisen over the distinction between the underlying customer asset, and customer equity as a measure of the value of that asset (cf. Brodie et al., 2006: 367; Rust et al., 2004a: 78). The second contribution is that we demonstrate the advantages for external stakeholders of including the actual drivers of customer equity in management commentaries to financial reporting, rather than simply reporting customer equity and its components, and show how this could be done using a Customer Equity Scorecard. This Customer Equity Scorecard could serve as a basis for an enhanced conversation between marketing theory and financial theory with regard to the management of customer assets and the measurement of customer equity. The paper is structured as follows. First, we review previous research on customer equity. Next, we describe in more detail the development of customer equity as a concept, including its drivers, components, and limitations. After that, we explore the potential role of customer equity in financial reporting. We conclude with a discussion and suggestions for further research.

Customer equity
Customer equity was originally conceptualized by Blattberg and Deighton (1996) as a way for firms to determine the optimal balance of customer acquisition and retention spending. They state that:
to measure that equity, we first measure each customers expected contribution toward offsetting the companys fixed costs over the expected life of that customer. Then we discount the expected contributions to a net present value at the companys target rate of return for marketing investments. Finally, we add together the discounted, expected contributions of all current customers. (Blattberg and Deighton, 1996: 1378)

Blattberg and Deighton note that valuing customer relationships has many analogies with the valuation of tangible assets, arguing that the appraisal of customer equity is conceptually similar to the appraisal of the value of a portfolio of income-producing real estate. Their ideas were further extended by Blattberg et al. (2001), who conceptualize customer equity as follows: the customer is a financial asset that companies and organizations should measure, manage, and maximize just like any other asset (Blattberg et al., 2001: 3). Thus, they integrated aspects of customer relationship management, database marketing, and customer satisfaction within a customer equity framework. They advocated a number of key changes to marketing strategy, such as managing customer lifecycles; organizing around customer acquisition, retention, and add-on selling; and balancing marketing costs against financial returns. Whereas Blattberg and Deighton (1996) only included current customers in their calculation of customer equity, Rust et al. (2004b: 110) emphasized the importance of future potential from a marketing perspective by incorporating the discounted lifetime values of prospective future customers into their definition of customer equity. This is in line with Hogan et al.s (2002b: 7) contention that customer equity is a combination of the value of a firms current and potential customer assets.

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Rust et al. (2000) argued for the existence of three key drivers of customer equity: value equity, brand equity and retention/relationship equity. Value equity is defined as the customers objective assessment of the utility of a brand, based on perceptions of what is given up for what is received; brand equity is the customers subjective and intangible assessment of the brand, above and beyond its objectively perceived value; and retention equity is defined as the tendency of the customer to stick with the brand, above and beyond the customers objective and subjective assessments of the brand (Rust et al., 2000: 567). We thus see that value, brand, and retention/ relationship equity are conceptualized by Rust et al. (2000) as value that a customer perceives in different aspects of the suppliers offering. So the marketers task would be to identify which of these drivers are most critical for different customers in order to increase their financial value to the supplier, i.e. the customer equity. Since the development of the original customer equity model (Blattberg and Deighton, 1996), various other models have been proposed, taking different aspects into account, such as brand switching (Rust et al., 2004b); the customer acquisition process (Villanueva et al., 2008); or using only publicly available data (Gupta et al., 2004). A number of studies have applied Rust et al.s (2004b) customer equity models in different contexts, such as retailing (Vogel et al., 2008) and the cell phone operator market (Sublaban and Aranha, 2009). Kumar and George (2007) discuss different distinguishing features with regard to the measurement and maximization of customer equity using various aggregate- and disaggregate-level approaches. They also propose a hybrid approach, which allows firms to select an appropriate approach or different combinations, based on the objectives of customer valuation and the consequent data requirements. To date, the financial valuation of customer relationships has primarily been of importance to marketing as a foundation for optimally selecting customers for marketing campaigns and measuring the effectiveness of marketing actions after implementation (Petersen et al., 2009). This has, however, given rise to some confusion over the distinction between the underlying customer asset, and customer equity as a measure of the value of that asset (cf. Brodie et al., 2006: 367; Rust et al., 2004a: 78). Because this confusion endangers acceptance of the customer equity concept by the finance community, we explore it in detail in the following section.

