PROFITABLE
CUSTOMER ENGAGEMENT
Concepts, Metrics & Strategies
V. Kumar
© Dr V.Kumar
Chapter 4
Valuing customer contributions
The future looks green!!!
Instructor’s Presentation Slides
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Traditional measures of Customer Value
 Recency-Frequency-Monetary Value (RFM)
 Past Customer Value (PCV)
 Share of Wallet (SOW)
 Tenure/Duration
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Customer Lifetime Value
Customer Lifetime Value (CLV) is defined as “the
sum of cumulated future cash flows – discounted
using the weighted average cost of capital (WACC) –
of a customer over their entire lifetime with the
company.”
CLV tracks the future purchase behavior of a
customer and computes his /her value in
present day terms.
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Measuring CLV
CLV Measurement Approach – A Conceptual Framework
Recurring
Revenues
minus
Recurring
Costs
Gross
Contribution
Margin
Adjusted for
NPV
minus
Net
Margin
Marketing
Costs
times
Expected
number of
purchases
over next
3 years
Accumulated
Margin
minus
Customer
Lifetime
Value
Acquisition
Costs
Source: Adapted from Kumar, V. (2008), Managing Customers for Profits, Upper Saddle River, NJ: Wharton School Publishing.
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Measuring CLV
CLV Computation in a Contractual Setting
M̂C it
Base GC T p̂(Buy it  1) * ĜC it
CLVi  


t
t
t
(1

r)
(1

r)
(1

r)
t 1
t 1
T
where,
CLVi = lifetime value for customer i
p(Buyit ) = predicted probability that customer i will purchase in time period t
GCit = predicted gross contribution margin provided by customer i in time period t
MCit = predicted marketing costs directed toward customer i in time period t
t = index for time periods; such as months, quarters, years, etc.
T = marks the end of the calibration or observation time frame
r = monthly discount factor
Base GC = predicted base monthly gross contribution margin
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Measuring CLV
CLV Computation in a Noncontractual Setting
p̂(Buy it  1) * ĜC it
M̂C it
CLVi  

t
t
(1

r)
(1

r)
t 1
T
where,
CLVi = lifetime value for customer i
p(Buyit ) = predicted probability that customer i will purchase in time period t
GCit = predicted gross contribution margin provided by customer i in time period t
MCit = predicted marketing costs directed toward customer i in time period t
t = index for time periods; such as months, quarters, years, etc.
T = marks the end of the calibration or observation time frame
r = monthly discount factor
Base GC = predicted base monthly gross contribution margin
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Drivers of CLV
Exchange Characteristics
Customer Characteristics
Product Characteristics
Firm’s Marketing Actions
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Maximizing CLV
Customer Retention
• Which customers should we retain? How can we retain
more customers?
• Can we ensure that the customers we retain are profitable
or potentially profitable?
• What efforts/programs influence customer retention and
CLV?
• When are customers prone to switch? What are the drivers
to switching?
Customer Acquisition
• How can we increase customer acquisition? Is it possible to
acquire profitable customers rather than just any
customers?
• What acquisition sources are most/least profitable? Which
sources are ultimately providing the best customers?
• How much to spend on acquiring a customer?
Customer Profitability
• How can we increase our overall profitability?
• How to recruit profitable customers who will stay longer?
• How long is the customer's actual lifecycle?
• Which customers are more prone to specific campaigns?
(e.g., discounts, deals etc.)
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1. Customer Selection
 Need for Strategy
 Traditional metrics like RFM, PCV, SOW, Tenure or Duration are
based on past customer behavior.
•
A poor indicator of future customer purchase behavior
•
Fails to identify customers who will be profitable in the future.
 CLV, a forward-looking metric, focuses on customers who are
likely to be profitable in the future.
 How does it work?
 Selection is important for two reasons;
a)
b)

Not all customers are equally profitable
Limited budgets to spend resources on
By selecting the right customers to manage, CLV enables firms to
rank-order customers based on their value to the company, and
prioritize resources accordingly.
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2. Managing Loyalty and Profitability Together
 Need for Strategy
 Loyalty is not always the true measure of customer
profitability.
 Traditionally, customer loyalty has been defined solely
as a behavioral measure with the assumption that the
loyalty of a customer is obtained from his purchasing
behavior.
 Chasing loyal customers is not the same as chasing
profitable customers.
 How does it work?
 Customers are rank-ordered and segmented into four
cells based on their loyalty and profitability levels.
 Segmentation and strategies shown on the next slide.
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2. Managing Loyalty and profitability together
BUTTERFLIES
High
Profitabil
ity
 Good fit between company offering and
customer needs
 High profit potential
Action:
 Aim to achieve transactional
satisfaction, not attitudinal loyalty.
 Milk the accounts as long as they
are active.
 Key challenge: Cease investment
once inflection point is reached
STRANGERS
Low
Profitabil
ity
 Little fit between company offering and
customer needs
 Lowest profit potential
Action:
 Eliminate all investments towards
these relationships
 Profitize every transaction
Short-term Customers
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TRUE FRIENDS
 Good fit between company offering and
customer needs
 Highest profit potential
Actions:
 Consistent intermittently spaced
communication
 Achieve attitudinal and behavioural
loyalty
 Delight to nurture/defend/retain.
BARNACLES
 Limited fit between company offering and
customer needs
 Low profit potential
Action:
 Measure size and share-of-wallet
 If share-of-wallet is low, specific upselling and cross-selling
 If size of wallet is small, strict cost
control
Long-term Customers
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3. Optimal Allocation of Resources
 Need for Strategy
 Firms cannot allocate equal resources to all of their customers.
 Also, not all customers are equally loyal and profitable.
 Hence, firms should allocate their limited resources to the most
loyal and profitable customers.
 How does it work?


