Predicting business successes in the future has proven to be a complicated task, even at the best of times. This challenge becomes greater when key drivers, such as customer relationships, are not easily quantified, making it difficult to predict their precise impact on a firm's long-term success.

Traditionally, a popular solution has been to ignore these factors in favor of focusing on measurable attributes, such as product management, wich leaves marketing decisions to be far more subjective than necessary.

However, recent research from IESE's Julian Villanueva and Dominique M. Hanssens from UCLA's Anderson School of Management, argues that measuring Customer Equity ("CE") has great potential for gaining a better understanding of why some businesses ultimately succeed while others fail.

Customer Equity, in its simplest form, recognizes customers as the primary source of cash flows. By measuring the present and future value of customers, it is possible to better understand return on marketing spending and, ultimately, the value of the firm itself.

While CE is a relatively new term, it builds upon previous concepts, including Customer Lifetime Value (CLV) and Customer Relationship Management (CRM). These concepts have been successfully applied for years, in direct marketing and within the financial services industry. However, CE has the potential for a much broader application, not only to a range of industries, but to multiple marketing channels as well.

One way to understand CE is by comparing it to the related concept of Brand Equity. Both are similar in some respects; they each attempts to measure the intangible value of marketing assets and hold customer loyalty as a fundamental consideration.

However, their differences are far greater. First, the basic unit of analysis is different, as Brand Equity focuses on the product, while CE is directly concerned with the customer. Second, CE measures observable customer behaviors, instead of focusing on less-tangible customer attitudes like Brand Equity.

Because customer behaviors and purchase decisions are directly linked, CE provides a more accurate understanding of the cause and effect relationships that ultimately drive revenues. When combined with financial metrics, such as net present value, a lifetime of customer revenue generation can be compressed into a single Customer Equity value. However, despite these advantages, Brand Equity is better known than CE at the moment. While this may seem to indicate that Brand Equity is a more popular or effective metric, in truth, it's a result of timing. As more literature is published over the next few years, popularity and use of CE will grow accordingly.

Firms that do not understand CE face the risk of making key marketing decisions without sufficient or appropriate information. Worse, firms will be more vulnerable to a number of common and costly mistakes.

One mistake is allocating resources to add new customers who provide short-term gains without any long-term benefits. This results from errors in targeting customers who are more likely to defect after a short period.

Secondly, firms can waste money by spending unnecessarily on activities with little or no influence on customer behavior and purchase decisions.

A third mistake is focusing exclusively on revenues and other figures that look promising from a financial perspective, while ignoring negative trends in the cost of acquiring and keeping customers that provide advance warning of problems that would otherwise go unrecognized. Finally, even well intended investment in expensive CRM platforms may prove a costly mistake, if the benefits are unrealized due to a lack of understanding how to use them to grow CE.