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This week: equity models.

In this era in which the tenure of CMOs is measured with stopwatches rather than calendars, the focus tends to be on this quarter's sales. At retailers that's often compressed to this week's sales. Or even today's. But companies which have the luxury of taking a longer-term perspective frequently deliver much better results over time.

There are two principal ways to track long term marketing ROI: Customer equity and brand equity. Both require a broader look at marketing activities than just marketing communications. Everything from customer experience to some aspects of product or service functionality and satisfaction is involved in the equation.

Customer equity is a concept which was originally developed and refined by catalog marketers decades ago.

Catalog merchants used database marketing before they had computers to manage their data. They kept customer information on Addressograph plates and Keysort cards which could be physically notched to record specific customer characteristics. Notched plates of cards would be mechanically separated from un-notched cards to segment a subset of customers.

Those subsets, or "selects," recorded basic demographic data, such as gender (from the name prefix) and presumed age (based on purchase patterns). They obviously included geographic data including the customer's address. But catalog merchants soon went farther. They collected source information to identify the mailing list the customer's name came from, and offer type information to gauge the type of merchandise and offer most likely to appeal to the purchaser.

In the 1930's George J. Cullinan's RFM method provided a key to profiling catalogs' most profitable customers based on the Recency of their last purchase, the Frequency with which they purchased during a predetermined period and the Monetary value of all purchases made during the period used to calculate frequency. Later overlays of a customer service code to identify and eliminate customers who frequently return merchandise (a significant expense for handling the return and restocking of the merchandise and crediting a refund to the customer's card) gave a very clear picture of which customers did most for a catalog merchant's bottom line.

Just one last piece remained: when catalog merchants added length of time as a customer to the selects they had all the components of lifetime customer value, the core concept of customer equity analysis. Because most could determine that various categories of customers had specific – predictable – lengths of time over which they would purchase from a particular cataloger.

Lifetime customer value is simply the total profit a marketer will earn from a customer throughout their entire business relationship. It is the marketer's equity in that customer.

Calculating customer equity takes a lot of data collected a long enough time to determine the length of customer relationships in various clusters of customer types. Compiling the database can take years, but using it is straightforward:

· Group customers into relatively homogenous clusters. The most significant factors in these clusters will be source of the customers, the classic RFM factors, demographics, inferred psychographics and the categories of products or services members of the cluster buy.

· Calculate the profit of sales to members of the group (taking into account the marketing cost of each sale).

· Chart the life cycle of customers in each cluster. Some may be customers for months, others for decades.

· Multiply the individual sale gross profit by the frequency of sales by probably life cycle to get probably gross lifetime profit per customer in the cluster.

· Subtract the initial acquisition cost of each customer – the cost required to generate the first store visit or purchase – from the gross lifetime profit to get net customer profit.

· Divide the new customer equity by the initial acquisition cost to get ROI.
Note that this number only gives the lifetime value of the spending of group members. If members of a particular cluster are especially satisfied with your product or service – that is, those who have a Net Promoter Score of 9 or 10 – they will attract other customers by word through referrals. Although many companies now measure Net Promoter Scores, few have mechanisms in place to place a monetary value on the referrals. Those that do can add that value to the lifetime value of the referring customers in their ROI analysis.

Brand equity is a bit more difficult to calculate.

For a decade or so a number of academics and research companies have been measuring the capital value of brand equity. Basically they compare how much more money a company carries to the bottom line because of the brand associated with their product versus what they would do with an unbranded product. Then they assign a capital value to that increased revenue stream, just as they would in evaluating a new production facility.

The annual Interbrand study rates the world's 100 most valuable brands based on that definition. In the 2007 study the top ten and their brand values (in billions) were:

1. Coca-Cola.............................................................................. $65.3
2. Microsoft............................................................................... $58.7
3. IBM......................................................................................... $57.1
4. GE........................................................................................... $51.6
5. Nokia...................................................................................... $33.7
6. Toyota.................................................................................... $32.1
7. Intel........................................................................................ $31.0
8. McDonald's............................................................................ $29.4
9. Disney.................................................................................... $29.2
10. Mercedes .............................................................................. $23.6

Those are the values of the brands. But what about the ROIs?

It's probably impossible to calculate an overall ROI for the lifetime of the brand, because part of the equity brands enjoy today was created years and decades in the past.

But some brand value is being created – or eroded – today. And in some cases it is possible to compare current marketing communications expenditures with changes in brand equity. For example:

· Coca-Cola's brand equity went down approximately $1.9 billion. They spend $1.6 billion on marketing to decrease their brand's value. Their ROI was a negative 119%.

· Microsoft's equity increased by $1.7 billion, and they spend $944 million on marketing communications, for a 181% ROI.

· Nokia did even better. They increased their brand equity about $3.6 billion with a marketing communications expenditure of just $287 million. A 1,254% ROI on marketing.

These examples are simplifications, of course. The selection of functions to include in companies' marketing budgets is arbitrary and often approximate. And Interbrand's methodology, although based on data, also must include some intelligent supposition. The amount of sweet, fizzy, black liquid Coke would sell if the stuff was called Generic Cola and came in a grey can must be a speculative number.

We've studied several formulae for do-it-yourself brand equity analysis, and have not been convinced by any of them. (Not even the one that went on for three pages). So, at least for the present, the Interbrand list, or monumentally expensive studies for brands that didn't make the cut, are the only ways to value a brand which we find credible and practical. Which means ROI analyses of brand equity are only for very major marketers.

But although this metric of marketing communications ROI may be impractical for most companies, the others are not. The nature of a company's product or service should determine which of the metrics and analyses it uses. It's a critically important decision, because selection of the right ROI model can improve the bottom-line effectiveness of marketing communications by orders of magnitude.