Determining How Much a Customer is Really Worth to You

by Lars Skari, Vice President and Financial Services Practice Lead

It is a familiar and well known fact: most companies experience a gross deviation in its customers’ value contribution. The 80/20 rule holds that 20% of a company’s customer base contributes 80% of a company’s profits. In some industries, such as the car rental business, 0.5% of customers rent some 25% of the cars according to Peppers and Rogers group. With value distribution so lopsided, why are companies not rushing to adopt a customer value focus? After all, understanding and acting on customer value insight will help determine everything a company does, from what programs to invest in, to attracting and retaining the right customer, to predicting ROI from marketing and sales investments.

Well publicized case studies have demonstrated how a few innovative companies, predominantly focusing in the business-to-consumer space and dealing in large transaction volumes, have adopted a customer value focus. Witness the proliferation of rewards programs in travel and hospitality or a few leading retail banks’ customer profitability based marketing, sales and service initiatives. To date, fewer B2B companies, defined as those focused on serving a predominantly business clientele, seem to leverage customer value management as a strategic tool. How come?

In the past many B2B companies lacked the ability to develop the necessary customer insight. With silos of customer information housed in disparate transactional and operational data stores, developing a single customer value view of the customer was difficult. Just as important, agreeing to a customer value model and developing a framework for actionable execution seemed monumental tasks. Moreover, a latent fear that customer value based programs were little more than disguised compensation schemes caused executive skepticism to embark on yet another profit draining initiative. Enterprises are discovering, however, that the shortest path to increased profitability and organic growth is to extract more from loyal, high value customers, and to find lower-costs ways of serving others.

Enterprises getting started on a customer value based path are finding that planning, implementation and execution is eased by a number of factors. On one hand, increasing maturing of technology, the “plumbing” that underlies customer value based initiatives, is easing implementation. Database, integration platform and business intelligence tools are reducing the technical complexities of building a customer value based infrastructure. Moreover, the advent of global professional services delivery models allows enterprises to develop this infrastructure in a cost effective way. On the other hand, the “management science” component of making effective use of the customer value infrastructure has also matured. For example, the application of customer segmentation methodologies and advanced analytics for customer churn and retention based on customer value insight have both evolved with a few innovators leading the way.

FROM DATA TO CUSTOMER VALUE INSIGHT

In our work with several B2B companies across industries, we have found that customer value based initiatives typically find an initial application in marketing and migrate towards other functions over time. This focus on marketing is in large part due to marketing’s immediate ability to reach a large audience of customers and prospects. Moreover, applying scientific methods to a function that in some instances has enjoyed unadulterated artistic license, is a way to address executives’ increased frustration with tying marketing performance to financial indicators.

At its most basic level, managers intent on developing customer value management capabilities must address a few, core questions:

• What value does a particular customer provide our organization?
• How does their value compare with our other customers?
• What level of service is required in order to attain this value?
• How has their value changed over time?
• How have we impacted this value?

In addition, customer value management must be based on the strategic priorities of the enterprise. What metrics are important to the organization? Can we influence these metrics or are these attributes out of our control? Finally, introducing an actionable framework for customer value management requires the determination of technical criteria. For instance, over what time-interval are we evaluating our customers? Do we need to account for geographically-based differences in customer performance?

We have found that it is essential for an organization to understand the RELATIVE value of a particular customer when compared to all of the firm’s customers. This enables an organization to understand a customer’s relative contribution, their performance and value-migration over time.

THE CUSTOMER VALUE MODEL

Developing the Model

The adoption of a successful B2B customer value based approach hinges on the development of the appropriate algorithm. The goal of a customer value should be to determine one overall customer ‘score’ that represents a customer’s relative importance. The first task is to determine what metrics should be captured to create the most accurate portrait of their customers regardless of data availability. Which variables provide and detract value? Second, take an inventory of the data currently available. Is it sufficient to create a viable customer value based model? Does it capture a sufficiently broad view of a customer’s interaction with the organization? Starting with this ‘perfect world’ scenario allows the business user to perform a gap analysis between the information currently available from their present data sources and the need and priority of tracking additional information. Finally, weight these variables appropriately. A health insurance provider, for example, may consider “Dollar Amount of Claims Paid” as a leading indicator of relative customer value since it directly impacts the firm’s overall performance.

Figure 1 illustrates an example of variable selection and weighting:

It is important to determine the time period necessary to fairly evaluate customers. Performing the calculation too often will lead to oversensitivity; too infrequently and analysis may provide little differentiation over time. For example, companies whose customers average ten to fifteen transactions a month will most likely desire monthly snapshots containing a rolling three months of data (ex. The January ‘snapshot’ will contain data from the previous October, November and December; February will evaluate November, December and January and so forth.), where companies whose customers complete several daily transactions will want a more frequent time interval.

