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WHAT ARE YOUR CUSTOMERS WORTH? Effectively managing your customer value
By Jesper Adeltoft, Kennet Hammerby, Morten Holm and Brian Nordlund
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EFFECTIVELY MANAGING CUSTOMER VALUE
If you consider your company to be customer oriented, you should be able to write down the names of your five best and five worst customers on the back of an envelope. Next to each name, you will be able to state the approximate amount of the net profit/loss they contributed to your firm’s bottom line last year. You will also be able to jot down how much your business is expected to grow with each of them is in the years to come, and how likely it is that they will move some or all of their business to a competitor. If you are not able to do this, there is a considerable risk you are betting some of your company’s scarce resources on the wrong horses. To reap the full benefits of customer orientation, companies need to differentiate their resource investments according to the profits various customers generate now and/or are expected to generate in the future. This discipline is referred to as Customer Value Management (CVM). The vast majority of companies characterise themselves as customer oriented, yet less than 40% quantify the financial value of their customers on a regular basis. This is somewhat surprising, especially because our study shows that com-
CVM PROVIDES 1. EFFICIENT RESOURCE ALLOCATION 2. GREATER RETURN ON ASSETS 3. SUPERIOR RESISTANCE TO MARKET TURBULENCE
panies using CVM as part of their customer orientation strategy are rewarded financially. In fact, companies that consistently measure and manage the value of their customer relationships achieve a Return On Assets (ROA) twice as high as companies that do not. Implementing CVM is not easy. Yet case studies from Carlsberg and IBM demonstrate how the barriers to implementing CVM can be successfully broken down by pursuing the right approach to implementation. So why use CVM? Because CVM provides you with efficient resource allocation, great ROA and superior resistance to market turbulence. This white paper provides commercial executives with insights into • • •
Why CVM is relevant – the value it brings to companies What CVM is all about – the concept in brief and considerations about implementation The approach – intriguing cases from companies using CVM successfully
Facts about the survey As part of a sponsored industrial PhD, Quartz+Co conducted a survey on Customer Value Management (CVM) practices during the winter and spring of 2010/11. 211 companies in Denmark and Sweden participated in the survey, sharing their insights and experiences about how they work with CVM. The companies in our sample are representative of the largest Danish and Swedish companies in terms of size (revenue) and in terms of the range of industries. Additionally, the majority of participants are executives in their company’s commercial departments (e.g. Sales and Marketing Directors or VPs, Chief Marketing Officers, Commercial Directors, etc.) who all have knowledge of the way CVM is used in their companies.
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CUSTOMER ORIENTATION
– INTENTIONS OR ACTIONS?
Today’s business environment requires customer orientation in order to design, communicate and deliver competitive value propositions. For over a decade, academics have suggested that shifting management focus from products to customers is vital. Or put another way: In order to build a sustainable competitive advantage, the mass marketing approach of selling products to anyone wanting to buy needs to be replaced by a more interactive customer relationship focusing on delivering products and services that satisfy the needs of individual customers. Global market leaders like Apple, IBM and Unilever long ago embraced customer orientation, making customer focus part of their organisational DNA. These companies quickly realised the benefits of listening to and acting according to customer needs and desires, and have consequently built an entire culture around exceeding customer expectations.
TRUE CUSTOMER ORIENTATION BALANCES TWO KEY QUESTIONS: WHAT VALUE DO WE CREATE FOR OUR CUSTOMERS, AND WHAT VALUE DO OUR CUSTOMERS CREATE FOR US? Few companies walk the talk CVM comes in many varieties, but always involves estimating customer profitability at some level of aggregation over a predefined period of time (past or future). CVM can be based on last year’s profits or expected future profits for individual customers as well as customer segments of any size. The important thing is that the differentiation of price and service levels is always based on a measure of customer profits.
