Customer Lifetime Value

Managing Customer Lifetime Value

• Marketing's goal is to attract and retain profitable customers, but companies still lose money on some customers.
• The 80/20 rule says 80% or more of a company's profits come from the top 20% of customers.
• In extreme cases, the most profitable 20% of customers can account for over 100% of a company's profits.
• The least profitable 10-20% can reduce profits, while the middle 60-70% results in breaking even.
• Companies can improve profits by "firing" their worst customers.
• Companies should focus on creating value efficiently from available customers and prospects.
• The largest customers who demand significant service and discounts are not always the most profitable.
• Smaller customers pay full price and receive minimal service; however, transaction costs can reduce profitability.
• Mid-size customers who receive good service and pay nearly full price are often very profitable.

The Concept of Customer Lifetime Value

• The aggregate value of a customer base is a key driver of shareholder value.
• Customer Relationship Management's (CRM) aim is to produce a high Customer Lifetime Value (CLV).
• Customer Lifetime Value (CLV) reflects the monetary value customers create during their relationship with a company.
• CLV can refer to the value of an individual customer or the cumulative value of all customers, also known as customer equity.
• Customer lifetime value is affected by revenue and the costs of acquisition, retention, and cross-selling.
• A profitable customer yields a revenue stream that exceeds the company's costs for attracting, selling to, and serving that customer.
• Focus should be on entire lifetime revenue and cost streams, not individual transactions.
• Marketers can assess lifetime customer value individually, by market segment or by channel.
• Companies must measure the value each customer is likely to bring over their tenure.
• Banks struggle to measure individual customer profitability because each customer uses different services logged in different departments.
• Banks linking customer transactions have discovered many unprofitable customers, with some losing money on over 45% of retail customers.
• Customer profitability analysis uses activity-based costing to identify real costs of serving each customer.
• Activity-based costing aims to identify the real costs associated with serving each customer.
• Costs include making/distributing products/services, phone calls, travel, entertainment, and gifts.
• Activity-based costing allocates indirect costs like clerical, office, and supplies based on activity use, not direct cost proportion.
• Variable and overhead costs should be tagged back to each customer.
• Companies that inaccurately measure costs may misallocate marketing efforts.
• Defining and judging "activities" properly is key to effective activity-based costing; one solution calculates the costs of activity use per minute of overhead.

Customer Lifetime Value and Brand Equity

• Both Customer Lifetime Value (customer equity) and brand equity emphasize customer loyalty and creating value by having as many high-paying customers as possible.
• Customer equity focuses on bottom-line financial value, yielding quantifiable measures of financial performance.
• Customer equity does not account advantages of a strong brand, such as attracting employees, gaining support of partners, and creating growth via extensions and licensing.
• Brand equity emphasizes strategic issues in managing brands and leveraging awareness/image with customers, providing guidance for marketing.
• Focusing on brands may not develop detailed customer analyses or long-term profitability created.
• Brand equity benefits the use of customer-level analyses and personalized marketing programs.
• Brand Equity has fewer financial considerations than Customer Equity.
• Focus on either equity depends on how a company creates market value.
• Product-centric companies (Procter & Gamble, Coca-Cola, PepsiCo) focus on brand equity as value/growth source.
• Service-centric companies (banks, airlines, credit cards, internet providers) focus on customer equity as key asset/performance measure.
• Firms utilizing subscription models find customer equity value, while firms that do not utilize contractual services tend to focus on brand equity.
• Companies uniquely identifying customers/assessing profitability focus on customer equity; those unable to link customer behavior/performance focus on brand equity.
• Companies producing self-expressive products focus on brand equity.
• Companies lacking customer-level data or direct contact focus on brand equity.
• Service-oriented companies focus on customer equity, while product-oriented firms focus on brand equity.

