This post is from our podcast with Dan McCarthy, Assistant Professor of Marketing at Emory University’s Goizueta School of Business. His research specialty is the application of leading-edge, statistical methodology to contemporary, empirical marketing problems. He received his Ph.D. in Statistics from the Wharton School of the University of Pennsylvania. His research interests include customer-based corporate valuation and customer lifetime value. Dan McCarthy was co-founder and Chief Statistician at Zodiac, a predictive customer analytics firm, until it was sold to Nike in March 2018. Dan has since co-founded Theta Equity Partners to commercialize his research on CBCV.
Dan McCarthy has a unique background. He spent six years working at an investment firm analyzing stocks. After that, he decided to go back to school for his Ph.D. in Statistics, which has always been his true passion. In his second year of the program, he begin to move into marketing.
Since then, he has become interested in studying customers - making predictions about what customers will do, what orders they will place, the amount they will spend, when they will churn, etc. He enjoys taking those problems and relating them to finance, which ended up becoming his dissertation. He has always been interested in finding out if there is any way to take the models that have been constructed in marketing and use them to better inform the valuation models he had spent so many years thinking about in finance.
McCarthy says that he has not yet been able to isolate the impact of experience on customer lifetime value but that he hopes in the future to be able to link customer experience or NPS to the overall value of firms. He believes that in the future, we will be able to incorporate new data sources and customer experience directly into a mathematical model.
McCarthy provided an description of how the customer-based corporate valuation model works and explained how this could be the game changer that unites marketing with finances. He said that there are two models - one for subscription-based companies and one for non subscription-based companies.
McCarthy said that at the most basic level, any valuation model needs to make forecasts for what future sales will be and that all customer-based corporate valuation is doing is providing a mechanical, scientific, data-driven approach to coming up with a better sales forecast.
He then provided an example about predicting sales in 2019. He explained that if we want to predict sales, we have to know that those sales are going to come from either customers that we already have or customers we acquire. We can break down sales into a few processes - existing customers, the orders they place, the spend on those orders, the new customers that we haven’t brought in yet, and those new customers’ purchases and their spend.
As McCarthy says, ultimately, sales is coming from customer acquisition, customer retention, the number of orders the customers place while they are alive, and the spend on those orders. He stressed that there is no other way that sales can be generated at a customer-based business.
McCarthy explained that there are two very tricky parts when it comes to valuation. The first is figuring out how we model customer acquisition, retention, and spend. The second is figuring out how we can do it when we have SEC data.
McCarthy told a story of his experience and findings studying Overstock and Wayfair. He had already finished his paper on subscription valuation but needed to create the second version of the paper with a non-subscription company.
The second version of the paper had Overstock and Wayfair, which were the first two companies they found that disclosed a lot of customer data. He and his team ran a lot of numbers on the two companies. The numbers they got for Overstock implied a very normal valuation, and the stock prices they got were right about where they company had been trading at.
However, with Wayfair, they always ended up with valuation estimates far below the current stock price no matter how they ran the numbers. After this, McCarthy ended up on Jim Cramer for a segment on Wayfair, and on a call with Wayfair's shareholders. He then went on to explain the true problem of the stocks and Wayfair’s essential issue.
The problem turned out to be very basic. At Overstock, when they acquire a customer, they make about $10 on their acquisition cost. At Wayfair, when they acquire a customer, they lose about $10. Wayfair is showing larger and larger losses. The more they grow revenues, the more money they lose. Because of this, it is almost impossible to get any reasonable stock price estimate.
McCarthy explained that customer centricity ultimately defines the strategies companies use when acquiring customers and how companies can acquire customers in a smarter way. He said that we are moving a little bit further away from the customer-based corporate valuation work, but ultimately the end goal is the same. He then discussed how companies can find out what makes their high-value customers better than their low-value customers and that doing this will help companies dictate how to reallocate their customer acquisition budget for the next period.
He provided an example by talking about Amazon. He commented that Amazon is a great example of a company that has been able to expand the value of their customers through retention. In addition, McCarthy said that It is very hard to argue that this is not coming from a great customer experience, and this is the reason that people keep coming back.