Editor's Note: Enjoy this blog from the Custora archive, acquired by Amperity in November 2019.
Customer equity is a retailer’s guiding light...or index fund...or leaky bucket? Whatever metaphor floats your proverbial boat, here’s why this metric is key to success in today’s retail landscape.
Customers are like your children: while you adamantly attest that you love them all equally, a bit of soul-searching might reveal that you do have a favorite. Akin to your favorite child who does their chores without nagging, the customers who curry favor with retailers are those that make frequent purchases, buy a larger volume of products, and have a taste for big-ticket items.
It’s natural to want to give these engaged customers preferential treatment. Big buyers are core members of any retail organization’s consumer base because they have a high customer lifetime value (CLV), generating steady revenue year after year with minimal encouragement required. Not to mention, the cost of acquiring them is already long behind you; there’s nothing but repeat purchases and sunny skies ahead.
Clearly, there’s motivation here for retailers to cultivate relationships with the customers who generate a high return on investment (ROI), but a lot of the metrics that retailers look to when assessing the health of their companies — such as products sold, monthly revenue generated, or new customers acquired — don’t reflect the importance of a customer’s lifetime value. That’s why retailers need a proverbial North Star by which they can gauge the value of their entire consumer base — and that star is customer equity.
What is Customer Equity?
Customer equity is the total value of all of a retailer’s customer relationships during a given period. It’s calculated by multiplying the number of new customers acquired by the CLV of those customers, which can be estimated based on previous purchasing habits, and it tends to be a fairly stable number. Customer equity is essentially the “index fund” of a retail organization — an individual “stock” may rise and fall, but, ideally, the value of the overall “stock market” is always gradually rising.
In other words, customer equity provides a broad view of how much customer value your company is creating, taking both quantity and quality into account. That means that, yes: customer equity and the overall value of a company are very, very similar. So when you think about your KPIs, increasing customer equity is a much more forward-thinking, comprehensive goal than simply increasing other metrics like repeat sales or new customers.
Unfortunately, creating spikes in those metrics now can hurt customer equity in the long term. For example, actions like offering a great Groupon deal may attract a lot of new, one-time customers, but it could also turn off some of your previously loyal customers who don’t want to pay full price again once the deal ends.
Putting Customer Equity to Use
If the North Star and index fund metaphors aren’t working for you, here’s a third: the leaky bucket. Customer equity is the water in the bucket, but this water isn’t your standard H2O; it’s made of a shifting ratio of “customers” and “each customer’s annual value.” While this fluctuation may cause a bit of water to drain out the bottom, this leak is balanced out by a periodic drizzle of new customers.
Last year, you might have taken a look in the bucket and noticed that it contained 1,000 customers at an annual value of $100 each — so, $100,000 total. This year, you took another look: now, you’re down to 900 customers, but each is predicted to spend $120.
On its own, that reduction in customers looks scary: a 10% loss seems pretty significant. However, looking at this metric alone misses the whole picture; your revenue should actually increase by $8,000 overall. That shows true, sustainable client health. Now you can decide if you’re still worried about your customer acquisition numbers, or contend that the dip will be offset with the higher predicted CLV.
You can also dive even deeper: which customer segment did you lose, and why? What drove the higher spending in other segments? You can decide to correct for the loss or lean into the segment that’s spending more, allocating your marketing budget appropriately to focus on promoting specific products, upping your performance marketing budget, or perfecting your win-back messages.
Regardless of which metaphor resonates with you the most, customer equity is the pulse of your organizational health. It’s just one metric, but it’s where change originates; customer equity provides a full picture of your company’s performance. Basing your marketing strategy on customer equity means planning for the long-term — and bringing your most valuable customers along with you.