Interpreting the Results

The goal of customer-based value is to provide the business user a single indexed score representing a particular customer’s relative value compared to the rest of the firm’s customer population. Indexing eliminates market influences in comparing your customer base. For example, the mortgage industry has experienced explosive growth over the past two years. It would be a good assumption that a large number (if not almost all) of a wholesale lender’s broker population have experienced tremendous growth during this time. In periods of high growth (or decline) indexing allows a company to quickly recognize which customers are not keeping pace (or are successfully weathering a downturn).

Figure 2 illustrates the customer value model used by ABC Company’s (ABC). This model uses customer value scores that are based on the last 2 months of business history. All customers receive an indexed score ranging from 0 to 100. ABC has determined its customers can be grouped into three categories: High, Medium and Low. If it chooses, ABC can now differentiate its customer interaction across all departments based on these basic segments. For example, ABC’s “High” customers are highly valued and represent 80% of the firm’s sales. By identifying these customers, ABC’s can express its appreciation on various fronts. Marketing will mail promotional items, Sales will ensure Account Executives make face-to-face visits and Operations will give them priority during customer service calls.

For some organizations the static view described above is enough. All customers have received a relative value. Preferential service will be delivered to “High” customers and interaction will be minimized with “Low” customers. However, most firms will prefer to go deeper. Understanding a customer’s value relative to their peers and their own performance over time is invaluable.

Figure 3 compares a customer’s relative performance not only to their peers but to themselves as well. By placing a customer’s current value (T) on the x-axis and its previous score (T-1) on the y-axis, ABC Company can now create four organizationally meaningful groups: Recognize, Recover, Develop and Sustain.

These descriptive segments will help managers understand the analysis and action necessary to successfully interact with and migrate their customers to higher tier value segments. For example, a “Recover” customer’s value was high in the prior period but has significantly decreased in the current period. Marketing can create a targeted mail campaign letting the customer know they are missed. A message such as, “We haven’t heard from you in a while and appreciate your business.” Significant movement can act as a trigger for action; the customer may be feeling neglected by their salesperson or the firm’s pricing for a favorite product is no longer competitive.

Reporting Insight

In order for customer value to gain traction in an organization it is essential to communicate the results. Early “big wins” provide concrete evidence proving customer value’s credibility. Tracking and distributing these results within your enterprise will help facilitate organizational change and provide a rallying cry binding functional departments.

Reporting requirements will vary by organization. Keep these four concepts in mind when determining your informational needs – simplicity, timeliness, stability and flexibility.

• Simplicity—An organization should be able to easily understand customer value results. Marketing, Sales and Operations managers will be skeptical of basing critical business decisions on a difficult to interpret model.
• Timeliness—Depending on the time periods chosen, an inherent lag exists between when a business manager is aware of a customer’s value contribution to when he/she can react. It is essential to communicate the correct message relative to a customer’s current performance.
• Stability—An organization should tailor its valuation model based on the average amount of transactions a customer performs in a specified time period. This will ‘smooth’ the results and will help eliminate any business variations over time (ex. Sole proprietor sick or on vacation).
• Flexibility—Business users will gain a greater understanding of their customers over time. As customer value gains traction other departments may seek a tailored customer value ‘snapshot.’ Flexibility can be accomplished through prudent model design.

CUSTOMER VALUATION AND YOUR ENTERPRISE

“The customer is always right” is a familiar adage; but are they a customer with whom you would PREFER to do business? Customer value allows decision makers to understand and prioritize their customers. Moreover, customer value can act as a catalyst that can bridge organizational divides. For example, Marketing can develop metrics that trigger events to help the sale team deliver the ‘right’ message to the ‘right’ customer.

Customer Value is a tool used to identify your “best” customers. It is also an instrument to selectively determine which customers your firm WANTS to be loyal. As many have discovered, not all profitable customers are loyal, and not all loyal customers are profitable. Promoting customer loyalty from the “right” customers is a cyclical, three step process. First, determine your customers’ value. Second, identify your highest value customers. Finally, create programs that foster customer retention from customers with whom you already have or are able to build a unique, mutually beneficial and sustainable business proposition.

CONCLUSION

Companies are discovering that customer value management can play a critical role in accelerating enterprise growth and profitability.

Our experience tells us that customer value management is a combination of sophisticated infrastructure, analytical tools and management models for execution. While the initial application of customer value is often found within the marketing department, a customer value approach should not be confined to the marketing organization alone. The customer value model can and should be applied firm-wide. We have observed customer value serving as the ‘unifying bridge’ across an enterprise’s departments, giving Marketing, Sales and Operations a common denominator to prioritize budgets and foster cross-departmental interaction as they work together to achieve sustainable and profitable growth.

ABOUT THE AUTHOR

Lars Skari is a Vice President and Financial Services Lead for Inforte Corp., a Customer Intelligence consultancy. He can be reached at lars.skari@inforte.com.