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