Searching for customer value
Inspiration
Searching for customer value
Understanding which customers your company should invest in is like searching an island for lost treasures. It requires an unflawed map, skill in reading the map properly and clarity in setting direction for your fellow travellers. Without it, you may end up with a lot of people digging empty holes. By John Glottrup, Brian Nordlund Nielsen and Morten Holm
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Searching for customer value Decisions on how to prioritise your company's market-facing investments are made every day. They range from operational prioritisation of sales or service activities to more tactical or even strategic decisions on which customers to target for acquisition or cross-selling efforts. Maximising return on investments, and hereby ultimately increasing shareholder value, is almost always reflected in any company strategy. But maximising returns is a general target that provides very little – if any – guidance on how to prioritise your efforts. Maximising return is an unequivocal target, but the ways to fulfil it might lead you up entirely different paths depending on your industry and the nature of the decision to be made. The decision to launch a campaign in the telecommunications sector, where an average customer may represent a value of EUR 1,200, is entirely different from the decision to start developing a new product in the electronic equipment industry, where each customer may represent a value counted in EUR millions. Targeting all efforts across the value chain to where money is made – today and in future – is by no means a trivial exercise. But it is a challenge that can be addressed in a practical and effective manner, which we will seek to demonstrate in this white paper. In our work, we have come across companies that have had very different approaches to making decisions about investing in customers. All too often, we
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have seen investments driven by text book convictions and undocumented beliefs about what drives profitability across the portfolio of customers. We have seen multiple companies that have put so much effort into hanging on to old, loyal customers that these have become unprofitable. We have also seen companies invest heavily in acquiring new customers without the potential of providing a return that sufficiently justifies the investment – often amplified by the fact that the company at the same time neglects existing customers with high potential, simply because their present profitability is low.
solid knowledge of the value potential of customers and segments is like searching an island for lost treasures without a map. You will need a lot of people on the ground, and a lot of precious time will be wasted digging empty holes. The process of generating an unflawed treasure map and learning how to read it properly has helped a lot of our customers to focus their resources on the right customers, hereby improving financial performance of their businesses. It is the key learnings from these experiences that constitute the foundation of our approach.
01. Abandon convictions
Based on our experience, we have developed a simple and pragmatic crossbusiness approach for identifying the customers that a business should invest in. Our approach is sufficiently specific to make it work, but broad enough to be adapted to the industries and companies that we have encountered. The approach involves three key steps:
Before any decision is made on how to allocate your resources, the true value of a customer in your customer universe must be clear. Relying on overemphasised rules of thumb or general perceptions is simply not good enough. Undocumented convictions also tend to become stronger the more they are repeated, and what is equally disturbing, they become harder to spot.
01. Abandon convictions 02. Understand the value and potential of YOUR customer universe 03. Tailor value proposition to priority segments
Figure I contains a number of standard convictions that we have come across in our work. Often, these convictions may prove to be right, but in some cases they may not stand up to scrutiny. We deliberately write "may", and unless you are absolutely certain about a given conviction, it is probably worth taking a closer look at its relevance to your business.
The crucial part is to establish a solid and fact-based understanding of the true value of your customer universe (existing customers as well as potential new customers). Tailoring value propositions and dimensioning front-end resources without
While abandoning undocumented convictions is desired in any business, creating documented convictions, which
Searching for customer value can be used to govern both strategic and operational decision-making, is very useful. But to develop these convictions, both future and current value potential of your customers must be taken into account, which will be addressed in the next section.
