What is Customer Equity?
Customer equity as a result of customer relationship management (CRM). Customer equity is defined as the sum of the discounted lifetime values of all of the company’s clients. The more loyal a customer is, the greater the amount of customer equity the customer has. Customer equity is extremely high in companies like McDonald’s, Apple, and Facebook, which explains why they have such a tremendous and long-lasting competitive advantage.
Customer equity, as described under the notion of customer equity, is the worth of possible future revenue created by a company’s customers throughout the course of the company’s whole existence. Companies with high levels of customer equity will command a higher market price when compared to companies with low levels of customer equity in today’s competitive economy.
Table of Content
Customer equity is a measure of the value that existing and future potential customers will contribute to a company over the course of their relationship with the organisation.
Importance of Customer Equity
- There is a whole driver tree dedicated to customer equity, and each of these drivers has some effect on customer equity. In order to optimise customer equity over a long length of time, strategic marketing must understand how these drivers need to be adjusted.
- As a point measure or as a probability distribution, it includes many other metrics crucial to a company’s marketing staff, making it a very valuable tool.
- Customer equity, on the other hand, can be utilised to estimate future marketing ROI, or return on marketing, which is critical. If companies don’t know what marketing approaches and interventions will be necessary to produce future value, they won’t be able to accurately measure customer equity.
- As far as marketing performance measurement and strategy are concerned, customer equity is one of the few forward-looking measures to find in the plan and measurement methodologies.
- Even while it may take some time and effort to calculate the whole worth in order to arrive at the appropriate conclusion, it’s terrible that so many marketers are afraid of the figures.
- Probability theory may be a much more powerful management tool when used to the calculation when statistical methods are used, which is why it becomes more intriguing in nature when statistical methods are applied to the calculation.
Components of Customer Equity
Customer equity is made up of the following three components:
Value Equity
This is the consumer’s unbiased appraisal of what the firm has to offer in the market, based on the customer’s opinions of what the customer is willing to or sacrifices for what he receives from the firm. Customer evaluations of an offer are based on three factors: price, quality, and convenience. To put it another way, high value equity is achieved when all three of these factors are met by the client.
McDonald’s is a fast food chain that can be found almost anywhere and whose prices are rather fair. A ‘value for money’ product, it has a high value equity value because of this. People are willing to go out of their way to purchase a pair of Reebok or Adidas sneakers because they are known as the industry leaders in athletic footwear.
Reebok and Adidas, on the other hand, have value equity. Because B2B clients are aware of the convenience and pricing parameters for high-cost products, value equity is particularly significant in Industrial markets.
Brand Equity
You should expect to pay roughly 100 rupees for a typical pizza. When it’s from Pizza Hut or Subway, you will be prepared to fork over additional money before you’ve even looked at the food. When it comes to brand equity, it’s all about what you think about it. This intangible assessment of a brand by customers is known as brand equity and is distinct from the brand’s actual value.
Essentially, a consumer may be willing to pay extra for a product or service because of his or her faith in the brand. There are three main factors that contribute to brand equity: brand awareness, customer attitudes, and the perception of customers. Advertising, public relations, and a comprehensive marketing strategy are the most common methods for building brand equity. Consumers place a high value on strong brand recognition.
Relationship Equity
Customer loyalty is defined as the ability of a customer to stick with a favored brand rather than switching to a competing one. True relationship equity, on the other hand, is achieved when a consumer is willing to stick with a brand despite the existence of loyalty programs, special recognition programs, and other programs.
Harley Davidson is an amazing example of a corporation that possesses what is arguably the highest level of relationship equity. Relationship equity accrues to a company that excels in maintaining human relationships, as a result of which the customer continues to do business with the supplier out of habit or inertia.
Consequently, the customer equity of a firm is formed by the combination of these three equities. The type of equity that a firm seeks to leverage the most varies depending on the type of product it sells and the norms in its industry.
How to Calculate Customer Equity?
Customer equity = sum of all customer lifetime values of the current and future customers Customers
Customers develop value throughout the course of their interactions with a firm, which is referred to as customer equity. Take a look at the steps listed below to figure it out.
- Determine the amount of money the company spends to acquire a new customer: Suppose your company spends ₹60,0000 a year on pre-roll advertisements that bring in 6000 consumers. You would pay around ₹100 on each new customer you bring in.
- Calculate how much money the brand spends on client retention each year: Customer loyalty programs, member cards, customer education programs, holiday marketing, and reactivation emails all necessitate the expenditure of additional funds. For example, you might spend ₹200 per year to have your email campaigns sent out to your subscribers.
- Estimate the approximate amount a client spends each year: Assume that your typical consumer purchases from your firm ten times a year and spends a total of ₹100 on each purchase. The total cost for the year would be 1000.
- Find out how much the company receives from each customer: A profit margin of 60%, for example, would be achieved by spending ₹4 for every ₹10 in revenue earned.
- List the cash flow of an average customer for a specific period: Establishing expectations for each and every consumer. For example, you may anticipate a customer staying with your organisation for five years or more. Make a chart outlining the expected cash flow you expect to receive over the course of several years.