Customer assets and customer equity

The idea that customers or customer relationships are valuable firm assets is by no means new (e.g. Anderson et al., 1994; Bursk, 1966; Levitt; 1983; Wayland and Cole, 1994). Cravens et al. (1997: 497) declare that satisfied customers are assets who represent long term value to an organization. The theoretical basis of the management of customers as assets or equity of a firm may thus seem straightforward, but the two concepts customer asset management (e.g. Berger et al., 2002; Bolton et al., 2004; Hogan et al., 2002a; Storbacka, 2006) and customer equity management (e.g. Bell et al., 2002; Blattberg et al., 2001; Hogan et al., 2002b; Kumar and George, 2007; Rust et al., 2005) are used by different authors when referring to the same underlying ideas. For example Hogan et al. (2002b) and Kumar and George (2007) discuss the management of customer equity as a practice that seeks to maximize customer equity by managing the customer asset. In the framework proposed by Srivastava et al. (1998), customer relationships are included as one type of market-based asset that should be developed and managed to increase shareholder value. Buyerseller relationships have also been identified as an example of a firms strategic assets (Amit and Schoemaker, 1993). Hence, it follows that with regard to customer management, customer relationships are the assets that marketing is concerned with managing.

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Customer equity, meanwhile, is simply a measure of the value of the customer relationship assets that are managed (Blattberg and Deighton, 1996; Hogan et al., 2002b; Kumar and George, 2007; Rust et al., 2004b). The use of the terms asset and equity in the fields of accounting and finance can help to clarify their use in marketing. Assets traditionally appear on the left-hand side of the balance sheet and are related to the investment decision, i.e. how funds should be allocated over time in order to increase shareholder wealth. Equity, alongside liabilities, appears on the righthand side of the balance sheet and is related to the financing decision, i.e. how to generate funds. Using the analogy of customer relationships as assets, it can be said that firms need to invest in these relationships through marketing activities, personnel training, product/service development, etc. This need to invest is an intangible liability, whereas the customer relationships themselves are intangible assets that are invested in and managed. Meanwhile, the potential value created by the investments in all of the firms customer relationships (the sum of the customer lifetime values) is customer equity, which contributes to shareholder value (cf. Berger et al., 2006; Bick, 2009; Hogan et al., 2002a; Kumar and Shah, 2009). Hence, it is more accurate to refer to the management of customer assets (in order to maximize customer equity) rather than to refer to the management of customer equity itself. This distinction enables us to avoid the confusion that may occur when the term customer equity is used to refer both to the customer asset and to the value of that asset (cf. Brodie et al., 2006: 367; Rust et al., 2004a: 78). Thus, we propose the following definitions: Customer assets are the relationships that a firm has with its customers. Customer equity is the value of those customer assets. Therefore, the function of marketing and of customer relationship management as a process is to manage the customer assets so as to maximize their value (customer equity). The notion of the management of customer assets as a process is illustrated by Rust et al. (2000), who use the word equity when what they are in fact doing is conceptualizing the drivers of customer equity, namely value equity, brand equity and retention equity. These three types of equity are viewed as the customers evaluation of value, and as such are not directly concerned with the equity created for the supplier (cf. Brodie et al., 2002). Rather, they are connected to the concept of customer-perceived value of a product/service, brand, or relationship, or in other words value that a customer gains from an exchange relationship with a supplier. It is important to recognize that value, brand, and relationship equity, as conceptualized by Rust et al. (2000), are not actual components of customer equity, but rather drivers of customer equity, i.e. drivers of the value of customer assets. In the next section, we examine the drivers and the components of customer equity.

Drivers and components of customer equity

Using the distinction between customer assets and customer equity allows us to clarify the drivers and components of customer equity. These drivers and components fit into a customer equity framework, as illustrated in Figure 1. Customer relationships the assets are on the left-hand side of the diagram. These customer assets are managed by the firm by engaging in marketing activities that affect customer perceptions and behaviour, which are the drivers of customer equity. Customer equity the measure of value is on the right-hand side of the diagram. The components

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MANAGEMENT

MEASUREMENT

Customer Assets (customer relationships)

Perceptions Behaviour Length (duration) / behavioural loyalty Depth (purchase frequency, upgrades) and patronage concentration Breadth (cross-buying) Intensity and channels of interaction Risk Attitudinal loyalty Referral behaviour Contribution to learning and innovation

CLV

Customer Equity

Value equity Brand equity Relationship equity Customer satisfaction

Projected customer lifetime (e.g. retention rate) Cash flows, profits or contribution to profit (revenues costs) Discount rate (e.g. WACC)

balance

New customer acquisition Additional potential Customer profitability distribution Customer portfolio diversification

Drivers of Customer Equity

Components of Customer Equity

Figure 1. Drivers and components of customer equity

of customer equity and CLV are affected by the firms management of its customer assets and the subsequent changes in the drivers of customer equity. In order to increase its customer equity, a firm naturally needs to continuously measure its customer equity.

