23646922 customer lifetime value

8/3/2019 23646922 Customer Lifetime Value

http://slidepdf.com/reader/full/23646922-customer-lifetime-value 1/98

Prof. A. K. Biswas 1




Management Tools

The essence of business is theacquisition , retention , and

enhancement of business fromcustomers at a profit to the company.There are few key issues here:

Which customers we shouldacquire?How do we acquire the desiredcustomers?




Management Tools

Which customers we should retainand grow our business with?

How can we retain the desiredcustomers?How do we enhance the businesswith these customers at a profit toour business?

What management tools can help usto take decisions on these issues?




Agenda What Is Customer Relationship

Management?

Why Customer RelationshipManagement?

Are All Loyal Customers Profitable?

With Which Customers To Build

Relationship? How To Grow Business With Profitable

Customers?

#




Agenda How To Retain Profitable Customers?

How to Measure the Impact of CRMStrategy? How To Measure Customer Lifetime Value?

How to Measure Net Promoter Score?


http://slidepdf.com/reader/full/23646922-customer-lifetime-value 7/98Prof. A. K. Biswas 7

What is Customer

Relationship Management? Customer relationship management is

the strategic use of information ,processes , technology , and people tomanage the customer’s relationshipwith your company across the wholecustomer life cycle.

Customer life cycle is the total time thatthe customer is engaged with yourcompany from the customer’s experience and viewpoint.



Business is all about getting , keeping ,and growing business with customers.

In a competitive market, customers aredifficult to find and hard to keep.

To remain competitive, the companymust figure out how to keep the

customers longer, grow them intobigger customers, make them moreprofitable and serve them moreefficiently.

Why Customer Relationship

Management?



Customers , therefore, should bethought of as assets , and expenditures

directly relating to acquiring andmaintaining them should be treatedaccordingly.

There are two sides of customer value –

the value a firm provides to thecustomer and the value of a customer tothe firm.


Management?



The value of a customer to a businessfirm over the ‘life time’ of its

relationship with the firm is the presentvalue of all current and future profits generated from the customer over itslife of business with the firm.

It is called Customer Life Time Value

(CLV). The longer a customer stays with the

firm, it generates more profit to thefirm.


Management?



Customer loyalty is generallymeasured by the retention rate - the

percentage of customers buying this year who also buy next year.

For most companies, customer

loyalty is the single most importantdeterminant of long term growth andprofit margins.


Management?

h C l i hi



Growth of Total Number of Customersover 10 year Period

Growth of new accounts

Retention (%) 0% 10% 20%

95 -37 55 252

90 -61 0 136

85 -77 -37 55

80 -87 -67 0

(Mature) (Moderate) (High)

Why Customer RelationshipManagement?



It is argued that there are four sourcesmaking loyal customers more profitable.

Profit from reduced operating costs. Profit from price premium.

Profit derived from increased

purchases. Profit from referrals to other

customers.


Management?




The customer lifetime value (CLV ) isthe net present value of a customer -that is, the discounted value of thenet cash flow (profit) generated overthe life of the relationship with thecompany.

The cash flow is usually low or evennegative at the beginning and thengrows strongly over the years as a

result of the factors described earlier.


Management?




How much a 5% increase in loyalty lifts CLV

B a n k i n g

C a r i n s u r a n c e

C a r S e r v i c e

S o f t w a r e

9585 85 84

81 75

35


Management?




Value with 90 per cent retention(with 10% growth of new accounts)

Customers 100,000 Average CLV Rs.10,000Business Value Rs.100 crore

Value with 95 percent retention

(with 10% growth of new accounts)Customers 155,000 Average CLV Rs.18,500Business Value Rs.287 crore


Management?




Are All Loyal Customers

Profitable? However, there are no strong evidence

that the loyal customers are alwaysmost profitable.

Certain empirical evidences suggestthat long-standing customers are notconsistently cheaper to manage thanshort term customers.

Within any one company, monthly costof maintaining relationship with anindividual customer vary enormously.




At the very least, the link betweenloyalty and lower costs is industryspecific.

No doubt there are industries in whichthe older customers are the cheapest to

serve, but there are also others in whichthey are more expensive to satisfy.


Profitable?




