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Smart CRM
February 11, 2004
Atlanta
Maximize Your
Return on Customersm
Don PeppersDon Peppers
[email protected]@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
Answer: To preserve and increase the value of the enterprise
Question: What is the CEO’s most basic, overall responsibility?
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 combinationsBest 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 customersA 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
Statistical
Analysis
Proxy-Based
Analysis
Financial
Analysis
Customer lifetime values – science and artThe spectrum of customer valuation analysis
progresses from qualitative to quantitative.
Actual value, equivalent to lifetime value.— NPV of what we expect to realize from a customer— Most useful financial measure: contribution
(1 + d)-i iLTV =
n
i = 1 Potential value
— 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
Profitability (estimated LTV in $)
2004
MVC's
2009
Share of market
Share of customer
2009 customers
Share of market
Customer equity: Managing the customer mix
Nu
mb
er
of
Cu
sto
mers
$0
This necessarily implies customer-specific
objectives and strategies
Relationships with individual customers become the vehicle
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:
“Treat the customer the way you would want to be
treated if you were the customer.”
Robert McDermott,former CEO of USAA
A culture of customer trust
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
Customer base is made up of many different needs-based clusters
YR 1. YR 3.YR 2. TV*
YR 1. YR 3.YR 2.
TV*
But do it right, and drive your value up…
Enterprise Value $7,500 MM
*Terminal Value
YR 1. YR 3.YR 2. TV*
Cash Flows ($MM)
Enterprise Value = Customer Equity – Infrastructure
NPV = ($2,000 MM)Infrastructure
(minus)
Performanceenthusiasts
Utilitarians
Safety &security
Time savers
Etc.
NPV = $9,500 MMCustomer Equity=
© 2004 Carlson Marketing Group, Inc. All rights reserved. Peppers & Rogers Group is a Carlson Marketing Group Company.
Increasing customer equity
© 2004 Carlson Marketing Group, Inc. All rights reserved. Peppers & Rogers Group is a Carlson Marketing Group Company.
Customer EquityBefore: $ 9,500 MMNet new: $ 1,061 MMAfter: $10,561 MM
Target
Net New NPV = +$43 MM (cost reduction)Acquisition
MGCs Objective:Increase Share ofCustomer
Net New NPV = $486 MM
BZs
Improve Margin
Net New NPV = +$82 MM (loss avoidance)
Net New NPV = $533 MM Objective:Retain
MVCs
Low Priority
MIGsNet New NPV = $167 MM
YR 1. YR 3.YR 2. TV*
Increase in Shareholder Value
$ 1,011 MM
NPV of infrastructurecost increases: ($ 50 MM)
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”
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
But what about the value chain?
Front Office
One Office
Back Office
The value chain
Raw materia
ls
suppliers
Manufacturer
End user
customers
Aggregators
Distributors
Supply chain Demand chain
SCM value added CRM value added
Supply chain Demand chain
Integrated value chain
Customer insight adds value all the way back along the value chain
Customer insight adds value within distribution network
SCM value added CRM value added
Non-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-replenishmentRack with 11,000 slots for crates
in the dispatch area12 very fast moving
stacker cranesFree access to crates
always in pairs On pallet/dollies: the family
group with the lightest-weight 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 chainCustomer governance vs. product-line governanceMetrics of successBudgeting, resource allocation, and reward structureCross-departmental coordination and conflict
resolutionMultiple 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
AcquiringAcquiring profitable customers
RetainingRetaining profitable customers longer
Eliminating unprofitableEliminating unprofitable customers
Up-sellingUp-selling additional products in a solution
Cross-sellingCross-selling other products to customers
ReferralReferral and word-of-mouth benefits
ReducingReducing 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 farmingConsider 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...
35
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
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…
trusttrust
commitmentcommitment
mutuality mutuality and and
alignmentalignment
categories of relationship
drivers
economic drivers
resources drivers
social drivers
categories of positive relationship
outcomes
financial outcomes
strategic outcomes
social outcomes
RSxRSxsmsm measures attitudes to analyze their measures attitudes to analyze their effects on relationships and customer equityeffects on relationships and customer equity
Tracking attitudinal indicators
Key Relationship ConstructsKey Relationship Constructs
Source: Linda Vytlacil, RSx
trusttrust
commitmentcommitment
mutuality mutuality and and
alignmentalignment
relationship outcomes
ease of complaining
Analyzing Retailer Z’s relationship outcomes
share of wallet
purchase intent
turnover intent
positive word of mouth
Company needed to quantify financial outcomes Company needed to quantify financial outcomes of better customer relationshipsof better customer relationships
trusttrust
commitmentcommitment
mutuality mutuality and and
alignmentalignment
relationship outcomes
ease of complaining
Here’s how a one-point increase in customer “commitment” Here’s how a one-point increase in customer “commitment” impacts on “share of wallet” and “intent to purchase more”impacts on “share of wallet” and “intent to purchase more”
Sample analysisSample analysis
share of wallet
purchase intent
turnover intent
positive word of mouth
.40
.28
trusttrust
commitmentcommitment
mutuality mutuality and and
alignmentalignment
relationship drivers
shared values
relationship outcomes
ease of complaining
Retailer Z next identified specific relationship driversRetailer Z next identified specific relationship drivers
From analytics to results From analytics to results
store convenience
communication
store personalization
share of wallet
purchase intent
turnover intent
positive word of mouth
trusttrust
commitmentcommitment
mutuality mutuality and and
alignmentalignment
relationship outcomes
ease of complaining
share of wallet
purchase intent
turnover intent
positive word of mouth
relationship drivers
shared values
One point increase in “store personalization” moves One point increase in “store personalization” moves brand “trust” by a quarter point brand “trust” by a quarter point
Knowing what to do with the insight… Knowing what to do with the insight…
store convenience
communication
store personalization
.25
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 ROC1. 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
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
Managing portfolios of customers
Objective: • Positive ROI events
Company
Customers targeted: • All, including BZs
Customer reaction: • Block interactions
Acceptance Rate: • 2-5%
Nature: • Transactions
Managing portfolios of customers
• Maximize lifetime value of customer portfolio
• Customers with highest value or potential
• Invite interactions
• 30-70%
• Relationships
Portfolios contrast with “campaign management”
Campaign management
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
• Support new or improved products and services
• Drive business-unit integration across product boundaries
Getting inside the customer’s head, but taking your company perspective with you
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
ROC is qualitative, not just quantitative
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.”
Government organizations also…
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
Maximizing your Return on Customer
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
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