- Separate the cash flow for each year: Divide the cash flow by the number of years since the beginning (plus the discount rate) to arrive at the current cash value. The amount of the reduction is determined by individual circumstances.
- Sum up the present values of all the cash flows throughout the defined period: The client lifetime value for your company can be calculated by adding up all of the present values over a certain period of time.
Customer Lifetime Value (CLV)
Customer Lifetime Value (CLV, also known as CLTV or LTV) is the present value of all net payments made by the customer to the business throughout the length of the customer’s full relationship with the company. When it comes to business, customer relationships are considered as investments that will yield money in the future. On the other hand, partnerships demand upkeep, hence there is an expense involved. As a result, all future income and costs must be reviewed in order to determine CLV.
How to Calculate Customer Lifetime Value (CLV)?
Customer Lifetime Value is calculated by multiplying the customers’ average purchase price, average purchase frequency, and average customer lifetime.
CLV = Average Purchase Value × Average Purchase Frequency × Average Customer Lifespan
Customer Lifetime Value Formula
Step 1: Average Purchase Value (APV) can be calculated by total- ling the revenue earned in a specific period and dividing it by the total number of sales generated during that same period.
Average Purchase Value = Total revenue / Total number of purchase
Example: If your company made ₹2,00,000 in revenue from 2,000 sales in a month, the APV for that period would be 2,00,000 / 2,000 = ₹100.
Step 2: Average Purchase Frequency (APF) is calculated by divid- ing the number of purchases made by the number of unique customers.
Average Purchase Frequency = Number of purchases / Number of unique customers
A customer’s repeated purchases during a certain time are only counted once in the calculation if they were made during that period. If your company generated ₹200000 in revenue in a year from 40 customers who made a total of 200 transactions, the APF is equal to 200 sales / 40 customers = 5 times.
Step 3: Average Customer Lifespan (ACL) is calculated by adding all of your customer lifespans and dividing by the total number of customers.
Average Customer Lifespan = Sum of customer lifespans / Number of customers
Lifespan = 1/Churn rate
If your company is young and does not yet have the sample size of customers required for the calculation, the ACL can be calculated from the churn rate instead.
Churn rate = (Customers at the beginning of the month – Customers at the end of the month) / Customers at the beginning of the month
For example, if your company has 50 clients at the beginning of the month but only 45 customers at the end of the month, the churn rate is (50 – 45) / 50 = 0.1, indicating a churn rate of 0.1.
The Average Customer Lifespan (ACL) will then be calculated as follows:
Churn rate = 1 / 0.10 = 10 months
Step 4: With all of the components required for CLV in hand, we can calculate it by multiplying them all together in one go. If a customer makes five purchases per year with an average purchase value of Rs100 and a customer lifetime value is 36 months, the Customer Lifetime Value is calculated as follows: Historical CLV is the value that a customer has spent with a company over time.
Average CLV = ₹100 × 5 × 36 = ₹18,000
Approaches to CLV
Customer Lifetime Value (CLV) is divided into two types: historical CLV and predicted CLV. When a corporation employs the historic technique, it examines previous transactions in order to determine the value of a customer. Client value is forecasted using a predictive technique, on the other hand, based on expectations of future purchases.
In the following section, we’ll go over some additional CLV formulas:
Historic Customer Lifetime Value (CLV): The total gross profit made by a single consumer over the course of their purchasing history is referred to as the historic CLV. The total amount of the transaction is equivalent to the total amount of the gross profit. In the event that a company has access to all the customers’ previous transactions, they can use the following method to determine their historical client lifetime value:
Customer Lifetime Value (Historic)= (Transaction 1+ Trans- action 2 + Transaction 3. + Transaction N) X AGM
Where:
N= Last Transaction made by the customer at a store
AGM = Average Gross Margin
When a company calculates customer lifetime value (CLV) based on net profit, it may determine the actual profit that a client gives to the company’s bottom line. When evaluating historical client lifetime value, customer service costs, return costs, acquisition costs, marketing costs, and other expenses are taken into consideration.
Predicted customer lifetime value: An algorithm that predicts future purchases by a consumer will produce more accurate value, i.e., the overall value that a customer will eventually deliver to an organisation over the course of their whole lifetime is more accurate than a human analyst.
Because of the fact that prices might fluctuate and discounts may be offered, among other things, this can be a bit tricky to accomplish in practice. When it comes to computing predictive CLV, there are a range of approaches available, each with a distinct amount of complexity and precision.
For the purpose of calculating simple predictive CLV, the following formula can be used:
Predictive CLV formula = (T×AOV×AGM×ALT) / Number of customers at the end of the particular period
Where
T = Average monthly transactions
AOV= Average order value
ALT= Average Customer Lifespan
AGM= Average gross margin
- T (Average number of transactions): Period: 3 months Total transactions: 120 T = 120/3 = 40
- AOV (Average Order Value) Total revenue over a specific month (September): ₹10,000 Number of orders: 20 AOV =10,000 / 20 = ₹500
- AGM (Average Gross Margin) – Calculate the gross margin percentage per month Gross Margin = [(Total Revenue – Cost of Goods Sold) / Total Revenue] * 100
