Profits, One Customer at a Time
Quarterly profit and loss is ultimately just an abstract aggregate of countless customer interactions. But company performance is bolstered or weakened one customer at a time, which is why it is no surprise that CRM theorists and practitioners often speak of the importance of measuring and acting on the profitability of each individual customer.
"It's the top of the playbook in terms of CRM strategies to understand customer profitability and segmenting, using that to drive the behavior of sales and marketing," says Robb Eklund, vice president of CRM product marketing for Oracle. Yet in practice it is not immediately clear what, exactly, it means to attempt to capture the net value of an individual client. Nor is it immediately clear how challenging it can be. And even capturing that individual net value with a high degree of accuracy does not solve every customer profitability problem that is on the table.
Return to Revenue
Individual customer-profitability measures fell out of favor in some organizations in recent years because cost-cutting was so widespread it rarely seemed worthwhile to consider the impact of any given client. "When you get solidly into [economic] recovery mode, the issue changes to, 'How do I maximize my revenues?', and in that context people are looking for how to maximize the profitability of customers," says Robert Kugel, vice president of Ventana Research.
Attempting to be granular with profitability readings raises a question that in almost any B2B environment has no easy answer: Who, exactly, is the customer? Is it the enterprise itself, the division using the products, or the individual purchasing agent? Even in the home, questions about the decision-maker and the impact of the next generation of customer come into play. Often, the nuances of the importance of the individual behind each purchase are not even readily available between partners on the supply side.
Gartner divides the individual profitability measurement discipline into eight distinct value categories, ranging from accumulated value from prior interactions, to a current reading ranging from a span of a few months to several years (depending on the product life cycle), to measuring some level of value as a marketing and research resource. The measure of a customer's total market value provides perspective on the entire worth of the customer to the market segment in which a company competes. This value can also be used to derive share-of-wallet.
"The ideal situation is being able to reach all the way to the end consumer" to measure profitability, says Todd Bixby, managing director of consumer, industrial, and technology CRM at BearingPoint. "Banking and insurance are probably the leaders in generating those kinds of numbers; retailers are probably laggards. The data exists, it's just not shared through the value chain."
What is clear is that making sense of individual customer profitability is nearly impossible without coordination. "You have to think about data comprehensively across the organization, not just [for]the transaction at hand," Oracle's Eklund says. "It may make sense to think about [offering] a loss-leader if in fact there is a larger opportunity with that customer somewhere else in the organization," but without collaboration, those judgments cannot be made. When customer performance is treated as an enterprisewide responsibility, rather than a profit-and-loss concern for each division or product line, such decisions become easier to make.
What's in a Number?
An individual customer's profitability could be as simple as a black or red number in a spreadsheet cell, but quite often companies use proxies. They are easier to measure than finding the proper mix of fixed and variable costs to factor against a customer's revenue. Airlines are a prime example: Typically, they establish service tiers based on miles flown or flight legs completed, working on assumptions about their own cost structure that above a certain level of consumption, clients will have attained a solidly profitable standing.
One proxy some companies use is loyalty. However, Wendy Close, a Gartner research director, warns that loyalty can be a dangerously misleading value proxy, because longevity and profitability are not necessarily one and the same. "If they are emotionally loyal, they stay with you because they love your business and will advocate new business," she says. "If it is rational loyalty, they stay with you because they know how to work your system."
Fixed costs in particular pose a problem for proper profitability measurement: They tend to more closely map to the company's choices, not the customer's. Marketing expenses also skew the measurement of profitability, because any sort of mass marketing will inevitably pay to reach out to a potentially unprofitable customer, perhaps even one that the firm has opted to cut ties with.
The challenges make reaching the goal of a single, clear-cut item in each client's ledger entry a difficult proposition at best. It is with those challenges in mind that companies that have been successful with value measurement make decisions about what they will and will not attempt to measure.
"We have shied away from absolute [measures], because there are too many pitfalls that lead to potentially dangerous assumptions being made in your organization where the finance folks start to believe these are hard numbers and roll forward predictions about corporate profitability," says Steve Elioff, senior vice president of CRM for investment firm AGF Management. By focusing on a relative scoring model, AGF learned to measure the value of its broker partners on a more refined scale than simple revenue size, and shifted support resources as a result. Whereas previously one quarter of the company's most profitable partners received no sales support, AGF has dropped that figure to just 5 percent.
"The best you can do [today]--and maybe it's not the final answer--is to optimize the marketing mix in the sense of what costs and expenses you can control, and get the biggest bang for your buck," says Ray Pettit, vice president of marketing services firm Longwoods International. Except in very coordinated direct marketing campaigns, "you can't really get to the individual level and save a lot of money by not marketing to [certain] people because you know they're not going to be profitable."
