Customer Equity - What does it mean?

In this article, we explain in detail what customer equity means, its main components, and the formula to calculate customer equity.

What is Customer Equity?

Customer Equity is defined as the total sum of the customer lifetime value of all customers and clients of a particular company. It is all the potential profits a customer provides a brand throughout their business-customer relationship. 

This equity is also referred to as customer lifetime value which is the net profit or cash flow generated by the customer over the estimated lifetime of the relationship. More profits a brand receives from their customers more is that brands customer equity. 

So in a way, customer equity essentially provides an empirical measurement of customer loyalty. It is a strong indicator of how much a customer is worth to a brand, ie how much profits they’ll generate depending on the length of the lifetime. 

So depending on the metric, businesses can focus their efforts on acquiring more customers. Modern product lifecycles are also quite small, so the equity ultimately decreases. So to maintain customer loyalty and increase the lifecycle, marketing teams have to create innovative ways to keep the customer hooked and improve their experience. 

Customer Equity Formula

Since customer equity is an empirical metric, you should be able to calculate it. The customer equity can be directly calculated using the following formula:

Customer Equity = Viral Coefficient x LTV - (Acquisition + Retention)

Let’s understand what the terms in the formula mean. 

  • LTV (Lifetime Customer Value) - The expected sum total of money made from a customer over some time
  • Viral Coefficient - Number of users or referrals a customer can generate
  • Acquisition - Amount spent to acquire new customers
  • Retention - Amount spent on customer retention

So the product of viral coefficient and LTV is the total cash flow provided by customers. The company spends a certain amount on customer acquisition and retention. So the total customer equity is the difference between the total cash flow over a period and the amount spent by the company over that same period. 

How to Calculate Customer Equity

In practice, calculating customer equity can be slightly tricky. Here’s how you can calculate customer equity with a real example. 

  1. Determine the amount spent on customer acquisition
  2. Determine the amount spent on customer retention
  3. Calculate the estimated amount a customer spends over a year
  4. Find out the net amount received by the company 
  5. Set an expected lifecycle for each customer
  6. If the lifecycle is x years, then separate the cash flow for each year
  7. Sum up the cashflow value for all years

Let's try to understand these steps with an example. Here is the base premise. 

  • The company has a customer base of 1000 customers
  • They acquire 100 new customers each year by spending $50,000 on customer acquisition. So the amount spent on customer acquisition in a year is $50,000.
  • The brand pays $500 each year on customer retention initiatives. So the amount spent on customer retention is $500. 
  • The customer spends $10 on each purchase 10 times a year. So the cumulative cash flow for a year is $100. 
  • The expected lifecycle of a customer is 5 years. So now we will have to divide the cash flow into 5 separate sections for each year. 
  • Here we will also consider the estimated discount value for each customer. 
  • Now depending on the retention rate, acquisition rate and customers lost each year you can calculate the brand equity for that particular year. 

Components of Customer Equity

There are three main components of customer equity.

1. Value Equity

Value equity is the customer’s unbiased assessment of what a brand offers for the price paid. It is essentially the perceived “Value for Money” assessed by the customer. Customers assess the product offer, the convenience of use, and the price of the product to conclude if the offer is reasonable considering the price. 

Luxury brands like Reebok and Adidas have high-value equity. Their products are fairly high-priced but people trust the quality of the product. So it can be said that Reebok and Adidas have high-value equity. 

2. Brand Equity

Brand equity is the total value of the brand as an asset. It is the customer’s subjective assessment of a brand as a whole where the sum total of all assets and liabilities are considered. 

Customers are willing to fish out more money for a product if it's a brand with high equity. For example, many customers pay higher prices for the same product only because there is a luxury brand name associated with it. 

The main drivers of brand equity are brand awareness, brand loyalty and brand association. 

  • Brand awareness is the foundation of building brand equity. It’s important that the customers know about your brand. 
  • Next is brand loyalty - it is when a customer develops a loyal relationship with the brand. 
  • And lastly, after interacting with the brand for a period, customers associate the brand with certain characteristics - which is brand association. 

3. Relationship Equity

Relationship equity is the third component of customer equity. Relationship equity is when a customer stays with a brand despite any loyalty programs, exclusive offers and incentives. They essentially stay for the core product and the brand and not the augmented product

These three components together build a company's customer equity. 

6 Ways to Increase Customer Equity

Now, you are probably wondering how marketing teams can create brand development strategies to increase customer equity. Here are 5 ways you can increase customer equity. 

customer equity
  1. Provide impeccable customer service to solve any problems your customers might face. 
  2. Make your processes as convenient as possible. Reducing the time to acquire your product can drastically improve the customer experience. 
  3. Show your customers you appreciate them through different programs. Make sure to understand your customers’ exact needs and design your programs accordingly. 
  4. Try to make the process as personalized as possible. 
  5. Create unique value propositions by providing innovative features and resources to your customers and not just add-ons to your products. 
  6. At the end of the day, the quality of your product attracts customers. So making sure your product is of top-notch quality also contributed to customer equity. 

Direct Cause of Customer Equity

Some parameters can effectively increase your company's customer equity. We have listed a few of them below.

  1. Brand loyalty - Brand loyalty can be one of the causes of high customer equity. Some customers love a brand and will periodically purchase their items. These customers are the most reliable set of users as they tend to repeat purchases more often than others. Brand loyalists stay with a particular brand despite slight deficiencies in the product or attempts by competitors to lure them away
  2. Customer support - Customers tend to stick with brands that give them the best customer support. If they come across a problem with your product, knowing that they’ll receive all the help they can from the company build trust. This goes a long way into establishing a positive relationship. 
  3. Exclusive offers - Offers and discounts are an important part of an augmented product offering. Exclusive offers can always contribute to building loyalty as well.
  4. Loyalty programs - Loyalty programs offer rewards, discounts and exclusive incentives to attract and retain customers. For example, miles programs used by airlines or points retention programs used by retailers, keep the customer hooked. They have reason to purchase your product again, which increases the customer lifetime value
  5. Ease of use -  Using a product that is difficult to operate is a pain. And no customer would want to purchase such a product. So the ease of use factor becomes very important. If the customer remembers a pleasant experience with your product, during the next purchase they’ll buy it instead of the competition’s product. This also includes how easy your purchase process is. 

You'll love these articles too!

Valuation- Definition, Methods, Reasons and Limitations
Karthik Sridharan
Karthik Sridharan

Valuation- Definition, Methods, Reasons and Limitations

Learn what Valuation is, How is it calculated, limitations and reasons for performing a business valuation

Tamilselvi Ramasamy
are talking about this