Certain evidences from the corporateservice provider show that long termcustomers consistently paid lower prices

than the new customers did – between5% to 7% lower, depending on theproduct category.

There is also no evidence that loyal

customers paid higher prices in theconsumer businesses as well.

Indeed, like corporate clients, consumersalso expect, and get, some tangible

benefits for their loyalty.


Profitable?




Empirical evidences do not also show anystrong link between customer longevity

and the propensity to market thecompany by word-of-mouth.

Empirical evidences do, however, suggestcustomers who scores high on both onattitudinal and actual loyalty are morelikely to be active word-of-mouthmarketers.


Profitable?




If all loyal customers are not necessarilyprofitable , or at least, not equallyprofitable, then with which customers

to we should build relationships? Since all customers are not equally

profitable, investment in customers should vary by their profit potential.

A firm provides value to the customer interms of products and services, and acustomer provides value to a firm interms of stream of profits over time.

With Which Customers to

Build Relationship?




V a l u e o f C u s t o m e r s

High

Low

Value to Customers

Low High

StarCustomers

Lost

Causes

VulnerableCustomers

Free

Riders


Build Relationship?




Vulnerable Customers provide highvalue to the firm but do not get lot of

value from the company’s productsand services.

These may include newly acquiredcustomers or long-standingcustomers who, largely throughinertia, remain loyal.


Build Relationship?




In a sense, these customers arebeing exploited by the company.

These customers are vulnerable andprone to defect to the competitors unless corrective action is taken.

A company can invest in thesecustomers through better productofferings, additional services, andrelated activities.


Build Relationship?




Free Riders get a superior value fromusing the company’s products and

services but are not very valuable tothe firm.

For whatever reason (large size,competition), these customers areexploiting the relationship with thecompany, appropriating the lion’s share of value.


Build Relationship?




In general, a firm should eitherreduce its service level or raise

prices for the Free Riders. Although there would be risk in

loosing these customers, it would,

if successful, enhance their valueto the firm.


Build Relationship?




Lost causes are a group of customers whogets low value from the companycompany and these customers are notvaluable for the company either.

It is not worth building relationships withsuch customers.

Star customers , on the other hand,receive high value from the company and

in turn, contributes high value to thecompany. These customers are more stable in their

relationship with the company andtherefore need to be retained and growbusiness with.


Build Relationship?

With Which Customers to Build




Butterflies• Good fit between company's

offerings and customers' needs• High profit potential Actions• Aim to achieve transactional

satisfaction, not attitudinalloyalty.

• Milk the accounts only as long asthey are active.

Strangers• Little fit between company's

offerings and customers' needs.• Lowest profit potential Actions• Make no investment in these

relationships• Make profit on every transaction

True Friends• Good fit between company's

offerings and customers' needs.• Highest profit potential. Actions• Communicate consistently but

not too often.• Build both attitudinal and

behavioral loyalty.• Delight these customers to

nurture, defend, and retain themBarnacles• Limited fit between company's

offerings and customers' needs.• Low profit potential

Actions• Measure both the size and share

of wallet.• If share of wallet is low, focus on

up-and cross-selling.• If size of wallet is small, impose

strict cost controls.

HighProfitability

Low

Profitability

With Which Customers to BuildRelationship?

Short Term Customers Long Term Customers




Every company’s customers can bedivided in three categories:

Promoters are loyal enthusiasts whokeep buying from a company andurge their friends to do the same.

Passives are satisfied but

unenthusiastic customers who can beeasily wooed by the competition.

Detractors are unhappy customerstrapped in a bad relationship.


Build Relationship?




Customers can be categorized accordingto their answer to the ultimate

question: How likely is it that you would

recommend this company to a friendor a colleague?

Those who answer nine or ten on azero-to-ten scale are promoters.


Build Relationship?




Those who score seven or eight arepassive.

Those who answer six to zero aredetractors.

A company should continuously makeeffort to increase the percentage of

promoters by building effective andmutually beneficial relationships withsuch customers and simultaneouslyreducing the percentage of detractors.


Build Relationship?




Customer profitability is primarilydriven by three components: Customer acquisition (acquisition

rate and cost);

Customer margin (profit marginand growth); and

Customer retention (retention rateand cost).


