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Optimizing customer returns

November 29, 2009

Here’s a thought. We believe those organisations that arm themselves with a clear view of the value and returns they get from their customers will have a better potential to survive and thrive, whatever the economy.

Why do we believe this? Because such organisations are not only talking about putting customers at the heart of their business, they are acting on it. By understanding their investment returns at a customer level, they are giving themselves a major competitive advantage because it is unlikely their competitors are doing so.

Before we get into this, take a few minutes to consider the following questions:

1. Do you segment your customers based on value measures?

2. Do you know how many customers you retain each year and how retention rates vary by segment?

3. Do you know how much it costs to serve your customers?

4. Do you measure customer satisfaction, or even better – customer commitment?

5. Do you know what share of wallet you have with each of your customer groups?

According to Professor Frances Frei of Harvard Business School “your customer is your most powerful asset”. Most organisations generate revenue from customers.

As obvious as this may appear, while companies expect to know how many products they sell, how much revenue each product line generates and how much capital they have invested in machinery or property, they are often unable to quantify anything beyond the most basic information about their customers. For example, just 12% of organisations are able to measure cost to serve according to QCi (State of the Nation IV: 2005.) A survey by Genroe in Australia further supports this, revealing that only 9% of organisations reported on comprehensive customer information in the way they would other ‘business assets’.

Unfortunately, without a view of current and potential value, customer reporting can be highly misleading. According to analysis by Unity UK, up to 60% of customers are typically unprofitable. In fact, they found that just 5% to 15% of customers generate 100% of profits in the organisations in the study. They also found that some 25% to 55% of company resources are consumed by unprofitable customers. Results from our own analyses support this. We commonly see situations where over 40% of customers will lapse before ever breaking even.

This information has a dramatic implication for those using return on investment (ROI) criteria to support decision making.

ROI assessments: Are yours giving your organisation the right steer?

A basic campaign ROI calculation multiplies response and contribution, and divides the result by the cost of activity. So a campaign that costs $100,000, delivered 6,667 customers each contributing $150, gives an ROI of 10:1 ($10 revenue resulting from each $1 spent.)

Now consider this example: Two acquisition campaigns each cost $100,000, each deliver a cost per acquisition of $15 with customers acquired spending $150. So the ROI is equal? What we don’t see is that customers from Campaign A are retained at the rate of 50%, whereas for Campaign B that same rate is 85%. In this scenario, after 3 years Campaign B would deliver $822,500 more revenue and retain 3,150 more customers.

Basic ROI calculations give you a steer on short-term tactical activity at best. However, they are lacking when it comes providing strategic direction.

To get a clear picture of ROI, it is our view that Customer Life Time Value (CLTV) segmentation is a pre-requisite. In simple terms, CLTV is “today’s value of all future profits you predict you’ll get from a customer” (Martha Rogers, Peppers & Rogers Group).   It takes account of the current value of a customer to the organisation, but vitally it factors in a probability around the potential value .   This can even inform prospecting as each prospect has a probability, however slim, of becoming a customer, and therefore can also be assigned a value.

Armed with a CLTV derived view of ‘customer return’ for the organisation, ROI calculations can move beyond the short-term hit and accurately support strategic decision making.   Instead of looking at immediate contribution, such an approach assesses returns based on the change to CLTV that results from that activity.

CLTV in action

 

In this example – based on a real scenario from Twenty’s archive – Lifetime Value is calculated by adding current value of a customer (income v cost of acquisition and maintenance) to tenure and potential value of future income.

The first part of this analysis looked at the relationship between costs and revenue to provide a steer on current value and customer breakeven.

That old chestnut ‘not all customers are created equal’ quickly became obvious. This work has very much highlighted the importance of targeting and recruiting the right type of prospects – those with a high probability to become profitable.

Unsurprisingly, one of the biggest factors in profitability is media. While certain media look much more cost effective on paper in terms of cost per contact and reach, they proved to be among the weakest at delivering profitable high-value customers.

Understanding the effects acquisition channels have on the subsequent behaviour and profitablity of customers is a clearly a huge asset in terms of media strategy as well as customer management.

Customers: Still the lifeblood of business.

It is customers that provide your organisation with most if not all its revenue – not products, services or capital investment. So treat them like a valuable business asset, and evaluate their worth. Understand not just what value you get from them but the value you provide to them. Then leverage this information to improve total customer returns, aligning your organisation, marketing investment and other resources to better meet your customer needs.

Getting under the skin of the customer returns will have a major impact on the way you approach the business of marketing. It takes vision and commitment, but applied well it will lead to strategically more robust decisions and deliver a real competitive advantage.

 

Mark Wilson is a founding partner and director of Twenty. As Director of Insight, he is responsible for driving the analytics division of the agency, with clients as diverse as CourierPost, Pace, ChildFund, Fisher & Paykel Finance and BMW. As well as being a judge for major industry awards, his own work has been highly recognised with numerous top Nexus awards over the years.

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