Maximize Your Return on Customer sm Smart CRM February 11, 2004 Atlanta Don Peppers dpeppers@1to1.com *Return on Customer and ROC are registered service marks of Peppers & Rogers Group, a Carlson Marketing Group company. It’s not just about “CRM” any more Question: What is the CEO’s most basic, overall responsibility? Answer: To preserve and increase the value of the enterprise The goal for a business: organic growth Same-store sales increases Account penetration Increased share of customer Margin protection and improvement Churn reduction New customer acquisition New products and services for unmet needs In contrast to purely financial growth… Today’s company executives are much more wary of acquisitions and business combinations Best examples of financially grown conglomerates are also “house of cards” empires with little lasting value: • • • • Enron Tyco Vivendi WorldCom New U.S. accounting guidelines impose more discipline on use of mergers as a tool for top-line revenue growth • • • Much less “pooling” allowed Stricter amortization of good will Constant re-evaluations (and write-downs) of acquired assets Organic top-line growth is now key, but elusive Making money the old-fashioned way: • From the value proposition made to their customers Organic growth fuels creativity and innovation, and keeps an organization vibrant “Organic growth is the Fountain of Youth for a company!” - Andre R. van Heenstra, Unilever NV But decisions taken without regard to customer equity can destroy value, rather than create it Bulletin: “Marketing” can destroy value! Example: Start with a million customers A marketing campaign generates a 1% response (10,000) • • Cost is $1 per solicitation, or $1 million total Each response generates $125 in LTV profit, or $1.25 million total • So each individual campaign is successful, with a $250,000 profit But suppose non-responders become just 0.5% less likely to respond with each solicitation Then with each campaign customer equity decreases by more than the “profit” harvested! Customer equity Defined as: Total lifetime values of all current and future customers Note the inclusion of future customers Customer base is a financial asset, should be tracked like other financial assets Subtract unallocated (infrastructure) costs from customer equity to get enterprise value Customer lifetime values – science and art The spectrum of customer valuation analysis progresses from qualitative to quantitative. Proxy-Based Financial Statistical Analysis Analysis Analysis Actual value, equivalent to lifetime value. — NPV of what we expect to realize from a customer — Most useful financial measure: contribution n Potential value LTV = (1 + d)-i pi i=1 — The “outside limit” of LTV growth for a customer. — Includes additional value we could realize, with a proactive customer strategy to change the customer’s future behavior Customer equity: Managing the customer mix Share of market 2009 Number of Customers Share of market 2004 This necessarily implies customer-specific objectives and strategies 2009 customers Relationships with individual customers become the vehicle Share of customer MVC's $0 Profitability (estimated LTV in $) But relationships can’t be installed. They must be adopted. The nature of a “relationship” Interaction is required, both ways between two parties Interactions drive a change in behavior Relationships are iterative by nature • • A context develops over time It gets easier and easier to continue the relationship There is an ongoing benefit to both parties • Each party has an incentive to recover from mistakes Every relationship is different Relationships are measurable Four steps to building relationships Identify customers, individually and addressably Differentiate them, by value and needs Interact with them more cost-efficiently and effectively Customize some aspect of the enterprise’s behavior Successful relationships generate trust Trust is the engine of all commerce When I trust the company I deal with: • • • I can share my personal, private, or sensitive information I trust you to make recommendations and act in my own interest You’ll help me even in areas outside of your main business Earning and keeping the trust of customers is equivalent to taking the customer’s point of view • • Trust is inversely related to the amount of “self-orientation” a customer perceives in a company The opposite of self-orientation: “the principle of reciprocity” The secret of USAA’s success: A culture of customer trust “Treat the customer the way you would want to be treated if you were the customer.” Robert McDermott, former CEO of USAA More than numbers and processes Both parties have to be willing to engage in a relationship • • • The customer must trust the company The parties must be committed to having a relationship There must be a mutual benefit and alignment between the parties So don’t be misled by economics and equations True success only comes from seeing your business from your customer’s perspective To get real value from customers, first deliver real value to them But do it right, and drive your value up… Enterprise Value = Customer Equity – Infrastructure Enterprise Value $7,500 MM = Customer base is made up of many different needsbased clusters Customer Equity NPV = $9,500 MM Safety & security Utilitarians YR 1. YR 2. YR 3. TV* (minus) YR 1. YR 2. YR 3. Cash Flows ($MM) TV* Performance enthusiasts Infrastructure NPV = ($2,000 MM) YR 1. YR 2. *Terminal Value © 2004 Carlson Marketing Group, Inc. All