CRM and the Retail Industry Benjamin Scribner November, 2001 www.bensplace.com Page: 1 of 9
Abstract This paper discusses the strategic significance and applications for Customer Relationship Management (CRM) in Retail businesses. Included are overviews of CRM strategy and the Retail industry. Special attention is given to CRM software, which is likely to be the primary CRM adoption vehicle for Retailers. Summary Retailers struggle to make profits in a competitive market. A low barrier to entry and the ease with which competitors copy services undermines differentiation. Retailers consolidate to capture economies of scale causing further homogenization of service. The Internet has exacerbated these conditions by lowering informational barriers for both customers and businesses alike. Competitors become locked in a death spiral of Bertrand price competition with the spoils going to the victor in a war of attrition. CRM is as old as commerce itself, but until recently, mass production and mass marketing have dominated most corporate strategies. Fortunately, the advances in information technology that have increased customer information are also facilitating customer data gathering, interaction, and customisation. The falling price of information technology combined with rapidly increasing power and speed of information technology has made CRM realistic. CRM is about developing learning relationships in which companies exchange personalized service for the loyalty of their customer: Customers convey their preferences, explicitly and implicitly, to the company through communications and purchasing behaviour. Companies track and act upon these preferences with customized products and personalized service. The companies understanding of customer preferences is hard won over time by both the company and the customer. This learning relationship becomes a unique and valuable service offered by the company and customers respond with loyalty and repeat business. The relationship a retail business has with its customers is its only defensible competitive advantage. Products are easy to copy. Services are harder to copy, but the learned relationship that a customer has with his or her supplier is nearly impossible to reproduce. CRM also increases profitability in five-key ways: Customer loyalty translates into reduced price competition Customer information allows companies to target profitable customers Predictable buying patterns lower inventory holding costs, spoilage, and distribution costs Customer loyalty reduces advertising and marketing costs Customer loyalty extends product life cycles CRM software grew out of Enterprise Resource Planning (ERP) software applications like SAP. ERP systems coordinated back end processes to allow for greater efficiency and management control. CRM software applied these systems to front end processes such as sales, marketing, and customer support. CRM solutions have three major challenges: First, CRM encourages forward integration, but growth makes it harder to maintain contact with individual customers. Second, when companies www.bensplace.com Page: 2 of 9
focus on what their customers want they can fall prey to disruptive technologies. Finally, ubiquitous customization is commoditization. If every retailer offers to sell you exactly what you want, then none of these retailers will be differentiated. CRM software offers the greatest ROI to large corporations. Small companies have fewer customers and data points to collect and analyze. However, database integration is one of the biggest issues for, and drives up the price of, many CRM implementations. Small and medium sized businesses that plan to grow into large enterprises can avoid these later costs by investing in and building their business operations around a CRM system. CRM as a strategy is best suited for companies that can easily collect information about their customers. It also works well for businesses where customer interactions can be automated. CRM is less valuable to businesses with highly complex products and who are already engaged in intense interactions with their customers. Finally, it s important to note that CRM is not a technology implementation, although it is a largely technology driven strategy. For large and complex corporations with thousands (or even millions) of customers and multiple lines of business, CRM is impossible without CRM software. But CRM also requires businesses processes that compliment and leverage the power that the software brings with it. Businesses must be willing to restructure themselves around the software to ensure favorable results. History Treating different customers differently is an old concept, dating back to the very beginning of trade and commerce. We began to lose sight of this concept amid the excesses of the Industrial Revolution and the decades of global turmoil that followed. The astonishing success of mass-production as a means for adequately feeding, clothing, and equipping unprecedented numbers of people pushed the concept even further into the background. 