Build Relationship?




The company should acquire customerswho desire its value proposition and sofit its core capabilities.

A company should acquire a customeronly if the value of the customer to thecompany over his/her entire life withthe company is more than the

acquisition cost. A customer acquisition strategy must

also take into account the differences incustomers’ lifetime value.


Build Relationship?




Customers’ value depends not onlyon how much they spend on a

single occasion but also theirpurchase frequency and longevity. Bank and credit card companies

have realized this for many years,

offering credit cards to studentswho have limited current butsignificant future value.


Build Relationship?




In business markets, a firm must look for customers who are expected to growdifferentially faster than the industry,

either because they are in fast growthmarket segments or because they havestrong competitive advantages (sharedetermining customers).

They may cost a lot to acquire, but theydeliver higher returns than many othercustomers because of the duration andextent of their influence.


Build Relationship?




A company may also targetcompetitors’ customers who have

low acquisition costs: the genuineswitchable customers.

In fact, a company should target

customers based on the life cycleof the product/market.


Build Relationship?




Customer TypeHigh-Profit

Share-Determining

Switchable

YourLoyal

Competitor’s Loyal

Entry

Growth

Maturity

Decline


Build Relationship?




A company may also like to acquire acustomer if it is an opinionleader/leading edge customer who can

open the door to other customers whoare influenced by them.

Finally, it makes sense to have a

portfolio of customers that takes intoaccount not only their expected lifetimevalue but also the risk or uncertainty associated with it.


Build Relationship?




While customer acquisition focuses ongrowing the number of customers,increasing customer margin focuses on

growing the profit from each customer. Growth can be achieved by a variety of

methods such as: Up-selling (e.g., migrating customers

to a higher price/profit product) and Cross-selling related products (e.g.,

providing a credit card to a bank customer).

How to Grow Business With

Profitable Customers?




A company which wants to growprofits from its customers, mustknow not just the amount of money customers spend with thecompany, but also the ‘share of wallet’ the company has.

Disney is a company thatsuccessfully increased itscustomers’ share of wallet.






During the mid-1980s, Disney foundthat a typical family of four people whovisited the theme park in Orlando,Florida, spent several thousand dollarsfor their trip which included cost of airfare, the hotel stay, and the entrancefee to the Disney’s theme park.

However, Disney found that it captured only a relatively small fraction of thetotal money spent by a family.






In its effort to increase it’s share of the customers’ wallet, Disney

decided to build hotels on Disneyproperty, offer a choice of multipleDisney restaurants , and even have aDisney cruise ship.

This investment has led to asubstantial increase in Disney’s shareof wallet of a typically Disney visitor.






Careful examination of share of wallet requires strategic thinking

about how you define your market (or wallet) and your competition.

The ‘share of wallet’ should not be

too broad (i.e., total spending), nottoo narrow (i.e., just yourrevenues), but ‘just right’ .






It often takes considerable effort toacquire a customer.

Once you establish a relationshipwith a customer, it makes sense tomaximize the value of therelationship by selling customers

multiple products. In many cases, there is a natural

progression of the products.






For example, bank customerstypically start with a savings

account and then gradually moveto loans and investment advice.

Cross-selling also has the potential

to improve customer satisfactionand retention.






Having invested in a customer, it alsoseems logical to prolong this

relationship by providing productsand services that meet the changingneeds of that customer over time.

In case of automobile manufacturers,financing has become a veryprofitable part of the business.






However, when products andservices seem to have little synergyin production or image match,

customers are skeptical of such jointoffering. Moreover, even seemingly related

products may require different skills

to produce and deliver. Moreover, a varied product line may

divide company’s attention so thatbusiness may suffer.






In their zeal to grow, many companiesfocus almost exclusively on enteringinto new markets, introducing newproducts, and acquiring new customers.

However, often as they add newcustomers, old ones defect from thefirm.

Some studies report that averageretention rate for U.S. companies isabout 80%.

How to Retain Profitable

Customers?




Studies also show that the cost of acquisition is generally much higher than the cost of retaining existingcustomers.

It is, therefore, obvious that a firmshould focus on retaining its existingcustomers.

Unfortunately, in general, the cost of retention increases dramatically as thecompany reaches high retention levels.


