PROFITABLE CUSTOMER ENGAGEMENT Concepts, Metrics & Strategies V. Kumar Dr V.Kumar
Chapter 4 Valuing customer contributions The future looks green!!! Instructor s Presentation Slides 2
Traditional measures of Customer Value Recency Frequency Monetary Value (RFM) Past Customer Value (PCV) Share of Wallet (SOW) Tenure/Duration 3
Customer Lifetime Value Customer Lifetime Value (CLV) is defined as the sum of cumulated future cash flows discounted using the weighted average cost of capital (WACC) of a customer over their entire lifetime with the company. CLV tracks the future purchase behavior of a customer and computes his /her value in present day terms. 4
Measuring CLV CLV Measurement Approach A Conceptual Framework Recurring Revenues minus Recurring Costs Gross Contribution Margin minus Net Margin Adjusted for NPV Marketing Costs times Expected number of purchases over next 3 years Accumulated Margin minus Acquisition Costs Customer Lifetime Value Source: Adapted from Kumar, V. (2008), Managing Customers for Profits, Upper Saddle River, NJ: Wharton School Publishing. 5
Measuring CLV CLV Computation in a Contractual Setting CLV i T t 1 Base GC (1 r) t T t 1 pˆ(buy it (1 1) *ĜC r) t it Mˆ (1 C it r) t where, CLV i = lifetime value for customer i p (Buy it = predicted probability that customer i will purchase in time period t G C = predicted gross contribution margin provided by customer iin time period t M C = predicted marketing costs directed toward customer iin time period t t = index for time periods; such as months, quarters, years, etc. T = marks the end of the calibration or observation time frame r = monthly discount factor Base GC = predicted base monthly gross contribution margin 6
Measuring CLV CLV Computation in a Noncontractual Setting CLV i T t 1 pˆ(buy it (1 1)*ĜC r) t it Mˆ C (1 it t r) where, CLV i = lifetime value for customer i p (Buy it = predicted probability that customer i will purchase in time period t G C = predicted gross contribution margin provided by customer iin time period t M C = predicted marketing costs directed toward customer iin time period t t = index for time periods; such as months, quarters, years, etc. T = marks the end of the calibration or observation time frame r = monthly discount factor Base GC = predicted base monthly gross contribution margin 7
Drivers of CLV Exchange Characteristics Customer Characteristics Product Characteristics Firm s Marketing Actions 8
Maximizing CLV Customer Retention Which customers should we retain? How can we retain more customers? Can we ensure that the customers we retain are profitable or potentially profitable? What efforts/programs influence customer retention and CLV? When are customers prone to switch? What are the drivers to switching? Customer Acquisition How can we increase customer acquisition? Is it possible to acquire profitable customers rather than just any customers? What acquisition sources are most/least profitable? Which sources are ultimately providing the best customers? How much to spend on acquiring a customer? Customer Profitability How can we increase our overall profitability? How to recruit profitable customers who will stay longer? How long is the customer's actual lifecycle? Which customers are more prone to specific campaigns? (e.g., discounts, deals etc.) 9
1. Customer Selection Need for Strategy Traditional metrics like RFM, PCV, SOW, Tenure or Duration are based on past customer behavior. A poor indicator of future customer purchase behavior Fails to identify customers who will be profitable in the future. CLV, a forward looking metric, focuses on customers who are likely to be profitable in the future. How does it work? Selection is important for two reasons; a) Not all customers are equally profitable b) Limited budgets to spend resources on By selecting the right customers to manage, CLV enables firms to rank order customers based on their value to the company, and prioritize resources accordingly. 10
2. Managing Loyalty and Profitability Together Need for Strategy Loyalty is not always the true measure of customer profitability. Traditionally, customer loyalty has been defined solely as a behavioral measure with the assumption that the loyalty of a customer is obtained from his purchasing behavior. Chasing loyal customers is not the same as chasing profitable customers. How does it work? Customers are rank ordered and segmented into four cells based on their loyalty and profitability levels. Segmentation and strategies shown on the next slide. 11
2. Managing Loyalty and profitability together High Profitabil ity BUTTERFLIES Good fit between company offering and customer needs High profit potential Action: Aim to achieve transactional satisfaction, not attitudinal loyalty. Milk the accounts as long as they are active. Key challenge: Cease investment once inflection point is reached STRANGERS TRUE FRIENDS Good fit between company offering and customer needs Highest profit potential Actions: Consistent intermittently spaced communication Achieve attitudinal and behavioural loyalty Delight to nurture/defend/retain. BARNACLES Low Profitabil ity Little fit between company offering and customer needs Lowest profit potential Action: Eliminate all investments towards these relationships Profitize every transaction Short term Customers Limited fit between company offering and customer needs Low profit potential Action: Measure size and share of wallet If share of wallet is low, specific upselling and cross selling If size of wallet is small, strict cost control Long term Customers 12
3. Optimal Allocation of Resources Need for Strategy Firms cannot allocate equal resources to all of their customers. Also, not all customers are equally loyal and profitable. Hence, firms should allocate their limited resources to the most loyal and profitable customers. How does it work? To optimally allocate resources, firms must identify; a) their most profitable customers, and b) those who are the most responsive to marketing efforts By carefully monitoring the purchase frequency of customers, the inter purchase time, and the contribution toward profit, managers can determine the frequency of marketing initiatives to maximize CLV through an optimal contact strategy. 13
