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.

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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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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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Customer Lifetime Value

• Lifetime value of a customer

• Lifetime value with constant margins

0 )1(tt

tt

i

rmLV

ri

rmLV

1

RetentionRate (r ) 10% 12% 14% 16%

60% 1.20 1.15 1.11 1.0770% 1.75 1.67 1.59 1.5280% 2.67 2.50 2.35 2.2290% 4.50 4.09 3.75 3.46

Discount Rate (i)

Margin Multiple

ri

r

1

5

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Model

Time 0 n0

1 n0r n1

2 n0r2 n1r n2

3 n0r3 n1r2 n2r n3 4 n0r4 n1r3 n2r2 n3r n4 . . . . . .

000

0 )1(cn

i

rmn

tt

tt

11

11

11

1 )1(cn

i

rmn

tt

tt

111

1

111

)1()1(cn

i

rm

i

n

tt

tt

6

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Value of Customer Base

• In discrete time

• In continuous time

00 )1()1()1( kk

kk

ktkt

ktkt

kk

k

i

cn

i

rm

i

nValue

00

1

k

ikkk

k kt

ktr

riik

ktk dkecndkdteemnValue

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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 CostCompany

Data Period No. of Customers

Quarterly Margin

Source: Annual Reports, 10K and 10Q Statements

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Number of CustomersAMAZON

-

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

Mar

-97

Jun-

97

Sep-

97

Dec-

97

Mar

-98

Jun-

98

Sep-

98

Dec-

98

Mar

-99

Jun-

99

Sep-

99

Dec-

99

Mar

-00

Jun-

00

Sep-

00

Dec-

00

Mar

-01

Jun-

01Time

No. o

f Cus

tom

ers

E-BAY

-

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

Dec-

96

Mar

-97

Jun-

97

Sep-

97

Dec-

97

Mar

-98

Jun-

98

Sep-

98

Dec-

98

Mar

-99

Jun-

99

Sep-

99

Dec-

99

Mar

-00

Jun-

00

Sep-

00

Dec-

00

Mar

-01

Jun-

01

Time

No. o

f Cus

tom

ers

AMERITRADE

-

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

Sep-

97

Dec-

97

Mar

-98

Jun-

98

Sep-

98

Dec-

98

Mar

-99

Jun-

99

Sep-

99

Dec-

99

Mar

-00

Jun-

00

Sep-

00

Dec-

00

Mar

-01

Jun-

01

Time

No. o

f Cus

tom

ers

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

Dec

-97

Mar

-98

Jun-

98

Sep

-98

Dec

-98

Mar

-99

Jun-

99

Sep

-99

Dec

-99

Mar

-00

Jun-

00

Sep

-00

Dec

-00

Mar

-01

Jun-

01

Time

No.

of C

usto

mer

s

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Modeling Number of Customers

• Cumulative number of customers

• Number of customers acquired

)exp(1 tN t

2)]exp(1[

)exp(

t

t

dt

dNn tt

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Parameter Estimatesfor Number of Customers (millions)

60% 70% 80% 82.20 70.53 60.21

-4.77 -4.67 -4.57

0.31 0.31 0.32MAD 0.84 0.75 0.63MSE 0.97 0.79 0.68 4.09 3.49 2.96

-3.73 -3.63 -3.52

0.28 0.28 0.28MAD 0.04 0.04 0.04MSE 0.003 0.003 0.003 95.02 84.68 75.24

-6.27 -6.17 -6.07

0.34 0.33 0.33MAD 0.98 0.71 0.62MSE 1.77 0.79 0.73 8.51 7.24 6.15

-3.75 -3.66 -3.57

0.34 0.34 0.35MAD 0.29 0.24 0.28MSE 0.09 0.06 0.08

E*Trade

Ameritrade

E-Bay

RetentionCompany ParameterAmazon

Peak of customeracquisition = -/or 15-20 quarters

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Quarterly Margin per CustomerAMAZON

$0

$3

$6

$9

$12

$15

$18

$21

Mar

-97

Jun-

97

Sep-

97

Dec-

97

Mar

-98

Jun-

98

Sep-

98

Dec-

98

Mar

-99

Jun-

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Sep-

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Dec-

99

Mar

-00

Jun-

00

Sep-

00

Dec-

00

Mar

-01

Jun-

01

Time

Mar

gin

per

cust

omer

AMERITRADE

$0

$30

$60

$90

$120

$150

$180

Sep-

97

Dec-

97

Mar

-98

Jun-

98

Sep-

98

Dec-

98

Mar

-99

Jun-

99

Sep-

99

Dec-

99

Mar

-00

Jun-

00

Sep-

00

Dec-

00

Mar

-01

Jun-

01

Time

Mar

gin

per c

usto

mer

E-BAY

$2

$3

$4

$5

$6

$7

$8

$9

$10

Mar

-97

Jun-

97

Sep-

97

Dec-

97

Mar

-98

Jun-

98

Sep-

98

Dec-

98

Mar

-99

Jun-

99

Sep-

99

Dec-

99

Mar

-00

Jun-

00

Sep-

00

Dec-

00

Mar

-01

Jun-

01

Time

Mar

gin

per

cust

omer

E-TRADE

$30

$40

$50

$60

$70

$80

$90

$100

$110

Dec-

97

Mar

-98

Jun-

98

Sep-

98

Dec-

98

Mar

-99

Jun-

99

Sep-

99

Dec-

99

Mar

-00

Jun-

00

Sep-

00

Dec-

00

Mar

-01

Jun-

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Time

Mar

gin

per

cust

omer

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Acquisition Cost per CustomerAMAZON

$0

$3

$6

$9

$12

$15

$18

Jun-

97

Sep-

97

Dec-

97

Mar

-98

Jun-

98

Sep-

98

Dec-

98

Mar

-99

Jun-

99

Sep-

99

Dec-

99

Mar

-00

Jun-

00

Sep-

00

Dec-

00

Mar

-01

Jun-

01

Time

Acq

uisi

tion

Cos

t per

C

usto

mer

AMERITRADE

$0

$60

$120

$180

$240

$300

$360

$420

$480

Dec

-97

Mar

-98

Jun-

98

Sep

-98

Dec

-98

Mar

-99

Jun-

99

Sep

-99

Dec

-99

Mar

-00

Jun-

00

Sep

-00

Dec

-00

Mar

-01

Jun-

01

Time

Acq

uis

itio

n C

os

t p

er

Cu

sto

me

r

E-BAY

$0

$3

$6

$9

$12

$15

$18

Mar

-97

Jun-

97

Sep-

97

Dec-

97

Mar

-98

Jun-

98

Sep-

98

Dec-

98

Mar

-99

Jun-

99

Sep-

99

Dec-

99

Mar

-00

Jun-

00

Sep-

00

Dec-

00

Mar

-01

Jun-

01

Time

Acq

uisi

tion

Cos

t per

C

usto

mer

E-TRADE

0

4080

120160

200

240280

320360

Mar

-98

Jun-

98

Sep

-98

Dec

-98

Mar

-99

Jun-

99

Sep

-99

Dec

-99

Mar

-00

Jun-

00

Sep

-00

Dec

-00

Mar

-01

Jun-

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Time

Acq

uis

itio

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os

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Cu

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me

r

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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

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Changes in Value over Time

Amazon

23.45

12.9113.69

5.56

3.675.13

2.21 2.16 2.413.14 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

$ bi

llion

s

Market Value

Customer Value

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Managing Customer ValueImpact 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

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Value of Marketing and Finance ActionsImpact 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 RateDiscount RateCustomer Value

Of Amazon ($b)

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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%