Customers?




Not all customers have the sameattraction to the company.

Some may receive high value from the

firm , while others may find the benefitsmarginal.

While the first group can be retainedrelatively easily, retaining the second

group is typically expensive. Therefore, there is an optimal level of

retention that a company should strivefor.


Customers?




At the core of customer retentionstrategy lies a simple commitment -

to deliver results. Not satisfaction, not delight, but thebest possible solution to anindividual customer's needs.

Each customer’s needs are uniqueand present an opportunity to deliveran unique solution.


Customers?




Learn these needs well, and promise your customer an unique solution.

Deliver the results promised. Flex your commercial imagination

and search ambitiously for ever-better solutions to your customer’s

needs.Probe their markets and theiroperations, their habits and theirhopes.


Customers?




Innovate constantly for delivering bestvalue to the customers at the lowestcost possible.Trust of the customer grows as youdeliver results, dependably, time aftertime.

Cultivating those relationships takesagility and flexibility, with a culture,systems, measurements, andeconomics to match.


Customers?




Engage the customers in an activedialogue and involve them increating the value for them.The competence that customersbring is a function of the knowledge

and skills they possess, theirwillingness to learn and experiment.


Customers?




More than 650,000 customerstested a beta version of Microsoft’s Windows 2000 andshared with the software gianttheir ideas of changing some of

the product’s features.


Customers?




CISCO gives its customers open accessto its information, resources, andsystems through an on-line service thatenables Cisco’s customers to engage ina dialogue.In this way, Cisco’s customers solves

the problems encountered by othercustomers, and each customer hasaccess to Cisco’s knowledge base anduser community.


Customers?




Michael Dell, Chairman and CEO of Dell Computer, in his book ‘Direct

from Dell’ says: ‘You need to involve yourcustomers intimately in the

process’ to ‘create a greatcustomer experience.’


Customers?




‘We take our customers’ pulse regularly through more than 300,000 telephone,

online, and face to face interactionsevery week and we are constantlyhumbled by the experience.They’ve taught us things that have

directly affected our success; they’ve kept us on course and prevented usfrom doing things that would have beendisastrous.’


Customers?




When you and your customers areinvolved together in creation of

value, you can shape the customers’ value criteria.

Successful companies often are oftenas effective at influencing thepurchase decision as they are atdelivering superior customer value.


Customers?




Incumbent companies have a majoradvantage in shaping their value criteriaas they have more information abouttheir customers than any competitor

would have. Oracle , the software giant, after initially

winning the customer, attacksapplications and integration services assoon as its sales team has gathered upenough information about the customerrequirements of these services.

Oracle, thus, has built an enviable recordof base retention.


Customers?




As you give customized solution to thecustomer effectively you are increasingthe switching costs of customers.

For your customer to enjoy the valueproposition of a new supplier, it mustincur the cost, aggravation, andinconvenience of switching.

If you have done a diligent job of entangling that customer , thoseswitching costs could be a formidablebarrier.


Customers?




If you can entice customers into complexrelationships to create enough immediateeconomic value for them, they may be

reluctant to go through the hassle of undoing these relationships.

GE’s initiative ‘At the Customer, for theCustomer’, was intended to make every

GE division a kind of consultant for itscustomers, providing free help and adviceto improve their operations and entanglethem with their benevolent supplier.


Customers?




As an organization translates abusiness model into action, it must

execute effectively at the level of theindividual customer – where profit isultimately created.

A company must therefore invest indeveloping a detailed understandingof how profit happens at this level.

CUSTOMER PROFITABILITY




Customer profitability analysis helps thefirm to focus on the handful of profitable accounts and make the others

profitable or replace them by moreprofitable customers.

An understanding of customerprofitability allows an organization to

rationalize investment, to focus on skillsand activities that are most importantto customers.`

CUSTOMER PROFITABILITY




PROTECTING PROFITABILITY

While a company is developing apowerful business model to generateprofit growth, it must simultaneously

search for and develop the strategiccontrol points in its industry.

The purpose of a strategic control pointis to protect the profit stream that the

business model has created against thecorrosive effects of competition andcustomer power.