Need for Strategy 4. Cross buying Behavior When customers buy across product categories; a) they contribute to an increase in revenue b) contribute to profits c) increase their own switching costs Therefore, firms should identify and target the right customers who are most likely to cross buy. How does it work? In order to identify the customers who are likely to cross buy, firms not only need to understand the motivation and drivers influencing customers to cross buy but also the impact on revenues and other customer related metrics. Drivers of cross buying will help managers retain customers for a greater duration. 14
5. Pitching the Right Product to the Right Customer at the Right Time Need for Strategy Cross selling is an important strategy for firms to increase customer retention and customer value. As not all customers are likely to cross buy, it is imperative for firms to identify customers who have a higher propensity to cross buy. How does it work? To predict the purchase sequence of each customer firms need to collect the following information: a) In which product category the customer is likely to make a purchase? b) At what intervals and at time period the customer will make a purchase? c) How much the customer is likely to spend towards that purchase? 15
6. Preventing Customer Attrition Need for Strategy As it is less expensive to retain a current customer than to gain a new one, monitoring customer churn/attrition is vital for companies. How does it work? By building a propensity to quit model. These models give us the probability of a customer quitting at a particular point in time. Based on when the customer is likely to leave and his/her ability to contribute profits, firms can provide appropriate intervention strategies that will aid retention. 16
7. Product Returns Need for Strategy Product returns: a) Reflect the discontent of customers with the firm s offering b) Increase service costs for the firm c) Eventually reduce margins for the firm Firms can benefit greatly by estimating optimal amount of product returns How does it work? Firms need to address the following questions: a) What factors affect customers return behavior? b) How does customers' return behavior influence their future buying behavior and the firm initiated marketing communication plans? c) Should firms consider product returns as a necessary evil in the exchange process? 17
8. Managing Multichannel Shoppers Need for Strategy Customers often engage through different channels such as retail stores, brick and mortar stores, the Internet, or by mail order catalogs. Each of these channels services a different set of customers and provides varying levels of service. How does it work? To effectively manage multiple channels, firms have to first identify who the multichannel shoppers are by studying the drivers associated with purchase behavior across multiple channels. After identifying the drivers, firms have to determine whether multichannel shoppers are: (a) more likely to buy in the future, (b) spend more money, and (c) more profitable than single channel customers. Ascertain which channel a customer is likely to adopt next and when this is likely to happen. 18
9. Linking Investments in Branding to Customer Profitability Need for Strategy Brands add value to companies How does it work? It is possible to strengthen a brand by ascertaining and increasing the value a customer provides to the brand. This value is referred to as the Customer Brand Value (CBV). 19
10. Acquiring Profitable Customers Need for Strategy Understanding how firms acquire customers and the best metric to use while acquiring those customers is essential for firms to maximize their overall profitability. How does it work? Using the concept of CLV, the study proposed the introduction of an ARPRO framework (Allocating Resources for Profit) that would help firms decide which customers are worth chasing and which dormant customers should be pursued to come back to the firm. Firms using this strategy can use customer profiles to identify customers who are most likely to be profitable and should be acquired and retained. 20
11. Interaction Orientation Need for Strategy Traditionally, firms used a product centric approach which focused on making and selling superior products. A customer centric approach allows firms to focus on the interaction with customers thereby maintain future profitability. How does it work? Customer Concept Interaction response capacity Customer empowerment Customer value management 21
12. Viral and Referral Marketing Strategies Need for Strategy Customers not only contribute through their own transactions but also have an impact on the transactions of other customers through word of mouth and referrals. How does it work? The concept of Customer Referral Value (CRV) enables managers to measure and manage customer referral behavior. In a B2B context, the concept of Business Reference Value (BRV) enables managers to measure and manage client references that are critical to business. Social media and its impact on marketing is captured under Customer Influence Value (CIV) where managers can understand the social media influence of their customers on prospects and current customers. 22
Conclusion CLV is a direct means to measure the value of a customer to a firm in the future It is a strong indicator of the level of customer engagement with the firm. A customer s value to a firm is not limited to the direct impact of that customer. Customers can also affect the profitability of other customers of a firm through their activities and behavior. As a result, firms should consider the influence of these indirect factors of customer engagement; CRV, CIV, and CKV, and their relationship with CLV which can further quantify the value of a customer to a firm. 23
End of Chapter 4 24