02. Understand the value and potential of YOUR customer universe With the right amount of data, it is possible to calculate the lifetime value of individual customers (CLV), which in one number encapsulates the current as well as the future value potential of a customer relationship. Our approach builds on the same principles
and has the same purpose, but takes a more pragmatic approach, which can be useful if the data, time and capabilities to properly calculate the customer lifetime value are not available. Our approach focuses on identifying current profitability and future potential, which makes the job much more manageable. It also has the benefit of illustrating where customer value comes from and is based on what the customer buys today as well as on what the customer is likely to buy in the future. The first task in our approach is always to calculate the current profitability of each customer. This includes assigning not only cost of goods sold, but also cost-to-serve elements such as sales force resources,
distribution set-up, customer service personnel, etc. for each customer. The company ERP system may contain a lot of the information needed, but typically quite a bit of manual work is required to make the picture accurate and workable. Creating a customer profitability view should be a business-driven exercise, with a strong understanding of what the business needs and is capable of taking action against. We typically drive the work based on the following key elements: •
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Explicit prioritisation of time, resources and accuracy – ensure that the analysis does not overcomplicate matters Robust and comprehensive frameworks
Figure 1: Common convictions and why they in many cases do not stand up to scrutiny
What is the standard conviction? "It is ten times more profitable to retain a customer than to acquire a new one" "Unprofitable customers should be axed" "A loyal customer is a good customer" "Customer churn must be kept at a minimum"
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Why this statement might not be valid? Depends on cost of acquisition and retention as well as overall service model The customer could potentially be made profitable with the right value proposition Depends on current profitability of the customer as well as potential for improvement Depends on value and potential of the customer, including potential for optimisation if customers were exited
Examples A low-cost airline company aggressively targeted flag carrier airlines' customers with the transaction-focused 'low cost, no frills' proposition, thus rendering investments in retention by the incumbent totally ineffective An FMCG company introduced a new, simplified value proposition for small and currently unprofitable customers, thereby maintaining share of stable market and lifting profitability Financial services company identified significant pricing loss with loyal customers and realigned pricing mechanisms to make loyal customers profitable (or exit) Communications company identified low-churn segments with low profitability and potential. Fixed costs could be lovered by moving customers to a different service offering, thereby triggering higher churn and/or higher profitability through lower costs
Searching for customer value
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that can be improved continuously – ensure that models can be developed as insights and needs evolve Pragmatic, operational tools and end products – ensure that results are actionable and can be communicated convincingly
Understanding the current profitability of a customer portfolio is a craft that requires skills, tools and experience plus, of course, a lot of hard work. Estimating the future profitability typically builds on the same principles as understanding the current profitability and can, in most cases, leverage the same data sources. Nonetheless, we have used many different methods over the years to identify the future value of the customers. Any choice of approach is dependent on the number of customers, time and data available at the time of analysis, but pragmatism is always a good starting point for any analysis. There is no uniform onesize-fits-all approach for estimating future growth – it all depends on the business' situation and needs. Thus, it requires a certain amount of creativity to find the way that fits each business. Some of the most frequently used methods include: regression, benchmarking, fair share analysis and sales force input. Regression For companies with ample transactional data at customer level, regression analysis can be applied to forecast future volumes and contributions per customer. The
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underlying assumption is that historic behavioural data can be applied to estimate the future customer demand via panel data regression techniques. Fair share of wallet analysis Fair share analysis can be used if solid information about how much the customer buys is publicly available. If you know how much your customer sells or buys of a certain category of products or services, your market share can be calculated, and this can be used as an indicator of the potential of each customer. Though this approach does not consider growing the size of the wallet or retention rate, it gives a very clear and approachable target and has often proven to be very powerful. Benchmarking If no reliable information is available about how much the customer buys, an alternative approach is to benchmark customers against one another based on the data from the customer profitability review. The benchmark is used to estimate how much a customer should be able to buy. This requires a relatively large pool of customers and some objective segmentation criteria in order to ensure the right level of nuance. For a company in fast moving consumer goods, this could be channel (kiosk, cinema, gas station, etc.) and location (urban, rural, etc). If retention rates are driving factors, the benchmark can be established by averaging value across a number of years. Sales force input As a supplement – or potential shortcut – to an analytical and data-driven approach,
simply asking frontline managers to identify potential can also prove very valuable. This requires that each sales representative has a manageable number of customers and a solid understanding of each customer. Depending on the complexity of the business and the sales representatives' understanding and insight, estimates can later be adjusted, extrapolated and refined. Once you understand the current and future customer profitability, it is time to segment your customer base. To keep it simple, we will use a 2-by-2 matrix as an illustration, but there is no reason why more dimensions could not be added. It all comes down to the specific customer universe of the given business.
Figure 2: Example of segmentation model
High
Nurse and protect
Drive value creation
Manage resources
Improve profitability to grow
Current profitability
Low Low
High Customer profitability potential
As the segmentation model is developed and populated, insights are developed about each of the segments. It is desired to have a relatively homogenous pool of customers in each segment – if this is not the case, the
Searching for customer value chosen segmentation model is most likely too simple, and a model with more segments should be chosen or the dimensions in the chosen model revisited to create more homogenous segments. With the segmentation model in place, work is needed to understand what drives profitability in each segment. For example it must be clear whether it is too high discounts, too many visits by the sales representatives, the wrong product mix or too many service calls that cause substandard performance.