There are many types of strategiccontrol points:

Brand Patent Two year product development lead Twenty percent cost advantage

Control of distribution Control of supply Value chain control

PROTECTING PROFITABILITY




STRATEGIC CONTROL POINTINDEX

ProfitProtecting

Power

StrategicControl Point

Example

High Own theStandard

Microsoft,Oracle

High Manage the

Value Chain

Intel

High Own theCustomer

Relationship

GE





ProfitProtecting

Power


Example

Medium Brand, Patent Countless

Medium Two-yearProduct

DevelopmentLead

Intel





ProfitProtecting

Power


Example

Low One YearProduct

DevelopmentLead

Countless

Low Commoditywith 10 to20% Cost

Advantage

Nucor, SW Air

i fi bl




The value of a customer is a mindset.

Its implementation requires a

cultural change in the organizationand needs to be supported byappropriate changes in the

organizational structure andincentive systems.


Customers?

i fi bl




The organizational culture and climatemust effectively encourage thefollowing behaviours:

Employees constantly try to seethings from the customer’s perspective , putting themselves in

the customer’s shoes. A set of beliefs that puts thecustomer’s interest first.


Customers?

H R i P fi bl




The ability of the organization togenerate , disseminate , and use superior information about

customers. Every decision is evaluated in terms

of the return it generates from thecustomer.

The coordinated application of inter-functional resources to the creationand delivery of superior customervalue.


Customers?

H t R t i P fit bl




In a product based organization , eachproduct manager tries to maximize hisor her own product’s profitability.

This structure does not facilitate thetransfer of relevant customerinformation across products.

However, a customer basedorganization provides a completepicture of a customer across products.


Customers?

H t R t i P fit bl




A product based organization issuboptimal because:

Individual product manager does notknow the potential of that customerfor another product of the firm andthus looses cross-sellingopportunities.

It can create inherent conflicts amongproduct managers and departments.


Customers?

H t R t i P fit bl




A new organizational structure mustalso be supported by an appropriateincentive system to reward employees.

Firstly, each manager should berewarded on the basis of profitability of each customer and not on theprofitability of individualproduct/brand.

Secondly, the incentive system shouldrecognize and reward the key elementsthat drive customer profitability.


Customers?

H t R t i P fit bl




As a firm moves from a product to acustomer based organization, it requiresa very different skill set for the

employees. While a product orientation requires an

employee to be an expert in his productonly, a customer orientation requires

that employees know about multipleproducts and understand customerneeds more than productcharacteristics.


Customers?

H t R t i P fit bl




A second aspect of employee trainingrelates to the training of frontline

employees. As these employees come in contact

with the customers, how they behave

and interact with customers has asignificant impact on customersatisfaction and retention.


Customers?

H t R t i P fit bl




A focus on customer profitabilityrequires firm to move to customer-

based costing , where costs areallocated to individual customers.

Without such cost allocation, it is

difficult to assess the profitabilityof each customer and hence designeffective customer strategies.


Customers?

How to Measure the




There are two methods to measurethe impact of Customer

Relationship Management Strategyof a company:

Customer long-term profitability orCustomer Lifetime Value of all thecustomers of the company.

Net Promoter Score of the company.

How to Measure theImpact of CRM Strategy?

How to Measure the




The fundamental metric incustomer-oriented strategy is a

customer’s long-term profitabilityor customer life time value.

Drivers of customer life time value,

such as acquisition cost, margin,and customer retention should alsobe monitored on a regular basis.

How to Measure theCustomer Lifetime Value?

How to Measure the




There is a simple approach to measurethe lifetime value of a customer that istransparent to both company executivesand investors, does not require largeamount of data, is easy to understandand use for decision-making purpose.

To arrive at this simplification, we needto make three assumptions:


How to Measure the




Profit margins remain constant overthe life of a customer.

Retention rate for customers remainconstant over time.

Customer lifetime value is estimatedover an infinite horizon.

There is ample justification for thesame.


How to Measure the




One study cautioned that there aresignificant costs associated withkeeping customers for a longer lifetime

through reward programs. Another study found that there is little

or no evidence to suggest thatcustomers who purchase steadily from

a company are necessarily cheaper toserve , less price sensitive orparticularly effective in bringing in newbusiness.


