If you’re like most organizations, when you forecast revenue, your finance department focuses on things like year-over-year same-store sales, trends among product lines, macroeconomic conditions, and internal YoY benchmarks.
Those things are incredibly important and useful for revenue forecasting and budgeting for the next quarter or fiscal year. But there’s an input that you’re missing. It’s the source of your revenue, your customer.
Enter Customer Equity
Your customer data has a powerful potential to forecast revenue from the bottom up called customer equity. This isn’t to replace your current forecasting practices — it fills in a gap that you’re probably not paying attention to.
Customer equity is the total value of all of a retailer’s customer relationships during a given period — say, for example, a year. It addresses the following concerns:
- What are my existing customers going to spend?
- How many customers am I going to bring in?
- How many customers are going to leave?
Customer equity is calculated by multiplying the number of new customers acquired by the predicted lifetime value 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 fund is always rising.
If you are a direct-to-consumer brand, every single dollar you earn is paid for by a customer. Your customer equity looks at the lifetime value or maybe future one-year spend of your customer base (and predicted new customers) to find the dollar-amount value of your customer file.
If you’re on the finance side of the retail house, and you’re not using customer equity to triangulate your forecasts and observations, you could find yourself misjudging the numbers. Say, for instance, you see that same-store YoY sales have increased even more than you’d predicted.
Without customer equity, this is unequivocally good news. Customer equity gives you a much-needed gut check, because if customer equity is down despite YoY sales being up, you know sales are being inflated by discount shoppers and one-time buyers. In other words, baseline metrics look good, but customer loyalty is down, and the next year looks bleaker than you anticipated.
Does Customer Equity Do Other Cool Things?
If you’re keeping an eye on this “stock portfolio,” you might see an annual percentage return that is lower than expected. If you’re an especially proactive investor, you might be curious to learn what stocks performed well and which ones didn’t.
Stepping away from the analogy, customer equity is the highest-level number that tells you if your lower-level goals are summing up to success. It’s valuable information to have, but it’s also a lagging indicator that requires some drill-down to see how customer economics affects your growth rate.
To totally simplify, let’s say you start your fiscal year with a one-year customer equity forecast of $1000, and you have 100 customers in your file.
This should be obvious, but to be clear, this does not mean that you have 100 customers who each spend $10 per year. Some only spend $1, while others might spend as much as $100. This is where customer lifetime value (CLV) becomes your other handy metric.
Now let’s say that for the CFO of the above-described Lilliputian retailer, the goal is to increase the company’s customer equity 10% year over year.
At the end of the year, mini-CFO looks at the customer equity again and sees:
Your customer file has increased by 50%, for a total of 150 customers. Great! Your product sell-through is looking good. Your same-store YoY is up. All is well.
But...here comes customer equity.
While the new customer acquisition of 50% growth is impressive, and everyone’s patting themselves on the back for hitting such an improbable goal, your customer equity is now only $860, a 14% year-over-year decrease in revenue.
Digging deeper, you realize that you’ve acquired a ton of customers who only spend a buck or two a year; they only shop with your brand during high-discount sales. And on top of that, you’ve lost some of your high-rollers without replacing them.
Your business is losing value at an alarming rate, not to mention that the perceived value of your brand has now dropped precipitously, which means that the past year’s “growth” will make it harder to acquire high-value customers going forward.
Without visibility into the economics of each customer relationship, the entire company treats its platinum-level customers the same way it treats its lead-level customers (our affectionate term for customers who only buy at the steepest discounts — they’re a literal drag).
So what would our theoretical CFO of the world’s smallest imaginary retailer do to increase the value of the business, i.e., spend less while increasing customer equity?
We’re sure you have ideas running through your head, but let’s summarize from a strategic level exactly what they’d do:
- Prioritize keeping and bringing in more people who are loyal, repeat shoppers...
- While cultivating middle-of-the-road and low-frequency shoppers to increase annual spend and...
- Cutting spend from acquisition efforts that attracted all of the low-spending shoppers in the first place.
Marketing, Product, and Customer Experience are all thinking about the best tactics to deploy with the budget they’re allocated. But, as we’ve seen, getting the best return on ad spend or product sell-through can still lead to dwindling customer equity.
If you’ve taken away anything from this article, understand the cautionary tale that without the lens of customer economics, someone with feet on the ground in Scenario 1 would think they were underperforming. And, perhaps more importantly, anyone in the weeds of Scenario 2 would be very pleased with their performance. If that happens, good tactics are thrown out and bad tactics get the money-pump. It’s like using your bucket to fill the sinking boat rather than to bail it out.
This is why we need Finance to surface the customer economics, align the organization on the goals that actually matter to the bottom line, and drive more efficient spend in high-growth resources across the organization. In other words, use your bucket wisely.
To get a sense of where your organization stands across key retail benchmarks in relation to similar companies, click here for a free benchmarking report leveraging data across Custora’s 100+ retail customers.