03. Tailor value proposition to priority segments With a detailed view on current and potential future profitability, the idea is now to develop overall "strategies" for each group. The strategy should outline the overall approach for how the customer in any given segment is serviced and managed, but it should also support decision-making when more operational trade offs must be made. The strategy for increasing performance for each segment varies with industry characteristics such as B2B or B2C operating model, product value, industry
growth, competitive pressure, etc. An example of how segmentation can be used is shown in figure 3 that outlines examples of generic strategic responses to improving profitability for each segment. The key objective when drafting these strategies is to identify what is needed to improve profitability for each segment by weighing the value of growing, losing or retaining customers. During these considerations, we often circle around the concept of "pay for performance" – where the dilemma is how to ensure that the services provided are valued by the customer and create an impact.
Figure 3: Generic strategic responses for each segment
Service level levers
Nurse and protect
Manage resources
Improve profitability to grow
Product • Assortment • Packaging • Innovation
• Use early access to new products and packaging as vehicle to build market share and grow overall customer volume
• Ensure that your product offering is at least as good as that of your competitors
• Use the proved core assortment to limit investments
• Consider innovation in packaging as a way of unleashing potential
Price • Price level • Price structure • Payment terms
• Discount/bonus structure that incentivise the customer to centralise purchases or grow overall volume
• Set sharp prices without compromising profitability
• Price structure that incentivise self-service and lowers cost-to-serve
• Make the trade-off between investment and volume transparent in the price structure to trigger commitment to higher volume or less service
Promotion • Mode of advertising • Budget • Campaign involvement
• Help drive your customers' • Use promotions as a means sales through campaigns of creating and reinforcing that position your products loyalty against those of competitors and drive overall volume
• Off-the-shelf initiatives only • Use promotions selectively and always with a • Any initiative must have documented short-term a documented short-term payback payback
• Use your sales force to help the customer drive his business, i.e. through category management
• Scale down sales force and drive towards automation and standardisation
Place • Use of sales force • Customer service • Distribution/logistics
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Drive value creation
• Ensure frequent touch points to maintain relationship and deter/ spot entry by competitors
• Careful use of sales force to drive market share or overall volume growth
Searching for customer value Customer value in short The impact from working effectively with customer value can be substantial. In B2C settings, the current profitability of different customers often varies by a factor of 20. In B2B settings, the differences are typically even bigger. Likewise when turning to future profit potential of different customers, where the same ratios and relationships apply.
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By combining current and future profit potential, you get an idea of the potential of allocating market resources to where the money is. A customer who is 20 times more profitable today and has say five times the growth potential of the least attractive customer should receive 100 times more attention than the least profitable customer for the numbers to add up. We almost never come across any business that is fully aligning its resources with this degree of insight.
The practical recommendations coming out of any study of customer value are always more nuanced and detailed than this, but considering customer lifetime value all the way through the business is almost always a big eye opener and, in our experience, a rewarding exercise if done properly.
Searching for customer value
Questions to consider when searching for customer value The approaches to understanding the current and future value of customers are plentiful, but if your answer to more than a few of the questions below is "no", it is likely that some structured work on revealing the true value of the customer portfolio would benefit both the current and future profitability of your business •
Do you have a strong understanding of the current profitability and future potential for all customers in your business?
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You have never come across statements like "all customers must be treated equally" or "1 EUR of sales is worth the same regardless of the customers" in your company?
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Do you know which customers you should make an effort to lose and which you should make an effort to keep?
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Do you have clearly defined service models for different groups of customers?
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Do your sales representatives and marketers know how much they can invest in each individual and group of customers?
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Do you have a structured format for discussing the current profitability and future potential across the business?
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Searching for customer value
Quartz Strategy Consultants Kohavevej 5 DK-2950 Vedbaek T: +45 70 13 38 00 E: quartz@quartz.dk W: quartz.dk
Quartz Strategy Consultants works for the largest companies in the Nordic countries – including the leading players in private equity. Within few years, Quartz has become the second largest management consulting firm in Denmark – thanks to a combination of high professional ambitions and consultancy services that are based on a deep understanding of the customer's situation.
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