Risk Considerations in the Management of Customer Equity

Ruth N. Bolton, Arizona State University
Crina Tarasi, Central Michigan University

Researchers and managers typically recognize “customer risk” by considering the probability of customer defection, as well as by discounting cash flows using the cost of capital. However, in the finance literature, risk is associated with unexpected variability in future cash flows. An understanding of cash flow variability is critical for firms to effectively forecast, allocate resources, manage customer equity and prepare for the future. The variability or unpredictability of future cash flows arises from underlying customer interactions, consumption patterns and purchase behavior – as well as from organizational processes that support them. This chapter summarizes alternative approaches to reducing variability in future cash flows without adversely affecting cash flow levels. First, firms can target customers with low cash flow variability or low risk. Second, since customers do not have fixed cash flow characteristics, the variability of individual customers’ future cash flows can be decreased through appropriate management actions. Third, firms can allocate resources to specific customers and market segments (through their marketing plan) to yield future cash flows that complement each other and thereby decrease aggregate variability of future cash flows. This chapter offers practical ways for firms to optimize their customer base by balancing return and risk and describes avenues for future research.

 

This paper is to appear in:  Handbook of Customer Equity, V. Kumar and Denish Shah (Editors), Edward Elgar Publishing Ltd.  forthcoming.