1 Mass production and mass marketing drive down costs by taking advantage of economies of scale. As stated in the quote above, this has been the strategy of choice for increasing profitability ever since the Industrial Revolution. Individual customer data is condensed into an aggregate and products are homogenized to meet the needs of the average customer. The homogenized product adequately meets the needs of a large cross section of the parent population. So it can be produced and sold in larger quantities and at a lower per unit cost. In this scenario, increased sales are synonymous with profits and success is measured in terms of market share. Unfortunately, this strategy does not produce a sustainable advantage. Profits attract competitors and successful products are relatively easy to copy. Homogenized product lines result in price competition. Profits are passed along to the customer in the form of lower prices and market saturation results in wars of attrition. 1 Don Peppers and Martha Rogers, Ph.D., The One To One Manager: Real-World Lessons in Customer Relationship Management (New York; London; Toronto; Sydney; Auckland: Currencey/Doubleday, 1999) p. 15. www.bensplace.com Page: 3 of 9
This strategy also undermines the company s relationship with its customers. The relentless pursuit of scale economies drives businesses toward a transaction-based, product-centric business model. And this results in an adversarial relationship between buyers and sellers: Buyers try to get the most product for the lowest price and sellers try to sell the least product at the highest price. The Retail Industry The retail trade sector is one of the major sources of jobs in the U.S. economy, consistently accounting for 21 percent of all non-farm jobs in the private sector. Retail establishments are primarily engaged in selling merchandise for personal or household consumption. Retailers sell an ever-changing combination of durable and nondurable merchandise. 2 The SIC division G represents the retail trade. This division includes establishments engaged in selling merchandise for personal or household consumption and rendering services incidental to the sale of goods. 3 A retail establishment is usually a place of business and is engaged in activities to attract the general public to buy The establishment may process its products. 4 SIC definition distinguishes retail establishments from wholesale establishments by the type of product sold. Establishments engaged in retail trade sell merchandise to the general public for personal or household consumption 5 while establishments engaged in wholesale trade sell merchandise for business consumption. A business that sells products like plumbing equipment, electrical supplies, used automobile parts, and office furniture will be classified as wholesale even if a higher proportion of their sales is made to other than individuals for personal or household consumption. 6 Retail is a mature industry with slow growth. There are low barriers to entry and there is little differentiation between competitors. Low differentiation means that personal income levels drive demand. Players try to avoid price competition by differentiating themselves with distinctive service and support. But competitors quickly copy services. And new players offer deep discounts in an effort to establish a beachhead in the mind of the consumer. These conditions lead to Bertrand price competition, which can be costly if not devastating. Businesses have large incentives to undercut their competitors on price: Having the lowest price can result in large increases in demand particularly if ones opponents are forced out of business. Companies pursue lower costs and immediately pass the profits along to the customer in the form of lower prices. Competitors become locked in a death spiral of price competition with the spoils going to the victor in a war of attrition. E-retailing has taken the retail industry by storm, offering opportunities for early adopters to capture significant cost savings and differentiation. But this differentiation is short lived as more and more retailers develop their own online component, making e-retailing ubiquitous. Already, 2 Specialty Retailing Industry Industry Analysis, U.S. Business Reporter, available at: http://www.activemediaguide.com/specialtyretailing_industry.htm, 3 SIC Division G Division G: Retail Trade, OSHA, available at: http://www.osha.gov/cgi-bin/sic/sicser3?g, 4 Ibid 5 Ibid 6 Ibid www.bensplace.com Page: 4 of 9
sixty-two percent of all e-retailing sales are accounted for by existing bricks and mortar stores and catalog companies. 7 But the real impact of the Internet has been the lowering informational barriers for both customers and businesses alike. Companies can find out more about their customers than ever before and customers can compare product and service offerings with greater ease. This is particularly true of the Y generation (born after 1985) which experiencing tremendous growth in spending power. 8 It s clear that the Internet has forever changed the way companies and customers interact. Retailers continue to search for ways to lower costs and this has resulted in consolidation to capture economies of scale. Major players in the retail category include Wal-Mart, Macys, and Nordstrom. But consolidation also spells homogenization of service, which destroys differentiation and makes customers more price-conscious. Indeed, customers are more value conscious than they ve been in the past. 9 Companies also try to lower costs through efficiency enhancing technologies that reduce bloated inventories, improve purchasing and forecasting, and reduce out-of-stock problems. 