Drivers of customer equity

A review of the customer management literature suggests that the drivers of customer equity fall into two categories customer perceptions and customer behaviour which Gupta and Zeithaml (2006) classify as unobservable and observable constructs respectively. Marketing activities can be used to drive profitable customer behaviour directly or indirectly by enhancing customer perceptions. The most widely discussed customer perceptions that have been found to drive profitable customer behaviour are satisfaction and attitudinal loyalty. For example the serviceprofit chain (e.g. Heskett et al., 1994; Kamakura et al., 2002) links service quality to customer satisfaction, loyalty and profitability. Fornell et al. (2006) show a positive correlation between firms scores on the American Customer Satisfaction Index (ACSI) and their stock prices. Furthermore, Reinartz and Kumar (2002) find that the attitudinal element of customer loyalty (a subjective measure), in addition to the behavioural one, is a crucial determinant of customer profitability. Rust et al.s (2000) categorization of customer perceptions into value equity, brand equity and relationship equity overlap the concepts of customer satisfaction and attitudinal loyalty to a great extent. Value equity resembles objective satisfaction with the firms offering; brand equity is comparative to subjective satisfaction with various aspects of the brand; and relationship equity is very similar

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to attitudinal loyalty. Rust et al. (2004b) provide a framework that allows firms to evaluate the effect of various marketing activities on value, brand and relationship equity, the subsequent effect on customer switching behaviour, and finally the impact on customer equity. Customer behaviour can be affected either by actions aimed at improving customer perceptions, or by marketing activities that aim at changing customer behaviour. Bolton et al. (2004: 274) classify customer behaviour that affects the value of the customer asset into three categories: relationship length (duration), depth (increased usage/upgrading) and breadth (cross-buying). Another aspect is the customers patronage concentration (Storbacka, 1994, 1997; Storbacka et al., 1994) or share-of-spending (Keiningham et al., 2005) with the firm. Several other facets of customer behaviour that affect the value of the customer asset are mentioned in other studies. For example Storbacka (1994) identifies two different ways in which firms can seek to change customer behaviour in order to decrease customer-related costs: decreasing the intensity of a customers interactions with the firm; and moving the customer to cheaper interaction channels. The issue of customer-related risk has also been discussed in connection with the value of customers. For example the risk in revenue streams and the costs to serve a customer (Ryals and Knox, 2005), as well as the risk of a total or partial loss of the customer relationship (Ryals and Knox, 2007) have been highlighted. The volatility of cash flows from customers has also been found to affect the relative value of customers at a customer base (or portfolio) level (Dhar and Glazer, 2003; Ryals et al., 2007). Furthermore, Kumar and Shah (2009) demonstrated that the relationship between a firms customer equity and market capitalization is moderated by the volatility and vulnerability of cash flows from customers. Finally, behaviour driving the indirect value of customers has recently been receiving increasing attention. Kumar et al. (2007) found that the referral value of customers is often higher than their lifetime value. Similarly, Ryals (2008a) demonstrated substantial indirect benefits from customer referrals and references, as well as customers contribution to a firms learning and innovation. The relative importance of the various drivers of customer equity, both customer perceptions and behaviour, will vary depending on the industry and on the company. When referring to the value of customer relationships, it is thus important to consider which aspects of the relationships are actually creating value for the firm, and how (cf. Rust et al., 2004b). In the following section, we will move on to consider the components of customer equity in more detail.

Components of customer equity

Customer equity measures the total value of customer assets, usually defined as the sum of the lifetime values of a firms customer relationships. The CLV of an individual customer is typically comprised of the projected lifetime of the customers relationship with the firm, often expressed as a retention rate; the cash flows the firm expects to receive from the customer in each future period; and a discount rate (Berger and Nasr, 1998; Jain and Singh, 2002). Although these are the core components of CLV, numerous variations and extensions appear in the marketing literature. For example common alternatives to cash flows are profits (e.g. Gupta and Lehmann, 2005) or contribution to profit (e.g. Rust et al., 2000). Furthermore, the importance of using a firms weighted average cost of capital (WACC) for the discount rate, as well as taking individual customer risk into account, is highlighted by Ryals and Knox (2007). Useful reviews of different types of CLV models are provided by Gupta et al. (2006) and Jain and Singh (2002). CLV and, by extension, customer equity draws on the discounted cash flow (DCF) approach used in finance. Gupta et al. (2006) point out, however, that there are two key differences between