To optimally allocate resources, firms must identify;
a)
their most profitable customers, and
b)
those who are the most responsive to marketing efforts
By carefully monitoring the purchase frequency of customers,
the inter-purchase time, and the contribution toward profit,
managers can determine the frequency of marketing initiatives
to maximize CLV through an optimal contact strategy.
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4. Cross-buying Behavior
 Need for Strategy
 When customers buy across product categories;
a) they contribute to an increase in revenue
b) contribute to profits
c) increase their own switching costs
 Therefore, firms should identify and target the right customers
who are most likely to cross-buy.
 How does it work?


© Dr V.Kumar
In order to identify the customers who are likely to cross-buy,
firms not only need to understand the motivation and drivers
influencing customers to cross-buy but also the impact on
revenues and other customer-related metrics.
Drivers of cross buying will help managers retain customers for
a greater duration.
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5. Pitching the Right Product to the Right Customer at the
Right Time
 Need for Strategy
 Cross-selling is an important strategy for firms to increase customer
retention and customer value.
 As not all customers are likely to cross-buy, it is imperative for firms to
identify customers who have a higher propensity to cross-buy.
 How does it work?

To predict the purchase sequence of each customer firms need to
collect the following information:
a) In which product category the customer is likely to make a
purchase?
b) At what intervals and at time period the customer will make a
purchase?
c) How much the customer is likely to spend towards that purchase?
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6. Preventing Customer Attrition
 Need for Strategy
 As it is less expensive to retain a current customer than to gain a
new one, monitoring customer churn/attrition is vital for
companies.
 How does it work?



By building a “propensity to quit” model.
These models give us the probability of a customer quitting at a
particular point in time.
Based on when the customer is likely to leave and his/her ability
to contribute profits, firms can provide appropriate intervention
strategies that will aid retention.
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7. Product Returns
 Need for Strategy
 Product returns:
a) Reflect the discontent of customers with the firm’s offering
b) Increase service costs for the firm
c) Eventually reduce margins for the firm
 Firms can benefit greatly by estimating optimal amount of product
returns
 How does it work?

© Dr V.Kumar
Firms need to address the following questions:
a) What factors affect customers’ return behavior?
b) How does customers' return behavior influence their future
buying behavior and the firm-initiated marketing
communication plans?
c) Should firms consider product returns as a necessary evil in the
exchange process?
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8. Managing Multichannel Shoppers
 Need for Strategy

Customers often engage through different channels such as retail stores,
brick-and-mortar stores, the Internet, or by mail-order catalogs.

Each of these channels services a different set of customers and provides
varying levels of service.
 How does it work?

To effectively manage multiple channels, firms have to first identify who
the multichannel shoppers are by studying the drivers associated with
purchase behavior across multiple channels.

After identifying the drivers, firms have to determine whether
multichannel shoppers are: (a) more likely to buy in the future, (b)
spend more money, and (c) more profitable than single-channel
customers.

Ascertain which channel a customer is likely to adopt next and when
this is likely to happen.
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9. Linking Investments in Branding to Customer
Profitability
 Need for Strategy
 Brands add value to companies
 How does it work?


It is possible to strengthen a brand by ascertaining
and increasing the value a customer provides to the
brand.
This value is referred to as the Customer Brand Value
(CBV).
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10. Acquiring Profitable Customers
 Need for Strategy
 Understanding how firms acquire customers and the best metric
to use while acquiring those customers is essential for firms to
maximize their overall profitability.
 How does it work?
 Using the concept of CLV, the study proposed the introduction of
an ARPRO framework (Allocating Resources for Profit) that would
help firms decide which customers are worth chasing and which
dormant customers should be pursued to come back to the firm.
 Firms using this strategy can use customer profiles to identify
customers who are most likely to be profitable and should be
acquired and retained.
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11. Interaction Orientation
 Need for Strategy
 Traditionally, firms used a product-centric approach which
focused on making and selling superior products.
 A customer-centric approach allows firms to focus on the
interaction with customers thereby maintain future profitability.
 How does it work?




Customer Concept
Interaction response capacity
Customer empowerment
Customer value management
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12. Viral and Referral Marketing Strategies
 Need for Strategy

Customers not only contribute through their own transactions
but also have an impact on the transactions of other customers
through word-of-mouth and referrals.
 How does it work?



The concept of Customer Referral Value (CRV) enables managers
to measure and manage customer referral behavior.
In a B2B context, the concept of Business Reference Value (BRV)
enables managers to measure and manage client references
that are critical to business.
Social media and its impact on marketing is captured under
Customer Influence Value (CIV) where managers can understand
the social media influence of their customers on prospects and
current customers.
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Conclusion
 CLV is a direct means to measure the value of a customer
to a firm in the future
 It is a strong indicator of the level of customer
engagement with the firm.
 A customer’s value to a firm is not limited to the direct
impact of that customer.
 Customers can also affect the profitability of other
customers of a firm through their activities and behavior.
 As a result, firms should consider the influence of these
indirect factors of customer engagement; CRV, CIV, and
CKV, and their relationship with CLV which can further
quantify the value of a customer to a firm.
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End of Chapter – 4
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