rights reserved. Peppers & Rogers Group is a Carlson Marketing Group Company. Time savers Etc. YR 3. TV* Increasing customer equity MVCs Net New NPV = $533 MM Objective: Retain MGCs Objective: Increase Share of Customer Increase in Shareholder Value $ 1,011 MM Net New NPV = $486 MM YR 1. Before: Net new: After: YR 2. YR 3. TV* Customer Equity $ 9,500 MM $ 1,061 MM $10,561 MM NPV of infrastructure cost increases: ($ 50 MM) MIGs Net New NPV = $167 MM Low Priority BZs Net New NPV = +$82 MM (loss avoidance) Acquisition Improve Margin Net New NPV = +$43 MM (cost reduction) Target © 2004 Carlson Marketing Group, Inc. All rights reserved. Peppers & Rogers Group is a Carlson Marketing Group Company. Customer equity: a “quick and dirty” estimate 1. Draw a random sample of customers from at least five years ago, with transaction histories ~ 1,000 customers Track all transactions for five years, including attrition 2. Replenish the sample each year with new customers in proportion to actual acquisitions Goal is for the sample to resemble the actual customer base 3. Make a judgment on remaining customers’ patronage patterns (use historical pattern as a guide) Estimate retention and attrition, as well as future purchases 4. Do NPV calculation of customer sample and project to the base Be careful to incorporate new customer acquisitions Relationships, in four words Treating Different Customers Differently Credito Emiliano 300 branches, 360,000 customers Ranked customers into three tiers • Private banking, high-asset, low-asset Also identified 30 separate, needs-based portfolios of customers • Risk tolerance, financial goals, services required Each portfolio managed at HQ by a “segment manager” But what about the value chain? The back end of your company has to be able do what the front end learns the customer needs Companies already integrated on the back end are more likely to succeed with CRM systems on the front end Hard to draw a “boundary” between back office and front office, when dealing with the customer Back Office Front Office One Office The value chain Customer insight adds value within distribution network CRM value added SCM value added Demand chain Supply chain Non-integrated value chain Customer insight adds value all the way back along the value chain CRM value added SCM value added Supply chain Demand chain Integrated value chain SPAR grocery retailer chain 16,000 stores, operating in 30 countries, >$26 b in sales • Mostly Eastern Europe A “soft franchise” operation – retailers all use the SPAR brand, but most are independently owned • • SPAR wholesales vast majority (but not all) of grocery products carried in each store For many storeowners, SPAR also does the books and manages payroll SPAR retailers are SPAR’s real customers SPAR Austria: Stocking shelves with individual treatment With 30% share of market, SPAR is dominant in Austria But many customers still took substantial deliveries from competitive distributors So SPAR introduced store-specific palletization • • SPAR products are shipped to each store on pallets that are individually tailored to the needs of that store Stock clerk just wheels the dolly down the aisles, and can put everything on the store shelves in the order arranged on the dolly SPAR warehouse: order consolidation with sorting Sorting of the crates in an outlet-individualized sequence for optimized shelf-replenishment Rack with 11,000 slots for crates in the dispatch area 12 very fast moving stacker cranes Free access to crates always in pairs On pallet/dollies: the family group with the lightestweight crates is on top not Is this demand-chain or supply-chain? Treating different customers differently Means dealing with management issues not actually part of marketing, sales, or service, per se: Integration along the value chain Customer governance vs. product-line governance Metrics of success Budgeting, resource allocation, and reward structure Cross-departmental coordination and conflict resolution Multiple channels of interaction with customers Customer equity is the right metric First, it is a matter of common sense: • • The firm is engaging its customers in customer-specific interactions and activities, therefore: Our objective must be to increase the long-term value of each customer engaged! But second, management needs an accurate way to evaluate its own actions: • • Resolving conflicts and prioritizing actions requires an over-arching set of guidelines Customer equity “stands above” these conflicts Every management decision should be made based on how it effects customer equity Choosing the right accounting treatment “Rolling up” LTVs to get customer equity • • Should LTV be based on marginal financial contribution? Or, should it be calculated from fully allocated profit? Recognizing capital costs • • Use a strict cash flow analysis? Or, add CRM capex and back out CRM depreciation? How customer equity is calculated will change based on the purpose of the analysis • • Is it to decide whether to launch a new business? Or are we cutting service costs? Actions that increase customer equity Acquiring profitable customers Retaining profitable customers longer Eliminating unprofitable customers Up-selling additional products in a solution Cross-selling other products to customers Referral and word-of-mouth benefits Reducing the cost of service for customers But each action involves a cost or trade-off Acquire more customers by increasing your promotion budget, but… • It’s possible to spend more on acquisition than a new customer is worth Reduce cost-to-serve by installing automated IVR system for handling inquiries, but… • • Don’t reduce capability for solving problems efficiently Service cost and customer attrition might increase! A carefully targeted campaign with individually relevant offers will generate higher response, but… • Targeting reduces the overall size of the pool of potential respondents Thus, this process involves an optimization problem • Balancing the increased profits generated by a firm’s actions against potential decreases in customer equity Creating value is similar to farming Consider good Farmer Wilson Wilson cultivates his land carefully 31 Wilson plants his seeds... 