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CLV and traditional DCF. First, CLV is usually estimated at an individual customer or segment level, allowing differentiation between customers based on profitability. Second, CLV explicitly incorporates the possibility for future customer defection, typically through a retention rate. If customer relationships are considered to be assets that firms invest in, adopting a version of the DCF asset valuation technique from finance appears logical, since a value can then be derived that estimates the present value of the cash flows generated by the customer relationship over its lifetime, discounted at the appropriate required rate of return. This fits well with Rust et al.s (2004a: 78) contention that marketing expenditures are investments and that marketing assets represent a reservoir of cash flow that has accumulated from marketing activities but has not yet translated into revenue. In effect then, firms invest their limited resources in marketing as well as other activities to establish, maintain and enhance relationships with customers, in order to maximize the return on these investments in the form of maximized customer lifetime values and customer equity. With regard to customer equity calculations, Ryals (2008b) emphasizes the need to include additional potential that could be obtained through changes in specific customer segments, or through the way they are managed. The costs and likely success rates of acquiring different types of new customers also need to be taken into account. Moreover, the balance between customer acquisition and retention is a key determinant of customer equity (Blattberg and Deighton, 1996; Reinartz et al., 2005). In addition, although not generally considered as a component of customer equity, the profitability distribution across the customer base (Ryals and Knox, 2007; Storbacka, 1994, 1997; van Raaij, 2005) could serve as a useful indicator of customer base risk, as could the volatility and vulnerability of cash flows from customers (Dhar and Glazer, 2003; Kumar and Shah, 2009; Ryals et al., 2007; Stahl et al., 2003).

Impact of customer equity drivers on customer equity components

There are numerous ways in which the components of customer equity can be impacted by its drivers. Two of the main components, the projected lifetime of a customer relationship and the cash flows that the firm expects to receive from the customer, are clearly affected by customer relationship management efforts. Indeed, two of the key tasks in the management of customer relationships are to extend the lifetimes of customers and to increase the cumulative cash flows from customers during their lifetimes (cf. Bolton et al., 2004). Much marketing effort is aimed both at lengthening customer relationships and at increasing cash flow. For example it is widely recognized that cross-selling increases behavioural loyalty by increasing switching costs while at the same time enhancing cash flows from customers as they purchase/use a wider range of products/services (Reinartz and Kumar, 2003; Venkatesan and Kumar, 2004). The success of a firms efforts to increase customer lifetimes and cash flows, meanwhile, is manifested through changes in the perceptual and behavioural drivers of customer equity. The third main component of customer equity, the discount rate, can also be affected by management of the customer equity drivers. Specifically, increases in customer satisfaction, loyalty and retention lead to a reduction in the volatility of sales and earnings, as the cash flow from customers becomes less susceptible to competitive activity (Anderson et al., 2004; Srivastava et al., 1998). This in turn reduces the firms cost of equity capital (Harrison-Walker and Perdue, 2007) and the discount rate. With regard to the components of customer equity, a firms success in customer acquisition is affected by the perceptions and referral behaviour of its current customers (Villanueva et al.,

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2008). Furthermore, the profitability distribution and diversification of the customer base (viewed as a portfolio) can also be affected by changing perceptions of the firm among existing and potential customers that will influence the acquisition and retention of customers (cf. Dhar and Glazer, 2003). Finally, additional potential, as conceptualized by Ryals (2008b), is by definition achieved through changes in the management of customer relationships, which in turn affects the drivers of customer equity. Given the considerable body of marketing literature, it is puzzling why customer equity has not already gained wider acceptance among marketing managers or, indeed, among shareholders, as a key performance metric. We have argued the need for greater clarity in marketing theory between customer assets and customer equity as one issue. However, there are also certain limitations relating to the practical application of customer equity which we will now examine.

Limitations of CLV and customer equity

Several limitations of customer lifetime value/customer equity metrics have been suggested; we review these from the perspective of marketing academics and managers, and then from the perspective of those academics working on the marketing/finance interface.

