The Ultimate Test Customer Profitability

largest customers demand greater service and receive the deepest discounts, thereby reducing the company's profit level. The smallest customers pay full price and receive less service, but the costs of transacting with small customers reduce their profitability. In many cases, mid-size customers that pay close to full price and receive good service are the most profitable. This helps to explain why many large firms that once targeted only large customers are now invading the middle market.

A company should not try to pursue and satisfy every customer. For example, if business customers of Courtyard (Marriott's less expensive motel) start asking for Marriott-level business services, Courtyard should say no. Providing such service would only confuse the respective positioning of the Marriott and Courtyard systems. Similarly, airlines differentiate between tourist- and business-class flyers, and Visa offers more services to gold-card users.

Some organizations ... try to do anything and everything customers suggest. ... Yet, while customers often make many good suggestions, they also suggest many courses of action that are unactionablc or unprofitable. Randomly following these suggestions is fundamentally different from market-focus - making a disciplined choice of which customers to serve and which specific combination of benefits and price to deliver to them (and which to deny them).-'"

customer lifetime value The amount by which re-venues from a given customer over time exceed the company's costs of attracting, selling and servicing that customer.

What makes a customer profitable? We define a profitable customer as a person, household or company whose revenues over time exceed, by an acceptable amount, the company's costs of attracting, selling and servicing that customer. Note that the definition emphasizes lifetime revenues and costs, not profit from a single transaction. Here are some dramatic illustrations of customer lifetime value;

Stew Leonard, who operates a highly profitable single-store supermarket, says that he sees $50,000 flying out of his store every time he sees a sulking customer. Why? Because his average customer spends about $100 a week, shops 50 weeks a year and remains in the area for about 10 years. If this customer has an unhappy experience and switches to another supermarket, Stew Leonard has lost S50,000 in revenue. The loss can be much greater if the disappointed customer shares the bud experience with other customers and causes them to defect.

Tom Peters, noted author of several books on managerial excellence, runs a business that spends 81,500 a month on Federal Express service. His company spends this amount 12 months a year and expects to remain in business for at least another 10 years. Therefore, he expects to spend more than 8180,000 on future Federal Express service. If Federal Express makes a 10 per cent profit margin, Peters' lifetime business will contribute 818,000 to Federal Express's profits. Federal Express risks all of this profit if Peters receives poor service from a Federal Express driver or if a competitor offers better service.

Few companies actively measure individual customer value and profitability, For example, banks claim that this is hard to do because customers use different banking services and transactions are logged in different departments. However, banks that have managed to link customer transactions and measure customet profitability have been appalled by how many unprofitable customers they find. Some banks report losing money on over 45 per cent of their retail customers. It

Figure 11.5

European Foundation for Quality Management's model of business excellence is not surprising that many banks now charge fees for services that they once supplied free.

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