Last week, we introduced our 2023 Strategic Agenda based on in-depth conversations with top CSOs in our Outthinker Strategy Network. We will be expanding on one of these trends every week with the intention of supporting your organization’s strategy for the next year and beyond. This is our first installment.
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In early 2022, we at Outthinker wrote about Netflix’s drop when their stock price sunk 35% after the company lost subscribers for the first time in a decade. As the year comes to a close and 2023 begins, we are seeing what appears to be a bounce back—Netflix’s stock price has increased about 10% already this year.
Investors are excited about what looks like a rally: the streaming service exceeded expectations by adding 7.66 million paid subscribers during the fourth quarter of 2022—much more than the 4.57 million predicted by Wall Street. Will these new subscribers turn things around for the long-term for the streaming giant? The answer: It is not enough to look at subscriber numbers; you must also consider the quality of those subscribers.
The problem with company valuations today
Wall Street is accustomed to deriving a company’s financial valuation from its quarterly revenue results. Discounted cashflows, expected quarterly earnings, projected revenue—all represent approaches to financial valuation. But, for the most part, they are focused on the short term.
Warren Buffett explained to us the volatile character, Mr. Market, in his 1987 Berkshire Hathaway letter to shareholders:
“…the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions, he will name a very low price, since he is terrified that you will unload your interest on him.”
The strategists we talk to every day at the Outthinker Strategy Network often express frustrations with their companies’ narrow focus on quarterly performance over a further horizon that will set them up for success in the long-term. We are all familiar with the volatility of market fluctuations, yet we continue to value companies based on quarterly ups and downs and projected revenue results. Perhaps there is a better way.
What does it mean to be customer-centric?
I must disclose that at the moment, I’m working on a book with Peter Fader, Wharton Professor of Marketing, whose research and work focuses on customer-centricity. He defines it as a strategy that aligns a company’s development and delivery of its products and services with the current and future needs of a selected set of customers in order to maximize their long-term financial value to the firm.
Let me call out two distinct wording choices here: a selected set of customers and long-term financial value. It’s not the “customer is always right” mentality that may have earned companies the label of being “customer-centric” in the past. And notice that it doesn’t mention acquiring as many customers as we can this quarter to meet our short-term revenue goals—instead, the focus is on long-term financial value.
Pete is unique in his approach to customer-centricity when he argues for treating your best, most valuable customers very well while essentially not bothering with the rest. His principles of customer-centricity are as follows:
- Not all customers are created equal
- Acknowledging this heterogeneity of customers, there is no typical customer because all customers differ
- Commit to identifying customers that matter most
- Dedicate a disproportionate amount of time and resources to understand what your most important customers want (and then deliver it)
- Understand that while some customers are more important and deserve more, other customers are less important and deserve less
- Once you’ve identified your most valuable customers, mine them for data
- Customers are not always right, but the right (i.e., most valuable) customers are always right
Using this definition of customer-centricity will help you identify your most valuable customers, whom according to Pete are the only ones you should be focusing on.
Marketers used to divvy customers into segments and personas based on certain demographics, behaviors, and preferences. However, the world has changed. We have more immediate feedback and customer data that can offer a real-time and more accurate measurement of Customer Lifetime Value (CLV). We can truly get to know and target customers down to the individual. By tracking spend over time, you can better predict who will be your most valuable customers and attract others like them.
Of course, by developing solutions and services that delight your best customers, you may naturally attract other customers who may not be categorized as “most valuable.” These lukewarm supporters should be treated as low-hanging fruit. Customer-centricity is not about abandoning them, but rather avoiding wasting time and money on them.
Not only will customer-centricity help you find your best customers, it can also provide a more strategic, long-term approach to valuing the entire enterprise.
Valuation based on Customer Lifetime Value (CLV)
Pete’s idea is that companies can improve long-term profitability by answering four key questions:
- How many customers will we acquire?
- How long will they stay with us?
- How many transactions will they make with us?
- How much will they spend on those transactions?
This gives you an overall estimate of total CLV, which in essence is the total value of the company.
Most financial models break down the sources of a company’s valuation to total equity based on operating assets (including brand and customers), non-operating assets, and net debt.
When we look at it this way, valuing based on CLV isn’t so far off. Consider, what does a “brand” really represent? The colors, images, emotions, or influencer representation are only valuable because the brand helps you acquire more customers, it helps you keep existing customers around, and it can make them stay longer and buy more from you.
In 2020, while many watched the online furniture company Wayfair’s stock price surge, Pete warned of its demise. He foresaw that the trend in people being stuck at home and spending to decorate their living spaces would be short-lived. Wayfair was acquiring low-value customers (who were unlikely to stay long or buy much) but losing valuable, long-lasting ones. Within two years, “Mr. Market” caught up and proved Pete was right. Those new customers did not return to purchase, and, as the foundation of fickle customers abandoned the company, the bottom dropped out, resulting in Wayfair being one of the worst-performing stocks of 2022.
What does this mean for streaming services struggling to maintain competitive advantage in an increasingly saturated market? If you’re looking to value Disney+, Netflix, or the next subscription video service, look to CLV as a metric. The survivors will be those who focus on maintaining and serving their most valuable customers.
Late last year, Netflix introduced its ad-supported plan at $6.99 per month in order to attract a budget audience. Time will tell, but according to CLV the low-tier may not be the right move for the streaming giant. CLV forces you to ask if those customers are going to stay and start making smarter choices between near-term revenue and long-term value.
For a deeper dive into the streaming business’ prospects when considering CLV, listen to our interview with Columbia Professor Jonathan Knee, and read his outstanding book, The Platform Delusion.
Many businesses claim to be customer-centric because they put customer needs first and focus on treating all customers well. Pete’s work shows that not every customer is created equal and not all of them are the right fit for you. Using CLV as a strategic tool, companies can focus their efforts where they are likely to have the biggest impact—by delighting the best customers who are most likely to deliver value for the long run.
What trends are on the minds of the Outthinker Strategy Network’s chief strategy officers? Find out here: 2023 Strategic Agenda.