Marketing management perspective

Most of the previous research related to customer equity has been concerned with measuring customer equity for internal management purposes (e.g. Berger et al., 2002; Blattberg and Deighton, 1996; Bolton et al., 2004; Reinartz et al., 2005; Rust et al, 2004b; Ryals, 2005; Venkatesan and Kumar, 2004). The focus of customer equity calculations in this context is to facilitate decision making with regard to optimal resource allocation in the management of different customer relationships. Several studies have provided empirical support for the successful use of CLV (e.g. Dhar and Glazer, 2003; Donkers et al., 2007; Kumar et al., 2008; Reinartz and Kumar, 2003; Reinartz et al., 2005; Ryals, 2005, 2006; Venkatesan and Kumar, 2004) and customer equity (e.g. Hanssens et al., 2008; Rust et al., 2004b; Ryals, 2005; Sublaban and Aranha, 2009; Tirenni et al., 2007). Nevertheless, a few studies also raise concerns regarding their accuracy and practical usability. For example Malthouse and Blattberg (2005) found in a study of four firms that allocated resources based on CLV, that of the top 20 per cent of customers, approximately 55 per cent were misclassified (and did not receive special treatment) while approximately 15 per cent of the future bottom 80 per cent were misclassified (and received special treatment). These findings demonstrate that historical customer behaviour and value are not very accurate predictors of future value, highlighting the uncertainty inherent in CLV calculations. Campbell and Frei (2004) similarly found that a substantial amount of variation in the future profitability of customers of a financial services firm was left unexplained by current profitability. Ambler (2006: 27) has also addressed several weaknesses associated with DCF-based techniques such as customer lifetime value and, although conceding that they may be useful for planning and could be included in a set of multiple performance metrics forming a dashboard, Ambler and Roberts (2008) maintain that no variant of DCF should be used as the sole silver metric.

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Marketing/finance interface perspective

From a finance perspective, the measurement of customer equity, rather than the management of customer assets (i.e. customer relationships) is the key issue. Hence, it is critical to clearly define the elements to be included in the measures, and to agree upon a consistent usage of terms. Unfortunately, in the marketing literature, as pointed out by Jain and Singh (2002), customer profitability (CP), customer lifetime value (CLV), and customer equity (CE) are often not recognized as distinct concepts. Pfeifer et al. (2005: 13) argue that many people use these terms interchangeably and loosely. Customer value becomes profit, which becomes companys profit. Gleaves et al. (2008: 836) concur, stating that
the actual usage of the term CP varies considerably and, especially in the marketing literature, there are additional terms, which can become blurred with CP including the terms CLV and CE which should have very specific meanings. There is also some vague use of costing terms in the marketing literature where collaboration with management accounting (MA) specialists should lead to greater clarity.

Thus, terminological confusion in the marketing field has hindered the acceptability of some of these key metrics as far as finance academics and practitioners are concerned (Gleaves et al., 2008). With regard to the terms CP, CLV and CE, and their calculation, Gleaves et al. (2008: 839) claim that the marketing literature suggests, from an accountants perspective, a lack of understanding and clear use of such terms. Although the concept of customer profitability has received some attention in the management accounting literature (Bellis-Jones, 1989; Foster and Gupta, 1994; Foster et al., 1996; Guilding and McManus, 2002), the lack of finance interest in CLV and customer equity appears to be due to reservations regarding the reliability of these measures. For example Weir (2008: 805) states that what can readily be seen from this is that it becomes increasingly complicated to determine a CLV figure, and that the metric itself becomes messier as it becomes more steeped in financial calculus. Without the called-for collaboration with the accounting and finance disciplines (Gleaves et al., 2008; Weir, 2008), marketing is unlikely to develop customer valuation measures that will be accepted as reliable enough for financial reporting purposes.

Customer equity in financial reporting

This lack of credibility is all the more concerning because customer equity has demonstrable potential as a financial metric and could be of great interest to potential shareholders. Customer equity is not only of interest for customer relationship management purposes within the firm, but also for firm valuation purposes by an external audience consisting of financial analysts, investors and possibly other stakeholders (Gupta et al., 2006). Wiesel et al. (2008) make a case for including customer equity statements in the management commentaries of firms financial reports. They propose that customer equity statements should include the value of the customer base, including the components of customer equity and changes in value over time (cf. Blattberg et al., 2001). The reported aim of including these statements is to answer the calls from the finance community (e.g. Canibano et al., 2000; IASB, 2005; Lev, 2001; Whitwell et al., 2007) for more transparency in financial reporting of intangible assets in order to assist investors decision making. However, the use of silver metrics is arguably as questionable for external financial reporting as it is for internal customer management purposes. Although customer equity and its components are useful indicators of the success of a firms marketing and customer management, they provide

