While there is growing talk of the role and importance of customer lifetime value, it has historically struggled with limited adoption moving outside of the marketing analytics department and into the C-suite. With the rise of customer-based corporate valuation (CBCV) in recent years, this has been changing. So, how do you apply the CBCV framework? Theta Director and Co-Founder Daniel McCarthy shares insights on how the cbcv framework can be used to measure company health and product-market fit.
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On the cbcv framework
Customer-based corporate valuation, or CBCV, is a method that uses customer metrics to assess a firm’s value. The goal is to estimate the present values of the free cash flows of the business, in other words, the valuation. Customer-based frameworks are becoming increasingly prevalent in the product world and can lead to a higher success rate for your product. This is what the cbcv framework is:
“Customer-based corporate valuation, in some sense, is the summarization of product market fit. In the sense that, we’re going to use a framework to be able to predict what customers will do. How many purchases they’re going to make and spend, and how quickly they adopt. “
“We use this to understand what that implies for the overall value of the firm. And it gives us all these other useful diagnostic measures like customer lifetime value, that can help us understand what might be driving our valuation.”
“In truth, durable, sustainable product market fit is the ability to get people to engage with your product and service.”
On how the cbcv framework works
What if you had a crystal ball that could predict customer behavior? That would revolutionize product management. The cbcv framework is pretty much as close as you can get to actually predicting the future. This is how the cbcv framework works:
“It’s like project finance, except a project is the customer. So, we take that framework and convert it into an estimate of the fair valuation of the firm. By first projecting how many customers we’re going to acquire, and how long those customers are going to stay after they’re acquired.”
“If we had a crystal ball that can do a good job of predicting both of those things, then that will give us the total size of the customer base over all future periods.”
“Finally, how many orders going to those customers are going to take place while with the firm, and then how much do they spend on those orders? In some sense, it’s kind of a dumb accounting identity but that has to give us what revenue is.”
On customer-based metrics that matter
The CBCV framework gives us a highly diagnostic unit of economic insights for free. In order to use the cbcv framework correctly, it is crucial to know customer metrics. But what specific customer-based metrics matter? These are the metrics to track when using the cbcv framework:
“We take into account the contribution margin, which gives us the variable profit, subtract-off, customer acquisition costs, and other overhead, accounting for working capital. And that gets us to free cash flows, which drive our estimate of the fair valuation of the firm.”
“Everything below the revenue line is more or less, what you would see in a traditional financial valuation model. But that revenue line is now being driven off of these additional processes.”
“The main thing that we need to be able to do this exercise is a predictive model for customer acquisition over time. Or at least some sort of retention model, a model for purchasing while customers are with the firm. And then, for how much is being spent on those orders.”