10 CRM software is one such technology, which companies are using to support their one-to-one strategies. Customer Relationships In a world of increasingly commodity-like products and services, a relationship founded on trust is the only genuinely sustainable competitive advantage. 11 The retailer s inability to differentiate itself from the competition is the biggest and longest standing issue for the retail industry. Increased customer information provided by the Internet, has only exacerbated these concerns. The relationship a retail business has with its customers is its only defensible competitive advantage. But consolidation in the industry undermines these relationships. Fortunately, the advances in information technology that have increased customer information are also facilitating customer data gathering and interaction. That s why many of the major players are investing in software to support CRM strategies. Products are easy to copy. Services are harder to copy. But the learned relationship that a customer has with his or her supplier is nearly impossible to reproduce. Why? Because, a relationship is hard won over time and through communication, trial, and error. In short, the company has learned the customer s preferences. Customers won t want to go through the trouble of teaching their preferences to multiple companies. So the customer has an incentive to remain loyal to the company and the company gains a strategically defensible advantage over its competitors. A relationship-based, customer-centric business model leverages the company s knowledge of customer preferences through CRM. The company cultivates its relationship with the customer by 7 Ibid 8 Specialty Retailing Industry Industry Analysis, U.S. Business Reporter, available at: http://www.activemediaguide.com/specialtyretailing_industry.htm, 9 SIC Division G Division G: Retail Trade, OSHA, available at: http://www.osha.gov/cgi-bin/sic/sicser3?g, 10 Ibid 11 Don Peppers and Martha Rogers, Ph.D., The One To One Manager: Real-World Lessons in Customer Relationship Management (New York; London; Toronto; Sydney; Auckland: Currencey/Doubleday, 1999), p.27 www.bensplace.com Page: 5 of 9
partnering with the customer in a learning relationship. Companies begin by recognizing and interacting with individual customers on an individual basis. Customers respond by explicitly and implicitly conveying their preferences to the company through communications and purchasing behaviour. Finally, companies track and act upon the customer s individual preferences with customized products and personalized service. Instead of measuring success in terms of market share, companies measure their success in terms of their share of a customer s overall purchases. In addition to developing a strategically defensible advantage, CRM also increases profitability. Customer loyalty translates into switching costs and reduced price-elasticity. In other words, customers are willing to pay a premium for personalized service and their loyalty protects the company from price competition. By tracking customers the company also learns the value of each individual customer and can market its services toward the more profitable customers. More predictable buying patterns actually lowers inventory holding costs, spoilage, and distribution costs. Customer loyalty reduces advertising and marketing costs because it costs less to keep a good customer than to acquire a new one. And customer loyalty extends product life cycles because customers are getting exactly what they want. CRM Software One-to-one marketing has only recently become practical and cost-efficient on a large scale, because of what the computer now makes possible. Database technology allows an enterprise to track its customers individually and tell them apart. 12 All this tracking and customization is extremely expensive. And yet, everywhere you look, companies are restructuring their businesses around CRM. Growth in the CRM Software Market has been astronomical, up from $1.2 billion in 1997 to $5.4 billion in 2000. And projections indicate the sales should reach $16.8 billion by 2003. 13 The increased profits outlined above must outweigh the increased costs of CRM. But this begs the question, if CRM is so profitable, then why are companies just getting into it now? One answer is that customers are harder to keep and expect more personalized service than they have in the past. The other answer is that CRM has only recently become affordable. The falling price of information technology combined with rapidly increasing power and speed of information technology has made CRM realistic. The emergence of CRM software seems to be part of a historic progression. Indeed, in industry after industry, technological innovations had profoundly affected companies relationships with their customers. 14 The telephone brought corporations closer to their customers through telemarketing and call centers. Automatic Teller Machines (ATMs) enabled banks to interact with their customers at all hours and every day of the week and year. And the emergence of the Internet has given companies new ways to interact with customers through the World Wide Web and e-mail. 12 Ibid, p. 7 13 Garth Saloner, PhD., Michael Spencer, PhD., and Eric Marti, Siebel Systems Inc., (Graduat School of Business, Stanford University, 2000) p.20, Exhibit 3 14 Ibid, p. 2 www.bensplace.com Page: 6 of 9
CRM software grew out of Enterprise Resource Planning (ERP) software applications like SAP. Businesses began applying IT to their general operations in large numbers during the 1960s and 70s, with the automation of internal processes such as manufacturing, purchasing, and payroll. 15 ERP systems were originally developed to capture operational efficiencies through business inteligence (BI). Business intelligence (BI) generally refers to the methods and techniques companies use to access and analyze information in their operational and knowledge systems and selected third party databases. 16 ERP systems coordinated back end processes to allow for greater efficiency and management control. CRM software applied these systems to front end processes such as sales, marketing, and customer support. For major corporations, CRM requires the collection and analysis of vast amounts of data. Most corporations have thousands, if not millions of customers, all of which exhibit complex buying patters. Having so many customers and employees makes it extremely difficult to maintain data cleanliness standards. Furthermore, corporations develop multiple lines of business, which often operate as entirely separate businesses under one corporate umbrella. These silos maintain separate databases with often disparate and sometimes redundant information about the same customers. Integrating these databases to develop a unified view of the customer is challenging for these corporations and adds to the complexity of implementing a CRM solution. Until recently, the cost of collecting, storing, cleaning, integrating, and analyzing customer data was prohibitive for most corporations. However, the rapidly falling price of storage and processing power has brought CRM solutions within reach. Today, it is feasible and economical for major corporations to collect, access, and manipulate vast amounts of data. CMR software packages leverage these advances to identify and evaluate individual customers and situations. Businesses that invest in these business inteligence 17 systems can build and defend their relationships with their most valuable customers and reap a substantial return on investment. These increased benefits created a market for CRM software and, by the mid-1980s, packaged software aimed at front office customer relationship functions began to appear. 18 CRM solutions have three major weaknesses in the pursuit of increased differentiation. CRM encourages forward integration because corporations will want to get closer to their customers so they can collect cleaner data. However, forward integration continues the cycle of growth that initially undermined the line of communication between the business and the customer. CRM also encourages companies to do whatever their most valuable customers want. But this strategy undermines creativity and risk taking. The risk is that a more creative competitor will come up with something that customers couldn t imagine and didn t know they wanted until they saw it. Finally, growth in CRM runs the risk of undermining itself. Ubiquitous customization is the same as no customization. If every retailer offers to sell you exactly what you want, then non of these retailers will be successful in differentiating themselves. Implementation 15 Ibid, p. 3 16 Wayne Eckerson, Q&A From the Expert, (What Works, The Data Warehousing Institute, vol.12) p. 19 17 18 Ibid www.bensplace.com Page: 7 of 9
For many small companies, collecting and analyzing data on individual customers is not very difficult. That s because these companies have fewer customers and data points to collect and analyze. For this reason, it would seem that CRM software is really only of value to a large corporation. However, database integration is one of the biggest issues for and drives up the price of many CRM implementations. Small and medium sized businesses that plan to grow into large enterprises can avoid these later costs by investing in and building their business operations around an CRM system. The nature of the business can also add to applicability of a CRM solution. Companies with highly complex products or those requiring heavy human-to-human customer contact are not ideal early candidates for one-to-one initiatives. On the other hand, companies with large numbers of data points can be promising candidates for 1to1 programs if customer interactions can be automated to some degree. 19 Finally, it s important to note that CRM is not a technology implementation, although it is a largely technology driven strategy. For large and complex corporations with thousands (or even millions) of customers and multiple lines of business, CRM is impossible without CRM software. But it also requires businesses processes that compliment and leverage the power that the software brings with it. Businesses must be willing to restructure themselves around the software to ensure results. 19 Don Peppers and Martha Rogers, Ph.D., The One To One Manager: Real-World Lessons in Customer Relationship Management (New York; London; Toronto; Sydney; Auckland: Currencey/Doubleday, 1999) p.23 www.bensplace.com Page: 8 of 9
Bibliography Don Peppers and Martha Rogers, Ph.D., The One To One Manager: Real-World Lessons in Customer Relationship Management (New York; London; