Teaching long term to short-term watchers

It is obvious to everyone that today's publicly owned businesses have a problem when it comes to reconciling Wall Street's demand for short-term results with their ultimate task, as managers, of achieving long-term value. In recent issues of more than one business magazine, the most admired and successful companies listed tend to be the privately held firms, not publicly traded, and therefore not subject to Wall Street's short-term demands. Surely this is a message. Surely this has some significance. Is there anything that financial analysts could do to address this problem? Well -- yes, actually. And that's why we're addressing this open letter to the analyst community.

The basic problem is that even though shareholders are in fact quite interested in the long-term value a company creates for them, at present there is no better, more reliable indicator of long-term value creation than short-term financial performance. The discounted-cash-flow (DCF) method for valuing a business is based on forecasting the firm's future cash flows, but in the end even the most sophisticated predictions rely mostly on aggregate business trends and market projections, and all future trends begin with today's events.

On the other hand, all the operating cash flows at any business come originally from customers. If you add up the lifetime values of all current and future customers, the customer equity you calculate should exactly equal the enterprise's overall discounted cash flow. Moreover, when analyzed this way, the firm's future cash flows can be divided not just into operating entities and business units, but also into the revenues expected from different types of customers. So customer equity can actually be broken down, analyzed, predicted and validated all the way down to the molecular level of the individual customer.

For a business, customers are the scarce resource. They are scarcer than capital. If you have a customer for your business, you can almost certainly obtain the capital needed to serve him. But the market -- any market -- contains only a finite number of customers, who are difficult to obtain and expensive to replace. So it is vital for any business to create the most value possible from its customers. Return on Customersm (ROC) is a metric designed to gauge the rate at which a business does, in fact, create enterprise value from any customer or group of customers.

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