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an incomplete view. Investors are likely to gain a more meaningful insight into a firms future potential if management commentaries of financial reports also contain information on the drivers of customer equity (see Figure 1). In fact, the reporting of both the drivers and the components of customer equity is implicitly supported by the finance community. The IASB discussion paper on management commentaries published in 2005 specifically mentions many of the recognized drivers and components of customer equity as measures that could be included in management commentaries:        customer satisfaction levels ( 121, 130 and 135) risks related to customers ( 128) customer loyalty ( 138) penetration (number of products purchased per customer) ( 138) customer churn rates ( 146) acquisition costs ( 146) average revenue per user ( 146).

Furthermore, the appendix to the discussion paper (IASB, 2005: A42) states that management should include information about key relationships the business has in place, how they are likely to affect the performance and value of the business and how they are managed. Thus, the finance community is calling for the inclusion of a diverse set of customer metrics in management commentaries on financial reports. To date, the most prolific response from the marketing community has proposed customer equity as the most suitable candidate for inclusion in financial reports (Wiesel et al., 2008). However, some parts of the finance community may actually prefer qualitative customer information rather than quantitative customer metrics. For example in a response to IASB 2005, the Austrian Financial Reporting and Auditing Committee (AFRAC) state that:
companies should not be obliged to present quantitative forecasts or give projections, but they should present information about those aspects and events for the year under review that could be relevant in assessing future prospects. Forward-looking information should focus on qualitative information. (AFRAC, 2006: 3)

In summary, some academics are starting to recognize that CLV and customer equity, although valuable, are insufficient measures for marketing managers who aim to manage customer relationships to maximize long-term cash flows. At the same time, the finance community is calling for more meaningful disclosure of customer-related information. Sidhu and Roberts (2008: 682) emphasize that from a financial analyst perspective, intermediate constructs must be related to value downstream and marketing activity upstream; the drivers and components of customer equity clearly fit this description. In the next section, we propose how companies could develop a Customer Equity Scorecard that would provide this information to shareholders and potential investors.

The Customer Equity Scorecard

Based on the discussion above, it appears that the inclusion of a section in financial reports where customer relationships and their management are discussed would be useful for investors. A range of customer metrics related to customer equity should be reported for the sake of objectivity and

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maximum provision of useful information. Based on the drivers and components of customer equity (Figure 1), we propose a Customer Equity Scorecard (Table 1). For each item on the scorecard, we have listed the data source and identified how it is related to the future earnings potential of the firm. Depending on the market situation, industry characteristics, and the current position of the firm, different metrics will be of varying importance. Naturally, management can provide guidance in the commentary regarding its view of the currently crucial measures, but financial analysts and investors should be capable of determining which weights they assign to the different metrics when undertaking their assessment of the value of the firms customer base. If the firm provides all the necessary information, the external audiences can, if they wish, even make their own customer equity calculations of the firm. Once a standardized system of measures is in place, it would also be possible to report the various customer equity drivers and components over several time periods, including future projections. The scorecard in its current form is not a standardized solution. However, it aims to illustrate the usefulness of including the two categories of customer equity drivers customer perceptions and behaviour as valuable items that complement the components of customer equity. For example components of customer equity (and changes in these), such as average customer revenue, costs, and acquisition and retention rates, will provide stakeholders with information on the effects of a firms efforts to increase customer equity, as well as the data required to actually calculate customer equity. However, these data will not give stakeholders any insight regarding why certain components increased or decreased, or what future developments may be expected. The behavioural drivers, on the other hand, potentially shed some light on these issues. For example changes in revenues and costs may be explained by changes in customers buying behaviour. Improvements in customer acquisition could be explained by a greater number of referrals. Data on the average length of customer relationships would show whether the firms current customer base consists of mainly long-term or short-term customers. A change in the risk profiles of customers, meanwhile, could be an indicator of future expectations with regard to revenues, costs and customer retention. Finally, greater insight into the behavioural drivers of customer equity can also be conveyed by reporting the perceptual drivers of customer equity. For example higher satisfaction scores may explain positive changes in buying and referral behaviour. Improvements in attitudinal loyalty, meanwhile, would signify greater potential for behavioural loyalty, as the firm would not have to rely solely on inertia or high switching costs to retain customers. Finally, changes in value, brand and relationship equity would indicate the firms success in improving different aspects of its offering, which should be reflected in changes in customer behaviour. The Customer Equity Scorecard has a number of limitations, which affect its applicability in practice. First, there is a risk that bias is introduced in the measurement of various items on the scorecard. For example in the case of using surveys to measure customer perceptions, nonresponse bias is definitely an issue for which researchers are still attempting to develop remedies (Kreuter et al., 2010). Nevertheless, various methods to account for biases are available; for example non-response weighting is commonly used in order to correct for variations in the probability of selection (cf. Rust et al., 2004b). Second, where companies have long sales cycles or a small customer base, it may be difficult for them to measure certain of the drivers and components of customer equity on an annual basis. That said, even in industries with long sales cycles for goods, such as heavy machinery or automobiles, companies often maintain ongoing relationships with customers through the provision of services. Finally, it is possible that the data in the proposed scorecard could lead stakeholders to different conclusions; and due to lagged effects, it might be necessary to compare scorecards over time to gain deeper insights regarding the firms ongoing and potential