Applying Value Measures
Once you understand how you will measure value and how much confidence can be placed in your measurement, look for tactical applications for that information. Many companies' instinctual reaction to customer profitability data is to throw support and retention resources at clients with high present value. A smaller relationship, however, may have a huge future upside that would be missed if the customer's potential lifetime value is not measured. "You may find that in fact, their contribution to margin per unit sold is substantially higher than when selling to your volume customers," Kugel says.
A fraction of accumulated value--that is, the profitability of the customer in the past--can be placed in a sort of internal escrow and budgeted to front-line customer service staff to resolve minor disputes. The same policy can be extended to measures of future value, but doing so is more risky.
Ultimately, the choice has as much to do with the company's goals and flexibility as with the magnitude of any one customer's profitability figure. "What's the best way to raise the value of customers? Reducing the cost to serve the customer? Improving wallet share with the customer? Making interactions more profitable? There's a lot of different dimensions," says Gareth Herschel, a Gartner research director.
North Shore Credit Union is an example of one organization using multiple value measures in tandem. Unlike many financial institutions that simply measure the worth of a customer by the number of products in her portfolio, North Shore Credit Union integrated Pivotal across 10 lines of business to score profitability on the full context of the relationship. "In the past we just looked at the treasury view--what they have done and what they have spent. Now it is much broader," says Fred Cook, North Shore CIO. In a competitive marketplace, North Shore is learning that not all customers rate the same consideration. Although not keen to be seen as "firing" customers, the institution has started to take serious note of customer profitability.
"We're not everything to everybody as a community credit union," Cook says. "We expect the relationship to be mutually beneficial." That can mean giving little credence to customer requests from those who consistently run the credit union red or deciding not to pursue a particular customer for further business. "For people who are rate-shopping [or] if all you want is an ATM card, then maybe we're not the right institution for you--and our staff cannot be afraid to make that decision, but it has to be an informed decision," he says.
Since the credit union reoriented its business around a profitability-minded yet customer-centric approach, profitability rose 40 percent and assets more than doubled, with just a 2 percent increase in membership.
Gartner's Herschel warns that cutting customers with low current values without making other changes to the business is unlikely to provide any relief, since the fixed costs will be spread across the remaining customer base. Many companies will still need time to build a customer to profitability, lest banks start turning away all teenagers and losing decades of adulthood profit potential.
Think of individual profitability as a lever for creativity rather than as a hammer. Chris Selland, vice president of sell-side research for Aberdeen Group, relates an example of a large mutual fund company that found its phone lines jammed by investors seeking updated prices at the close of the stock market. The demographics of the customers did not call for diverting all of them to the Web site--and by time the customers placed those calls it was already too late. Rather than boost staffing for just a few hours or risk alienating customers, the firm instituted an automated service that customers could call to hear prices--a solution that cost less per interaction than handling an inbound inquiry. "That's the kind of situation where understanding the cost of revenue and how to make allocations [to individual customers] leads to improvement," Selland says.
Above all else, be prepared to be specific about what customer profitability does and does not represent. It can be a powerful tool for market planning far beyond the individual campaign or service center policy level, as long as everyone understands the implications. "If you want to walk into the CFO's office with credibility," Selland says, "you ultimately want to be making an apples-to-apples comparison on [profit] return from customers, margin-per-transaction, lower-cost-of-serving, or a higher loyalty factor."
Value is what you make of it
"You have to recognize that customer profitability is a model, it's not a real number," says Chris Selland, vice president of sell-side research for Aberdeen Group. "Anybody who comes in and says they can tell you what customer profitability is,
is lying to you."
"We believe in relative value, so the only thing that becomes important is that we are using the same measuring stick to apply to everyone," says Steve Elioff, senior vice president of CRM for investment firm AGF Management. With the help of PeopleSoft, AGF measures the individual profitability of the indirect agents who recommend and sell its financial products to end investors, scoring them on their entire book of business, their propensity to deal with AGF, and the company's ability to convert more of their investor dollars to AGF products.
Any valuation that looks to purchases that have not yet occurred can only be modeled, such as future or lifetime value, because the customer could behave unexpectedly and terminate the relationship--switching to a competitor, exiting the market, even dying. As a result, even more important than the profitability number the model spits out is the confidence you have in the model itself. And no predictor of future events is ever 100 percent accurate.
"You can make decisions based on a model, as long as you understand that it is a model," Selland says. --J.C.
Contact Executive Editor Jason Compton at jcompton@destinationCRM.com