Failing to measure and manage customer value means failing to keep track of what each customer is worth to the firm. This not only makes the customer resource differentiation exercise extremely difficult to perform in a meaningful way; companies may also unknowingly be providing expensive extraordinary services to satisfy many customers that are not particularly profitable and therefore do not justify any kind of special treatment. This kind of “over-servicing” can be extremely costly.
WITHOUT CVM, A CUSTOMER – FOCUSED STRATEGY MAY LEAD TO POOR FINANCIAL PERFORMANCE Given the intensive focus on customer orientation, it is surprising that the majority of managers in large Danish and Swedish companies do not attempt to separate profitable customers from unprofitable ones when allocating resources (see Figure 1).
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“I do not work for the shareholder, to be honest; I work for the consumer, the customer. I discovered a long time ago that if I focus on doing the right thing for the long term to improve the lives of consumers and customers all over the world, the business results will come”
PAUL POLMAN, CEO IN UNILEVER
“Apple has a long history of creating products that exceed the expectations of their customers. More than any other tech company, however, Apple’s business model is set up to encourage a customer focus”
GERSON LEHRMAN GROUP
FIG. 1 FIRMS PERCEIVE THEMSELVES AS CUSTOMER-ORIENTED, ALTHOUGH ONLY A MINORITY KNOWS THE VALUE OF THEIR CUSTOMERS
HOW DO YOU PERCEIVE YOUR COMPANY (DENMARK)? PERCENTAGE
Customer oriented Product and customer oriented Product oriented Don’t know
KNOWLEDGE/USE OF CVM FOR RESOURCE ALLOCATION PURPSES (DENMARK AND SWEDEN) PERCENTAGE
Source: Profitable kunder nu – Analyse om kunderelationer, Per Østergaard Jacobsen og Torsten Ringberg, CBS (2011)
Using CVM Aware of/considering CVM Unaware of CVM
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MANAGING CUSTOMER VALUE PAYS OFF ON THE BOTTOM LINE Barriers to Customer Value Management Like any other organisational change process, there are barriers to implementing CVM practices across customerfacing and support functions. Figure 2 outlines the relative importance of the challenges encountered by companies that are currently considering measuring customer value. According to Figure 2, CVM is perceived as a resource-laden, complex practice to implement and use. Nearly half the companies currently considering implementing CVM feel the process requires unjustifiably heavy resource investments, and nearly 40% perceive CVM as too complex for their organisations to use. What is perhaps more surprising is that the second largest issue encountered by the companies in the survey is that it is unclear what additional benefits CVM provides besides optimising resource allocation.
Bottom-line impact Beliefs that it is not possible to achieve improvements via CVM seem to reflect technical, cultural and perhaps political barriers (e.g. “It is too complex to allocate costs to customers in our company”, “We have decided to focus on product profitability”, “If it turns out that we can improve significantly, I haven’t done my job properly”). However, our study shows that companies that successfully break down such barriers are rewarded financially. Companies using CVM for resource allocation significantly outperform peers that have not implemented CVM, generating twice as high Return on Assets (ROA1) (see Figure 3). The strong performance effect of CVM is good news to managers struggling to convince colleagues about the merits of CVM. Yet there is more: Our study also shows that CVM not only enhances performance; companies that
FIG. 2 THERE ARE MANY CHALLENGES AND BARRIERS TO IMPLEMENTING CVM
SHARE OF FIRMS THAT AGREE OR STRONGLY AGREE TO THE FOLLOWING STATEMENTS PER CENT OF TOTAL FIRMS CURRENTLY CONSIDERING IMPLEMENTING CVM
48 Implementing CVM requires unjustifiably heavy resource investments
40 CVM provides no significant improvement to our firm
37 CVM is too complicated to use at our firm
32 CVM provides an incorrect estimate of customer value
28 The proposed benefits of implementing CVM are too uncertain
22 Quantifying customer value does not correspond well with our culture
15 Top management will not support CVM
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started implementing CVM in the years leading up to the recent global financial recession have experienced a very stable rise in ROA since 2006. Companies that did not adopt CVM encountered a massive decline in ROA (see Figure 4). CVM users not only achieve higher performance; they are also more resistant to macroeconomic turbulence compared to the rest of their respective industries.
model-fits-all” solutions. The efficiency of different CVM approaches varies across customer environments and marketing contexts. Generally, CVM models are more straightforward and create value in a direct marketing context rather than in a mass marketing context. Choosing models is a matter of achieving a proper fit with the type of complexity encountered within the firm’s customer portfolio.