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Table 1. Customer equity scorecard for financial reporting purposes

Customer equity (CE) driver/component Data source Survey Implications for future earnings potential of the firm

Customer perceptions Value equity Brand equity Relationship equity Survey

Customer satisfaction

Attitudinal loyalty

Survey

Positively correlated with behavioural loyalty, retention and acquisition of new customers (Danaher and Rust, 1996; Rust et al., 2004b) Negatively correlated with risk (Anderson et al., 2004; Srivastava et al., 1998) and discount rate (Harrison-Walker and Perdue, 2007) Positively correlated with behavioural loyalty, patronage concentration, cross-buying, retention (Loveman, 1998) and referral behaviour (Verhoef et al., 2002) Negatively correlated with risk (Anderson et al., 2004; Srivastava et al., 1998) and discount rate (Harrison-Walker and Perdue, 2007) Positively correlated with behavioural loyalty, purchase frequency, patronage concentration, retention (Kamakura et al., 2002) and referral behaviour (Reinartz and Kumar, 2002) Negatively correlated with risk (Anderson et al., 2004; Srivastava et al., 1998) and discount rate (Harrison-Walker and Perdue, 2007)

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Customer behaviour Behavioural loyalty (average length of customer relationships) Database Database Survey/ database Database Database Survey/ database

Average number of purchases Average patronage concentration/share-of-spending Average number of different products/ services bought/held Average customer risk score Number of customers acquired by referral

Positively correlated with retention (by definition) Negatively correlated with risk (Anderson et al., 2004; Srivastava et al., 1998) and discount rate (Harrison-Walker and Perdue, 2007) Positively correlated with customer revenues (by definition) Positively correlated with customer revenues (by definition) and retention (Perkins-Munn et al., 2005) Positively correlated with customer revenues and retention (Reinartz and Kumar, 2003; Venkatesan and Kumar, 2004) Positively correlated with discount rate (by definition) Positively correlated with acquisition rate (Stahl et al., 2003), customer revenues and future referral behaviour (Villanueva et al., 2008) Negatively correlated with acquisition expenditures (Stahl et al., 2003) (continued)

429

430 Data source Database Database Database Database Database Database Database Estimated or determined by borrowing costs Database Implications for future earnings potential of the firm Positively correlated with customer equity (by definition). Negatively correlated with CLV and customer equity (by definition). Positively correlated with CLV and customer equity (by definition) Negatively correlated with CLV and customer equity (by definition) Inverse of retention rate (by definition) Positively correlated with CLV and customer equity (by definition) Negatively correlated with CLV and customer equity (by definition) Negatively correlated with CLV and customer equity (by definition)

Table 1 (continued)

Customer equity (CE) driver/component

CE components Acquisition rate Acquisition expenditures per customer Retention rate Retention expenditures per customer Churn rate Average customer revenues Average customer costs Discount rate (e.g. WACC)

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Customer base profitability distribution

Customer portfolio diversification

Database

Higher dependence on profits from a smaller number of customers ( higher risk) positively correlated with discount rate (by definition; cf. Storbacka, 1994) Negatively correlated with customer equity (by definition) Optimization of investments across the customer base ( higher risk-adjusted return) positively correlated with customer equity (by definition; cf. Dhar and Glazer, 2003)

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future performance. Qualitative descriptions by management to complement the data in the scorecard could enhance the meaningfulness of the reported measures.

