Intro to Portfolio Theory, Risk and Return, and Customer Equity optimisation

There was until recently limited coverage of customer risk in marketing practice. In the corporate finance world, discussions around risk and return would almost invariably lead to discussions about portfolio management, a concept that is actually not new to marketing and where the debate often centres on how to most efficiently allocate marketing spend, the topic of quite a few of my last blog articles. Indeed, marketing research confirms that customers can be viewed as a portfolio of assets, where the objective of doing so is to use the tool to help maximise customer equity. 

The application of portfolio theory in corporate finance requires a consideration of risk, where measures such as the standard deviation of returns, variance of returns, range of returns and β (aah, beta! It's been a while since I wrote about you in Greek - the last time was in my corporate finance consulting days!) are used, where β is a measure of the relative risk of an entity with respect to the market or a market proxy. β is perhaps better known as an element in the equation for the calculation of the Weighted Average Cost of Capital (WACC), that in turn determines the total cost of all capital in the business - debt and equity - with due consideration for tax and its capital structure. WACC is key to company valuation, being the relevant discount rate mentioned in a previous paragraph. 

Other than improving the understanding of riskiness and therefore being able to act on the information, risk is a very useful attribute to have around because risk reduction strategies are as valid a route to value creation as are any other strategies that are designed to increase returns. For more on another day perhaps (what, yet another article topic in the wings?), in cases where one of the corporate objectives is to achieve consistent (low risk) cash flows, many people, even marketers, don't entirely realise that brand equity has a significant role to play as a risk management tool.   

The objective of the application of portfolio theory to the problem of customer equity optimisation is to determine where best to focus marketing spend. To demonstrate how it works, a real operating example of this will soon be presented in a follow up article. Yep, portfolio theory makes for an extremely powerful strategic marketing tool! As a teaser, below is an illustration from work done in a Business Banking context. Explanations and interpretations upcoming...