Another finding from our study is that the positive performance effect of using CVM declines over time. Sustaining the positive effects of CVM is therefore apparently a challenge. Failing to integrate CVM properly into the organisational DNA and failing to keep CVM models up to date are therefore two important caveats during implementing and integrating CVM. In order to manage customer value efficiently, it is important to fully understand what CVM is all about. It is also important to recognise that there are no “one-
FIG. 3 CVM USERS OUTPERFORM PEERS THAT DO NOT USE CVM
FIG. 4 FIRMS THAT ADOPTED CVM IN 2007-09 NAVIGATED SIGNIFICANTLY BETTER THROUGH THE GLOBAL FINANCIAL RECESSION
AVERAGE RETURN ON ASSETS, 2009 PERCENTAGE
AVERAGE RETURN ON ASSETS, 2006-09 PERCENTAGE RECENT ADOPTERS (2007-09) NON-ADOPTERS
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FIRMS USING CVM 5,7
10 8 6 FIRMS NOT USING CVM 2,9
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THE ROUTE TO SUCCESSFUL CVM
What is CVM really all about? How can customer value be quantified, and how does the valuation process impact a company’s strategic and operational priorities? A myriad of models for measuring customer value exist, and the potential levels of sophistication are endless. However, they can all be categorised into two distinct CVM approaches, and – depending on the nature of your company – they are not equally relevant.
The two distinct approaches are: The Customer Profit & Loss2 (CPL) approach. If differences in cost-to-serve are the strongest factor explaining differences in customer value, you should focus on CPL. The Customer Lifetime Value (CLV) approach. If differences in customer behaviour (e.g., loyalty and share of wallet) are the strongest factors explaining differences in customer value, you should focus on CLV (see Figure 5).
DIVERSE
FIG. 5 THE “RIGHT” APPROACH TO MEASURING CUSTOMER VALUE DEPENDS ON THE NATURE OF THE CUSTOMER ENVIRONMENT
“CUSTOMER P&L” (CPL)
INTEGRATED CUSTOMER VALUE (CPL AND CLV)
CUSTOMER SIZE
“CUSTOMER LIFETIME VALUE” (CLV)
IDENTICAL
CUSTOMER SERVICE LEVELS
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STATIC
DYNAMIC CUSTOMER BEHAVIOUR
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CUSTOMER PROFIT & LOSS (CPL) APPROACH In some industries, service capacity in terms of sales force, order-handling departments, storage facilities, delivery set-up, after-sales service, etc. constitutes a substantial share of total cost. Large diversity in customer service requirements defines customer profitability for companies operating in this type of context. Behavioural patterns like loyalty will not change the picture; only enforce it. The risk of betting the company’s resources on the wrong horse increases in step with the level of complexity when judging whether one customer is more costly to serve than another. B2B product manufacturers that operate full-scale supply chains supplying customers in fragmented industries are examples of companies facing this kind of customer service complexity. When estimating cost-to-serve per customer, the trick is to find a way to be approximately right (rather than precisely wrong). Activity-Based Costing (ABC) is a celebrated technique for determining product costs. The same technique can be applied to cost-to-serve outside the factory. In such an exercise, the various components in cost-to-serve are approximated at customer level, yielding a Profit & Loss (P&L) account with an estimate of net profitability within a specific time period for each customer.
Based on this CPL, managers are able to identify the amount of resources that can be invested in order to “defend� the good customers or identify customers where profitability should be improved through price negotiations or service level adjustments. Below you will find a case demonstration of the practical implementation of CPL at Carlsberg. This case was chosen because CPL has made a tremendous impact at Carlsberg, applying a relatively simple model to a complex business.
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CPL IN ACTION
THE CASE OF CARLSBERG
Carlsberg in Denmark has worked with customer P&Ls for their approximately 16,000 on-trade customers (bars, restaurants, hotels and other establishments where beer is served “on the premises”) since 2006, when the concept was introduced as part of a global commercial excellence programme. Working with customer profitability is particularly relevant for Carlsberg because their business is characterised by •
A large share and range of cost-to-serve components (logistics set-up, sales force, key account management team, trade marketing investments, technical service personnel and installations, event equipment, etc.)
•
A large and diverse range of customers with very different service needs (small local pubs, fine dining restaurants, dance venues, large sports arenas, etc.)
• Declining beer volume across the market and consequently declining margins The implementation and development of CPL at Carlsberg was fundamentally different from the typical approach. The development did not start as an IT or finance and accounting project. It was a commercial project run by the sales organisation for the sales organisation. In Carlsberg’s CPL model, all costs are allocated to a combination of customers and product categories. This allows aggregation of cost and revenue data at all levels, from a specific element (segments, sales territories, regions, etc.) all the way to the total aggregated P&L for the entire ontrade business. The initial pilot CPL was developed in close co-operation between the concept developers and the front line. This approach ensured a proper fit with front-line personnel needs. Since the pilot was developed in Excel, it was easy to make changes according to feedback. It was not until after the commercial side of the business had created the first pilot P&L that discussions about how to integrate it into Carlsberg’s accounting system were initiated.
Implementation and use of CPL at Carlsberg have had three major implications for customer management strategies, which in turn have contributed to an increase in profit per litre in a declining market. 1. Customer performance management impact With a full, detailed customer P&L in hand, Carlsberg is able to assess improvement opportunities for each and every customer. It is possible for each account manager to browse through and analyse the P&L for each customer in order to identify how the customer benchmarks against other customers in everything from sales visits, draught equipment deployment, Point-of-Sales (POS) material investment, and a number of other costs elements at the overall level – and also for each product group like beer, soft drinks, ready-todrink, etc. These insights are used proactively to identify customers that are no longer meeting profitability targets and engage in dialogue with them about how to improve. Yet using the CPL is not a zero-sum game. Rather than providing a one-size-fits-all approach to investing in the customer, a higher degree of cost transparency allows the sales rep to pick those elements from the mix that will provide the highest value to the customer. For some customers, additional POS materials (branded glasses, beer mats, etc.) could have higher impact on sales than additional draught equipment, though they might have the same cost for Carlsberg. It is about finding the combination of investments that creates the highest value for both Carlsberg and their customers. 2. Sales force management impact With CPL, the sales management team at Carlsberg also gained a new tool for managing their sales force. CPL allows them to follow up in a completely new way. Rather than focusing merely on gross profits – thereby ignoring a substantial share of cost components managed by account managers – the sales management team now has a complete overview of all cost elements under the influence of the account manager. In addition, it creates transparency as to why a given account manager is performing above or below expectations, because it is possible to drill down to the specific
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customer level to understand if deviations from targets are due to the sales person having a tendency to overspend on one or more cost-to-serve elements, or if it is because of special circumstances. 3. Strategic impact Besides insights at the customer level-, which provide great value in their own right, CPL facilitates a whole new level of strategic analysis. With detailed P&L data on 16,000 customers which reconciles to the overall financial statements, Carlsberg is now able to understand their financials at a much greater level of detail. They can, for example, see in which geographies discounts on beer are extraordinarily high this quarter, which channels show the greatest increase in trade marketing, etc. This knowledge allows Carlsberg to define a set of strategic initiatives targeted at particular segments or a certain group of costs to either reduce expenses or improve service, e.g., efforts to reduce certain types of discounts by focusing on pay for performance, reorganisation of the technical service organisation, etc.
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CUSTOMER LIFETIME VALUE (CLV) APPROACH CLV moves customer profitability perspective from the present towards the future. While the focus of CPL is to estimate the cost of serving customers today, the CLV approach focuses on benefits in terms of future cash flows that can be derived from a customer relationship.
approaches, depending on organisational capabilities and the availability of data. Yet the more intuitive and simplistic the model, the higher the probability it will actually become an integrated part of the strategic as well as operational routines and processes across customer-facing functions.
CLV is therefore more appropriate in dynamic customer environments where the main differentiators between customers are how long they can be retained (loyalty), how frequently and intensely they use a firm’s offerings, and how many various product categories they purchase. Retailers and mass service providers (e.g. telecom or financial services) with relatively fixed service capacity but very dynamic customer environments are examples of industries where CLV can be particularly useful.
Below you will find the CLV case from the American giant IBM. This case has been chosen because it demonstrates aspects of successful CLV in an industry where CLV can be particularly useful. Furthermore, IBM is a first mover within CLV-based customer management.
CLV is a product of a company’s ability to (1) profitably acquire new customers; (2) retain the most profitable existing customers; and (3) grow customer engagements over time. All three components can be estimated either via advanced statistical modelling techniques or more pragmatic qualitative
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CLV IN ACTION
THE CASE OF IBM
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IBM has worked with CLV for at least ten years, gradually testing and refining their approach on small samples of customers. This gradual implementation of the CLV concept has been a successful way of demonstrating the benefits of using CLV while at the same time generating useful learning experiences that could be leveraged in later, more large-scale experimentation with CLV-based customer management strategies. Recently, IBM managed to grow revenue USD 20 million merely by reallocating marketing resources among 14% of a sample of 35,000 mid-market customers. Top-line growth was realised without any additional resource investment. Ranking of customer relationships is not a new exercise at IBM, as the company has been working with differentiated customer contact strategies since the 1990s. Previously, however, the ranking was based on revenue rather than profits. This logic was challenged as it became increasingly evident that size alone did not capture all the relevant dimensions of a customer’s financial attractiveness. CLV at IBM was implemented in two stages (see Figure 6). First, a model for measuring and managing CLV was developed. The model includes four main drivers 1. The probability that the specific customer will buy, estimated for each month during a three-year forecast period 2. The predicted product contribution margin earned from the specific customer for each purchase during the threeyear forecast period 3. The number of expected marketing contacts (direct mail, phone calls, sales visits, etc.) performed each month over the three-year forecast period 4. The average cost per marketing contact.
Based on historical purchase data from IBM’s transaction database (number of past purchases, frequency of past purchases, time since last purchase, cross-buying behaviour, etc.), marketing information (previous marketing contacts) and gross margin data from the financial system, IBM was able to predict each of the four main CLV drivers mentioned above. Based on this model, customers were ranked according to CLV and contact strategies, and front-line guidelines vis-àvis individual customers were developed accordingly. This new approach provided radically different recommendations than the traditional approach.
“BY SHIFTING PRIORITIES FROM UNATTRACTIVE CUSTOMERS THAT HAD BEEN CONTACTED IN THE PAST TO HIGHLY ATTRACTIVE CUSTOMERS THAT HAD GENERALLY BEEN IGNORED, IBM MANAGED TO INCREASE THE REVENUE OF PRIORITISED CUSTOMERS TENFOLD.” Whereas revenue of unattractive customers that now received less attention remained the same. It was this resource reallocation exercise that yielded a USD 20 million revenue increase for IBM without any additional marketing resource investment. Since this implementation, IBM has expanded with two additional CLV-based initiatives. Firstly, IBM has initiated the utilisation of CLV insights as a tool for segmenting and profiling prospect accounts. Profiles of high and low CLV customers are being developed in terms of their “firmographic” characteristics (size, industry, geographical scope, etc.). This way IBM can identify the most attractive prospects on which to focus their customer acquisition activities. Secondly, IBM has started analysing reasons for customer migration between high and low CLV segments. A number of drivers of customer migration are being analysed and retention efforts are prioritised accordingly.
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FIG 6 IBM’S CLV MANAGEMENT IMPLEMENTATION FRAMEWORK
PURCHASE HISTORY
MARKETING INFORMATION
GROSS MARGIN DATA
COMPUTATION OF CUSTOMER SELECTION METRICS
COMPARE CUSTOMER SELECTION METRICS FOR SELECTING VALUABLE CUSTOMERS
ESTIMATION TIME PERIOD
IDENTIFY THE OPTIMAL CONTACT STRATEGY FOR CUSTOMER SELECTION USING CLV
DEVELOP CONTACT STRATEGY
PROPENSITY MODELLING
FIELD STUDY
CONTACT GROUP
EXPERIMENTATION TIME PERIOD
NO CONTACT GROUP
COMPARE PERFORMANCE
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FOOTNOTES 1, This finding is robust even when taking into account other factors that may influence company performance such as growth, size, risk and industry. In other words, if we take two equally large companies in the same industry with approximately the same market position, growth prospects and risk exposure, and only one of them has implemented CVM for resource allocation, then this company will generate a superior ROA compared to the firm that does not use CVM. 2, A Customer Profit & Loss account is fairly similar to the company’s Profit & Loss account. The main cost components in the firm’s cost structure are assigned to customers, thus facilitating a detailed analysis of each component at the customer level, as well as the computation of net profit (equivalent to EBIT or EBITDA) for each customer. 3, Source: Based on Kumar et al. (2008), “The Power of CLV: Managing Customer Lifetime Value at IBM”, Marketing Science, Vol. 27 (4)
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IS CVM SOMETHING FOR YOU? The following circumstances provide guidance for the decision to pursue implementing CVM in your organisation: If you have a fragmented B2B customer base, rely on direct sales to end users, have a large proportion of overhead service costs, face large diversity in churn rates and fluctuations in sales per transaction, or face large diversity in customer service needs – the chances are you will benefit from CVM. If you rely heavily on brand-building activities and/or product development activities, then the chances are that CVM will have a relatively low impact. How to get started? Before investing a lot of resources and time in pursuing CVM, we recommend you run a pilot test in order to configure the concept to fit your company and validate if you stand to gain enough from the benefits vis-à-vis the required investments. Step 1: Define which cross-section of your customers are the most relevant to investigate – across geography, channels (direct/wholesalers) and segments, and ensure that you have the few key individuals on board early on in the process. Step 2: Define whether you should aim for CPL or CLV and prepare the data to analyse. Without defining the right data set from the start, the chances of capturing the full potential of CVM are low. Step 3: Establish a new picture of customer value, and collate with current resource allocation and market position. This is not a finance-driven exercise, but an extensive iteration with account managers and the sales force (workshops and one-to-one meetings) to validate the hypotheses.
Step 4: Define your company’s CVM model – making explicit choices on the basis of the analysis, i.e., do we need to reallocate our resources and how do we currently perceive our customers? Step 5: Educate and train the account managers/sales force in these new insights. This involves preparing new revised budgets and aligned incentives. Finally, prepare the roll-out, i.e., document the key teachings from the pilot phase, document the performance effects of implementation, and prepare to roll out in other relevant departments of the company. Continuously refining the use of CVM will ensure capturing long-term value, as cost and behavioural patterns continuously change.
CONTACT
For further information about this white paper, please contact Jesper Adeltoft or Kennet Hammerby at jesper.adeltoft@ quartzco.com and kennet.hammerby@quartzco.com
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