Building Customer Lifetime Value

• Marketers use customer profitability analysis and acquisition funnel to manage customer groups based on loyalty, profitability, risk, etc.
• Companies improve value by improving customer service, engaging customers, and enhancing individual growth potential.
• Improving customer service involves knowledgeable, friendly employees, such as Whole Foods' commitment to fresh food and service.
• Engaging customers increases retention, like Honda's high resale value reputation; consumer advice engages customers.
• Enhancing customer growth involves new offerings, like Harley-Davidson's expanded product lines - exceeding 3,000 clothing items at locations like dealerships.
• Cross-selling isn't profitable if customers require many services/returns, cherry-pick promos, or limit total spending.
• Marketers encourage unprofitable customers to buy more/larger sizes, forgo features/services, or pay higher fees.
• Banks, phone companies, and travel agencies charge for services to ensure minimum revenues.
• Firms discourage those with questionable profitability prospects; Progressive Insurance screens/diverts potentially unprofitable customers.
• "Free" customers subsidized by paying customers may create useful network effects, like in media, employment, dating services, and shopping malls.
• Rewarding profitable customers can include gestures like birthday greetings, gifts or event invitations, to send a positive signal.
• Hotels, airlines, credit card and rental car agencies ensure best loyalty by providing superior service to their best customers .
• Companies should build customer value across all touch points, from experience to communication to observation.
• For instance, hotels' points include reservations, frequent-stay programs, business services, laundry, restaurants, and bars.
• Four Seasons relies on personal touches by knowing customer names, a great staff, and a top restaurant or spa.

Creating Customer Loyalty by Building Trust

• Establishing and maintaining trust relies on competence, honesty, and benevolence.
• Competence trust ensures managers have the required skills to perform effectively and exceed expectations.
• Honesty trust is built by consistently telling the truth and keeping promises.
• Benevolence trust is built by genuine concern for customer/employee interests and goals.
• Companies are often stronger in some building blocks than others; Facebook may be more competent than benevolent/honest while a local bank may be more honest/benevolent than competent.
• Determining which blocks are strong or weak allows the fortification of a trust.

Other Trust-Building Notes

• The Kellogg School of Management suggests that activities influence customer trust based on competency, honesty, and benevolence.
• Consumers judge competence through comparisons to similar experiences; room service at a three-star hotel is judged against other three-star hotels and restaurants.
• Trust in a hotel's competence is negatively affected if it is a five-star hotel verses a three-star hotel.
• Company honesty is assessed by comparing statements with actions; an airline that claims to have “no hidden fees" will become mistrusted by customers when surprising fees are discovered.
• Benevolence is judged on whether something is perceived as a fair deal; charging customers different prices based on ZIP codes promotes mistrust.
• The activities that influence perceptions of the three building blocks of trust will depend on customer perceptions of the company’s brand.
• Companies must engage in customer research before deciding which activities require investment.
• Competence is more strongly affected by positive information compared to negative information.
• Failure related to competence is more forgivable; lack of honesty or benevolence is less so even after being honest and benevolent in the past.
• Trust is more salient early in the relationship and is not as important once established.
• Maintaining established trust creates benefits for employees and customers alike.
• Breaching established trust can cause significant negative effects.

Measuring Customer Lifetime Value

• Customer lifetime value formula is the net present value of future profits from customer purchases.
• Subtract expected costs of attracting, selling, and servicing that customer from the revenues, applying the appropriate discount rate.
• Lifetime value calculations can reach tens of thousands of dollars.
• Lifetime value calculations provide a framework for planning customer investment and help marketers adopt a long-term perspective.
• Common factors in models include revenue, acquisition/servicing costs, repeat-buying probability, tenure, and discount rate.
• Marketers also consider short-term, brand-building activities.
• Measuring customer lifetime value should consider monetary and strategic value created through endorsements.
• A customer's value depends on how well they make referrals.
• Feedback lead to greater loyalty/sales.

Summary

• Customer loyalty reflects a commitment to repatronize.
• Loyalty is a continuum ranging from satisfaction to advocacy.
• Customer satisfaction builds loyalty via pleasure comparing performance of a product or service against expectations.
• High satisfaction leads to loyalty so companies must meet or exceed customer expectations.
• Higher quality equals higher satisfaction which can support higher prices and lower costs.
• Sustain growth by keeping existing customers and increasing their business.
• Losing customers affects profits.
• Interaction, loyalty programs, and brand communities are building strategies with customers.
• Customer relationship management (CRM) is a process for managing information about customers and touch points.
• CRM develops programs to attract, retain, and meet customer needs using customization, empowerment, word of mouth, etc.
• Customer lifetime value (CLV) reflects the monetary value customers bring during their tenure.
• High customer lifetime value (CLV) is the goal through managing relationships.
• Value must be build across products, services, and brands across all avenues.
• Superior customer value from companies will prevent the erosion of their customer base.
• Calculating customer lifetime value (CLV) enables analysis of profit implications; customer profitability informs loyalty strategies.
• Monetary value and strategic value via endorsement must be considered.