Customer Equity Overview: How to Calculate Customer Equity

Customer equity is a quantitative measure of the value of a business’s customers in terms of future revenue. This unit of measure helps companies identify how efficiently they can acquire new customers and grow their customer base. A business with high customer equity can expect a large base of highly loyal customers to spend more per transaction over an extended period. In this case, the value those customers put into the business is greater than the amount paid to retain their business.

One of the primary purposes of customer equity is to evaluate a business’s marketing strategies. Suppose a company’s marketing efforts and customer acquisition campaigns are expensive relative to the amount of money new customers bring in. In that case, the business may need to find a new marketing approach. The low returns may also indicate that the company needs to find ways to improve their customer experience—for example, by creating more attractive loyalty programs, conducting focus groups to improve customer relationships, or offering better service to boost customer satisfaction.

Customer equity numbers give the company a sense of how much it should spend to build customer loyalty and whether that’s money well spent.

Brand equity is one of the crucial drivers of customer equity, but they are distinct business values. Brand equity qualitatively evaluates the brand’s competitive advantage in the marketplace and is essentially a matter of public relations. This form of equity involves brand awareness and whether current and potential customers have positive associations with the brand. (Learn how to build brand equity.)

On the other hand, customer equity exists in quantitative terms and tells a company in real terms what its customer value is relative to the expenses associated with its marketing strategy. Two brands could each have high brand equity, but that doesn’t necessarily mean one will outperform the other, even if they’re selling more products at a higher price. For example: If, despite apparent brand loyalty, one brand’s marketing budget saps their cash flow, they could wind up with lower customer equity than another company.

You can measure customer equity using the customer lifetime value (or CLV), which is a calculation of the cash flow from a given customer throughout their entire relationship with the company. To determine CLV, add up the average customer’s cash flow for every year of the relationship.

For example, assume that you’re a business owner whose customers tend to buy your products for three years. In the first year, you can calculate their average cash flow using the following formula:

CLV = Average transaction amount x Transactions per year x Profit margin - Amount spent on marketing and customer retention

You would then repeat that calculation for each year of the relationship and sum the results to find the CLV.

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