Michael Mauboussin: The Economics of Customer Businesses

Johnny HopkinsMichael MauboussinLeave a Comment

In his latest paper titled – The Economics of Customer Businesses, Calculating Customer-Based Corporate Valuation, Michael Mauboussin discusses a robust framework called ‘customer based corporate valuation’ (CBCV), which was developed by professors of marketing, Daniel McCarthy and Peter Fader, that links customer economics to corporate value.

This allows investors to build a model, based on the drivers of customer value from the bottom up, that generates a warranted stock price. It also lets investors assess what expectations for the drivers of customer value are priced into a company’s stock price. Here’s an excerpt from the paper:

Understanding the basic unit of analysis is an essential element of security analysis. An investor should have a point of view on how a company makes money, what opportunities exist, and the role competition might play in shaping the financial outcome.

Boiled down to the core, the basic unit of analysis seeks to assess whether a company’s investments are likely to earn a return in excess of the cost of capital. An investment is attractive when it has a positive net present value, which occurs when the present value of its inflows exceeds the present value of the outflow.

The concept applies whether it’s a new retail store, a research and development outlay in search of a viable drug, a manufacturing plant, an acquisition, or a customer who transacts with a firm. The form of investment may be different, but the application of the net present value rule is the same. This report focuses on the as the basic unit of analysis.

The idea of customer lifetime value (CLV) has been around for decades. CLV equals the present value of the cash flows that a customer generates while they are engaged with the firm minus the cost to acquire the customer. The present value of cash flows, in turn, is a function of sales, costs, and customer longevity. Since the mid-1990s, there has been a growing emphasis on the value of customer loyalty.

But much of this work is limited because it does not tie all the way to shareholder value. Daniel McCarthy and Peter Fader, professors of marketing, have developed a robust framework they call “customer-based corporate valuation” (CBCV), which links customer economics to corporate value.

This allows investors to build a model, based on the drivers of customer value from the bottom up, that generates a warranted stock price. It also lets investors assess what expectations for the drivers of customer value are priced into a company’s stock price.

You can read the entire paper here:

https://www.morganstanley.com/im/publication/insights/articles/article_theeconomicsofcustomerbusinesses.pdf?1621441813718

 

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