Conclusions and future research directions

Marketing, in its quest for accountability, has recently afforded increasing attention to techniques (such as DCF), and terms (such as assets and equity) from finance and accounting. However, in marketings eagerness to demonstrate its impact on shareholder value and to grab a seat in the boardroom, it has placed a misguided focus on aggregate financial metrics such as CLV and customer equity, apparently assuming that this is the only language that finance and accounting speak. In reality, accounting and finance are not such precise disciplines as might be imagined, and they are also becoming increasingly qualitative, with the development of for example behavioural finance and calls from accounting for further development of narrative reporting (Ambler and Neely, 2008; Roslender and Wilson, 2008). Hence, rather than continuing on the quantitative path and attempting to value customer assets and include customer equity in a firms financial reporting as suggested by Wiesel et al. (2008), a more fruitful exercise would be to seek to determine how and to what extent various aspects of customer relationships and their management can be reported, in order to provide information that can be used by investors and other external audiences to predict the future earnings potential of the firm. To this end, we have argued the case for a clear distinction between, on the one hand, the management of customer assets and the drivers of customer equity; and, on the other hand, the measurement of customer equity and its components. Identification of the drivers and components of customer equity not only serves marketing managers in their efforts to manage customer relationships profitably. The provision of these metrics in the management commentaries of financial reports would also more directly answer the call from the finance community for more transparency in financial reporting of intangible assets in order to assist investors decision making. The potential positive implications of including customer equity drivers and components in financial reporting are not only limited to more well informed firm valuations by an external audience. The concretization of the intermediate and financial outcomes of customer relationship management efforts in financial reports will also enable marketing to demonstrate accountability, thereby preventing any further erosion of its influence within the firm. Based on this analysis, we suggest two propositions that might guide future research into customer lifetime value and customer equity: P1: In practice, marketing managers make use of qualitative data and of heuristics rather than detailed analyses of customer lifetime value or customer equity. These heuristics guide their perceptions of the value of customer assets and are used to develop strategies to manage customer relationships. P2: In companies where marketing makes use of customer lifetime value or customer equity calculations to determine customer management strategies, marketing is seen as more accountable than in organizations that do not make use of such measures. Many CEOs feel that their future potential, based particularly on their ability to leverage various types of intangible assets, is not fairly reflected in their share prices. Such firms could attempt to provide greater transparency to the investor community by including more detailed information on the performance of the firms intangible assets in their financial reports. However, a few issues should be considered here. First, there is a clear risk that companies abuse this possibility by using creative methods of measuring the performance of their

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customer relationships and other intangible assets. This risk could be neutralized by the introduction of standardized, industry-wide measures (cf. Stewart, 2009). Second, rather than attempting to include customer relationships and other intangible assets on the balance sheet, the management commentary on financial reports appears to be a more useful place in which to describe the underlying reasons for the gap between book value and market value and/or the firms own assessment of what its market value should be, based on its potential to utilize its capabilities to leverage its various tangible and intangible assets. Such supplemental reporting should include both qualitative and quantitative data and could take the form of a scorecard. We have in this paper suggested a set of customer metrics that could be included on a customer dimension of such a scorecard. Brands and networks could be other dimensions on such a scorecard, in line with Brodie et al.s (2002, 2006) arguments for the integration of the concepts of customer equity, brand equity, and network equity into a theory of marketplace equity. Further research could investigate the feasibility and usefulness of including these and various other dimensions on a scorecard, in order to provide financial analysts and investors with sufficient information to make decisions while at the same time allowing firms to be held accountable for the management of their customer relationships. Thus, our third and fourth propositions to guide future research: P3: A customer equity scorecard would be a useful managerial tool for marketing. P4: A customer equity scorecard would be a useful indicator of shareholder value for investors and analysts. In summary, this paper has offered a contribution to marketing theory by bringing added clarity to the literature on customer assets and customer equity. It thereby also provides the foundation for further meaningful theoretical development on the management of customer assets and the measurement of customer equity. In addition, the proposed Customer Equity Scorecard contributes to a bridging of the gap between marketing theory and financial theory with regard to customer equity-related issues. Acknowledgements
The first author, Andreas Persson, gratefully acknowledges the financial support provided by the Finnish Center for Service and Relationship Management (FCSRM) and Liikesivistysrahasto Foundation for Economic Education. The authors also extend their thanks to the two anonymous reviewers for their valuable comments, and to Liz Parsons for her editorial guidance.

Note
1. Customer equity can be regarded as the sum of the lifetime values of a firms customers, but may also include potential customers.

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