How to Measure the




Many studies have shown that modelswith constant retention rates for acustomer or customer segment that

allows for differences across customersare consistent with most data.

It is also not necessary to arbitrarilythe duration of a customer lifecycle,since the retention rate automaticallyaccounts for the fact that over time thechances of a customer staying with afirm go down significantly.


How to Measure the




Using the three simple, but reasonableassumptions, the Customer Lifetime

Value may be estimated simply as under:

CLV = m{r/(1+i-r)}

where

m = margin or profit from a customer per

period (e.g., per year)r = retention rate (e.g., 80%)

i = discount rate (e.g., 12%)


How to Measure the




CLV is thus equal to the margin (m)multiplied by a factor r/(1 + i - r).

This factor is called the margin multiple.

This multiple depends on customerretention rate (r) and the company’s discount rate (i).

This discount rate is a function of thecompany’s cost of capital and depends onthe riskiness of its business and its debt-equity structure.


How to Measure the





Some typical margin multiple isprovided in the table below:

Retention

Rate

Discount

Rate10% 12% 14% 16%

60% 1.20 1.15 1.11 1.07

70% 1.75 1.67 1.59 1.52

80% 2.67 2.50 2.35 2.22

90% 4.50 4.09 3.75 3.46

How to Measure the




The table provides a quick and easy wayto estimate the lifetime value of acustomer.

For example, consider a company withdiscount rate of 12%, retention rate of 90%, and the annual margin for one of

its customer is $100. The lifetime value of this customer is

$100*4.09 = $409


How to Measure the




The table also shows the value of retention.

For example, at a 12% discount rate and80% retention, the margin multiple is 2.5

instead of 4.09. Put differently, the lifetime value of a

customer with $100 margin increasesfrom $250 to $409 if the retention rate

can be increased from 80% to 90%. This difference in customer value

provides us with an idea of the maximumamount of money a firm should be willingto invest to improve customer retention.


How to Measure the




If we add together all the life timevalues of a firm’s current and futurecustomers, the result is ‘customer equity’ .

Customer Equity is the net value(profit), discounted back to the present,

of all the future cash flows a firmexpects its customers to generate.


How to Measure the




Customer equity management is anew approach to marketing and

corporate strategy that finally putscustomers, and more important,strategies designed to grow thevalue of each customer, at theheart of the organization.


How to Measure the Net




Besides customer lifetime value (andcustomer equity), another still simplerway to assess the impact of acompany’s CRM strategy is to measurethe Net Promoter Score of the company.

Net Promoter Score (NPS)of a companyis the percentage of promoters minusthe percentage of detractors in its

customer base. It provides the easiest-to-understand

measure of how a company isperforming.

How to Measure the NetPromoter Score?





Tracking net promoters offersorganizations a powerful way tomeasure and manage customer loyalty.

Firms with the highest net promoterscores consistently garner the lion’s share of industry growth.

Those companies with most efficientgrowth engines – companies such as Amazon. com , eBay , Dell – operate atNPS efficiency ratings of about 50 to 80percent.






So even they have room for improvement.

But the average sputters along at an NPSefficiency of only 5 to 10 percent.

Many firms have negative NPS , whichmeans that they are creating moredetractors than promoters day in and dayout.

These abysmal scores explain why somany companies can’t deliver profitablesustainable growth , no matter howaggressively they spend to acquire newbusiness.






For a measure to be practical ,operational , and reliable – that is todetermine the percentage of net

promoters among customers and allowmanagers to act on it – the process andresults need to be owned and accepted by all of the business functions.

And all the people in the organizationmust know which customers they areresponsible for.






Overseeing such a process is a moreappropriate task for the General managerof the business unit , than for themarketing department.

The path to sustainable, profitablegrowth begins with creating morepromoters and few detractors andmaking the net-promoter numbertransparent throughout the organization.

This number is the number you need togrow. It is that simple and that profound.


The Manifesto For Blowing The




You are a product of your decisions , not your conditions.

Choose to be a player.

Choose to be accountable.

Choose service over self-interest.

Choose to focus forward.

Choose to play to your genius. Choose to get it done.

Choose to risk more and gain more.

#

The Manifesto For Blowing TheDoors Off Business-as-Usual

23646922 customer lifetime value

Documents