32 Rotates his crops, leaves some land fallow 33 Customers grow up and bear fruit 34 Generating many years of value... Farmer Wilson invests in conservation It takes money to fertilize, to leave some land fallow, to cultivate in contours, and to rotate crops But Wilson’s land will remain productive for many years 35 Contrast with bad Farmer Miller Miller does not practice conservation He plants the most profitable cash crop every year, on every available acre of land He saves money by reducing his fertilizer expenditures, and by avoiding crop rotation In the beginning, he easily harvests more profit than Wilson does But over time Miller’s land burns out Customer equity is similar to capital Economic Value Added (EVA) [registered TM of Stern Stewart] • • Incorporates cost of capital, showing capital dilution IBM’s Return on Assets was 11% in its most profitable year, but its cost of capital was 13%… EVA alerts a firm when capital is being diluted Tracking ROC is also necessary • • Or else a firm risks destroying value even while it earns a nominal “profit” And it will probably destroy value unknowingly But not exactly like capital An intangible asset, unlike trucks or factories customer equity can explode or evaporate over night • • Routine service or price changes, good or bad publicity When JetBlue violated its customer privacy policy, some customer equity was vaporized Does a current sale reduce customer equity? • • Companies consume capital in routine business Converting LTV to current profit – is that “consuming” customer equity? Yes and no. A sale is also an interaction with a customer, so… • Interactions that are well-managed can be used to increase a customer’s LTV Enterprise creates value two ways Profits are harvested, and Customer equity is created or destroyed Needed: A metric to capture the effects of both types of value creation Customers are the scarce resource So what is the rate at which a company creates economic value from its customers? Return on Customer Return on Customersm (ROCsm) defined: The rate at which a firm creates value from its customers ROC = πi + ΔCE CEi ROC > 0 Value is created ROC < 0 Value is destroyed ROC = 0 Value is converted ROC: A speedometer for organic growth ROC measures the efficiency of a firm’s true value creation with customers Return on Customer has important implications for • • • • • Pricing policy Sales force organization Distribution channel management Product and service development Supply-chain automation ROC should also be used to evaluate new ventures and business combinations • ROC >0 means customer equity of the combined entity exceeds the sum of the separate entities Making it practical Maximize Return on Customer by breaking customer base into portfolios • Evaluate managers based on portfolio’s ROC But changes in customer equity must now be predicted from current actions • Otherwise, how will managers be evaluated? So what are the “leading indicators” of customer equity change? Three types of leading indicators Attitudinal indicators • Willingness to recommend, customer satisfaction, brand preference, level of trust and confidence… Behavioral indicators • Changes in account profile, interactions, sales, referrals, returns, complaints… LTV components • • What variables go into the company’s LTV equation? Churn rate, frequency of purchase, share of customer, service contract, account penetration level… Tracking attitudinal indicators RSxsm measures attitudes to analyze their effects on relationships and customer equity Key Relationship Constructs categories of relationship drivers commitment economic drivers mutuality and alignment resources drivers social drivers Source: Linda Vytlacil, RSx categories of positive relationship outcomes financial outcomes strategic outcomes trust social outcomes Analyzing Retailer Z’s relationship outcomes Company needed to quantify financial outcomes of better customer relationships relationship outcomes commitment share of wallet purchase intent mutuality and alignment turnover intent positive word of mouth trust ease of complaining Sample analysis Here’s how a one-point increase in customer “commitment” impacts on “share of wallet” and “intent to purchase more” relationship outcomes commitment mutuality and alignment .40 .28 share of wallet purchase intent turnover intent positive word of mouth trust ease of complaining From analytics to results Retailer Z next identified specific relationship drivers relationship drivers store convenience relationship outcomes commitment communication shared values share of wallet purchase intent mutuality and alignment store personalization turnover intent positive word of mouth trust ease of complaining Knowing what to do with the insight… One point increase in “store personalization” moves brand “trust” by a quarter point relationship drivers relationship outcomes store convenience commitment communication share of wallet purchase intent mutuality and alignment shared values store personalization turnover intent positive word of mouth .25 trust ease of complaining Behavioral indicators Financial services firm • A fall-off in transactions indicates increased risk of attrition Credit card firm • Married couple each using a jointly held card increases loyalty dramatically Automotive firm • Customer buying on referral is more likely to be satisfied longer and and to buy additional products and services Electronics retailer • Customer enlisting for email newsletter more likely to return to store for future purchases LTV components According to one academic study* of customer equity at five firms in retail and financial services: • • • • Customer retention had an elasticity from 2.45 to 6.75 Acquisition cost elasticity from 0.02 to 0.32 Margin elasticity from 1.02 to 1.32 Discount rate elasticity from 0.46 to 1.17 Some lessons for using LTV components: • • LTV equation should be designed to include leading indicator components that can be easily measured Discount rate is a function of risk, so better customer insight justifies a higher discount rate (and greater customer equity) *Source: Gupta, Lehmann and Stuart, “Valuing Customers,” Columbia Business School (forthcoming). “Quick and dirty” estimate of ROC 1. First do an estimate of current customer equity 2. Break your LTV equations into their components Find the primary drivers for each of these components Identify leading indicators to be linked to LTV 3. Quantify the relationship between leading indicators and LTV Use research, if possible, including sampling Quantifications based on judgment are also useful, however 4. For the customers involved in your ROC initiative Think through any LTV differences that might exist Measure LTV drivers from a sample prior to the initiative Compare to a (statistically identical) sample afterwards 5. Do the math Managing portfolios of customers For each individual customer portfolio: • • Benchmark the beginning level of customer equity Define leading indicators and calculate elasticities Portfolio managers are “in charge” of devising and executing treatments for different customers Portfolio managers: authority versus responsibility • • Authority for pricing, offer, communication flows Responsibility for customer equity improvement Your goal is to ensure that someone’s interest is served by clearing the obstacles to value creation Portfolios contrast with “campaign management” Company Campaign management Managing portfolios of customers Customers targeted: • All, including BZs • Customers with highest value or potential Objective: • Positive ROI events • Maximize lifetime value of customer portfolio Customer reaction: • Block interactions • Invite interactions Acceptance Rate: • 2-5% • 30-70% Nature: • Transactions • Relationships Portfolio managers orchestrate treatments Analyze Customer value Customer needs Individual customer economics Understand competitive landscape (for customer) See the company from the customer’s perspective Act Determine value maximizing treatment strategies Launch campaigns and programs supporting those strategies And GET THINGS DONE! • • Influence service delivery • Drive business-unit integration across product boundaries Support new or improved products and services Getting inside the customer’s head, but taking your company perspective with you ROC is qualitative, not just quantitative Gaining customer trust involves both culture and capabilities Up to now, the best examples of ROC success have been from companies not tracking it formally • Ritz-Carlton, USAA, Charles Schwab, Peter Jones What any company can do: • • • Even without financial tracking mechanisms See things from the customer perspective Act in the customer’s interest, to solve customer problem Employees want the capability to behave this way • But companies are hesitant to push customer service without the metrics to hold costs down • Now, with ROC, a company can measure costs and benefits accurately Government organizations also… Gaining the trust of their constituents Seeing things from the perspective of the citizens being served • • Making it easier to get information or solve a problem Faster, more efficient, less costly service Inland Revenue in the UK • Architecting the network of interactions with consumer and business taxpayers 311 phone service by cities in the US • New York City’s mayor: “Who ya gonna call? 311.” Maximizing your Return on Customer 1. You can’t do any of this without relationships… …and that means your corporate culture must be oriented around earning the customer’s trust 2. LTV is the number you need to deal with, but: Lots of ways to estimate it besides sophisticated modeling First benchmark your customer equity Then track your leading indicators to link changes in customer equity to Return on Customer calculations 3. You can’t take customer-specific action without assigning customer-specific responsibility Assign responsibility for customer portfolios Resolve conflicts and measure results with customer equity Peppers & Rogers Group Management consulting in customer strategy issues 150 people around the world • Norwalk, San Mateo, London, Brussels, Istanbul, Mexico, Sao Paulo Now the strategic consulting arm of Carlson Marketing Group Magazines, newsletters, research white papers www.1to1.com dpeppers@1to1.com