The Net Promoter System Podcast
Late last year, I wrote a letter to the Financial Accounting Standards Board proposing that FASB consider creating disclosure standards and guidelines for metrics that would help investors more accurately value a company by gauging the health of its customer base. My guest on the latest episode of the podcast, Pete Fader, also wrote a letter, noting to FASB that “it is now possible to observe, project and understand the value of customer relationships in a way that executives and investors can seamlessly embed them into their valuation practices.”
Pete is a professor of marketing at the Wharton School of the University of Pennsylvania and a past guest on the podcast. His letter was jointly signed by past podcast guest Dan McCarthy, of Emory University’s Goizueta Business School. Pete and Dan are cofounders of Theta Equity Partners, a company that offers customer-based corporate valuation—a way of valuing firms based on the quality, and loyalty, of their customer base.
Pete joined me on the podcast to talk about the metrics that he says are “not only good, they should almost be required. Any sensible investor should be demanding these kinds of metrics. And of course, any sensible executive should be obsessed over these kinds of metrics internally.”
Although they’re still more the exception than the rule, some companies are starting to provide metrics that Pete says are almost as revealing as raw transaction log data. For example, he says, he and Dan found two furniture companies, Overstock.com and Wayfair, that published how many active customers they had in any given period—a relatively common metric—and how many total orders were placed, a far less common disclosure. “You give me those metrics over, let’s say, you know, 10 to 12 quarters of data, and it’s remarkable what I can do with them,” says Pete. “Yet very few companies are putting them out there, and very few investors are demanding them.”
In my work with companies, I focus on what executives can do with the same metrics to change the way they look at customer investments. All too often, for example, a company will focus on acquiring lots of customers at low cost. After all, many salesforces are measured on raw customer acquisition or raw dollar sales, rather than the future value of sales. But, as Pete notes, if companies had metrics that focused them on the “lifetime value of customers acquired, as well as the cost of acquiring them, not just the overall tonnage,” it would go a long way toward changing internal practices and internal investments in customer acquisition and retention.
This episode is a continuation of our series on the nature of loyalty, how to place financial value on customer relationships, and how companies can apply that to accelerate growth and profitability. You can learn more about Pete and Dan’s work in their recent article, “How to Value a Company by Analyzing Its Customers,” which was published in the January/February 2020 issue of the Harvard Business Review alongside my own article as part of a spotlight section called “The Loyalty Economy.”
In the following excerpt, Pete explains some of the metrics and strategies he uses when thinking about balancing customer retention with valuing those customers appropriately and accurately.
Rob Markey: One of the things that you do in [your book] The Customer Centricity Playbook is you develop this idea of offense vs. defense for high-value vs. low-value customers.
Pete Fader: It’s a good point. Because the good news and bad news of customer retention and development is that they are so closely aligned. And this is something that you and Fred [Reichheld] and so many other people have laid out, that is just glorious: that the same kinds of things that we do to try to get customers to do more with us—to be better developed—will also keep them around longer. So that’s good. But the bad news is that we sometimes lose sight of what we’re trying to do strategically. So, given where we are right now, which of those two things is more important to us? Playing offense or playing defense? And so it’s nice to know that there are some tactics that will let us accomplish both; that’s kind of convenient. But there are some tactics that are purely one or the other, and then maybe we should be playing them up if we have a more specialized viewpoint.
So it’s thinking strategically to then drive tactics. Which sounds kind of obvious. But we just want to call a little bit more attention to it, especially in a world where some of these tactics are relatively new, relatively unproven, and there’s still some misunderstanding and skepticism within the organization.
Rob Markey: Well, I think that in The Customer Centricity Playbook you develop this idea of the 80-20 rule. And the tension between serving your best customers—the 20% of your best customers—with excellence and earning their loyalty, developing their value, vs. the acquisition and retention of the other 80% of the customers, who account for 20% of the value. And I think that one of the challenges in any organization is that, while we know that 20% of the customers account for 80% of the value, we don't always know which 20% in the early tenure or when they’re prospective customers.
Pete Fader: Yeah. There’s actually a couple of problems. That is one, “the cold start problem.” You know, very early on, how do we know and project ahead what their trajectory is going to be? But then at a slightly higher level, we’re also looking at mixes of customers. We look at cohorts. How is this cohort, again early on, going to compare to its predecessor or its successor? So how do we play connect-the-dots across the cohorts to know at a more aggregate level, are we moving in the right direction? Are we bringing in a better blend of customers? So there are all kinds of questions there. Again, we’re coming up with the metrics to help us evaluate those things as accurately and quickly as possible, as well as the tactics to help us leverage those insights.
And once again, it’s just beautiful to see how well aligned it is with the kinds of conversations that you’ve been having with your colleagues and clients. And it just shows that, you know what, there really is some established science here! The fact that we’ve been developing these things more or less in parallel yet in such an aligned manner, how can people ignore it? How can people continue to stay with kind of old-school or kind of suboptimal practices, when the answers are, I’d like to think, so readily available?
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