Maximizing Customer Lifetime Value

Ultimately marketing is (lie art of attracting and keeping profitable customers. According 10 James V rm ten ot American Impress. (lie best customers nul spend others by ratios of Hi to I in retailing, 13 in 1 in the restau mm business, 12 to 1 in ihe airline business, ami 5 to i in (lie hotel and motel industry,3' Vet every company loses money pn some of its customers, the well-knOwn 20-&0 jijle says that the top 20 percent oft he cur: turners may generate as much as ISO percent of I lie company's pro fits. Sherderl suggested amending the rule lo read L'D-iî(KîO. lo reflect the idea that the top 2D percent of customers generate !)U percent of ihe company'-* profits, hal J of which are lost serving [he bottom 'SO percent of urtpnoli table customers.3" 11 if implication is thai a company coukl Improve ils pro lits by "firing" its worst customers,

Furthermore, it is not necessarily the company's largest ens turners who yield ihe most profit Ihe largest customers demand considerable service and receive the deepest discounts, the smallest customers pay full price tint! receive minimal service, but the costs of transacting with small customers reduce their profitability. The midsize customers receive good service and pay nearly full price and are often the most profitable. This fact helps expiai rt Why many large firms are now invading the middle market, Major air express carriers, for instance, are finding that it does run pay to ignore small and midsize international shippers. Programs geared toward smaller eusiomers provide n network of drop boxes, which allow for substantial discounts over letters and packages picked up al the shipper's place of business, United Parcel Service (Itl'Sl conduct * seminars to instruct exporters in the finer points ot shipping overseas,'1

Customer Profitability

Uliat makes a customer pro limbic? A profitable customer is a person, household, or company that over lime yields a revenue stream that exceeds byati acccptable amount ilie company's cost stream of attracting, selling and servicing that customer. Note that the emphasis is on the lifetime stream of revenue and cost, not on die profit from a particular transaction.1" Customer fircifitabililv can be assessed individually, by market segment, or bv channel.

Although many companies measure customer satisfaction, most companies fail to measure individual customer profitability, banks claim that ibis is a difficult task because a customer uses different banking services and die transactions arc logged in different departments. 1 lowcver, banks that have Succeeded in linking customer transactions have been appalled by the number of unprofitable customers in their customer base, Some banks report losing money on over 45 percent of their reiail customers. There are only two solutions to handling unprofitable customers; Staise fees or reduce service support.35

"ITA A useful type of profitability analysis is shown in figure S.■fl> Cnsiouiers are arrayed along the columns and products along ilic rows. Each ccll contains a symbol for the profitability of selling that product to that customer. Customer ] is very profil able; he buys three profit-making products tPl, P£, and IM). Customer 2 yields ii picture of mixed profitability lie buys one profitable product and orle unprofitable product. Customer 3 is a losing customer because lie buys one profitable product and two unprofitable products.

What can the company do about customers I and 3? (L> It can raise the price of its less profil able products or eliminate them, or [2) it can try itir sell ihcm Us proflMtiaking prod' nets. Unprofitable customers who defect should not concern the company In fact, the Company should encourage these customers tri switch to competitors.

Customer profitability analysis (CPA) is best conducted with the tools of an accounting tcclinique called Activity-Based < 'osting (ABC), The company estimates all revenue coming ftnm the customer, less all costs. The costs should Include not only the tust of making and distributing the product? and services, but also such costs as taking phone calls from Hie customer, traveling to visit the customer, entertainment and gifts—all the company's resources that went into servi tig that customer. When ibis is done for each customer, it is possible lo classify customers into different profit tiers: piaiinuni customers (most profitable!, guld customers (profitable), jion customers (low profitability tint desirable), and lead customers (un pro Hi able and undesirable)'

[he company's job is to move iron customers into I lie gold tier and gold customers into die platinum tier, while dropping die lead customers or making them profitable by raising their prices or lowering the cost of serving them. More generally, marketers must segment customers into those worth pursuing versus those potentially less lucrative customers that ihuuld receive less attention, if any at all.

Dharand Glazermake an interesting analogy between the individuals that make up the firm's cusiomet portfolio for a firm and the stocks that make tip an investment portfolio.1" |ll$t as with the latter, it is itn portant to calculate the beta, or risk-reward value, for each customer and diversify the customer portfolio accordingly. From their perspective, firms




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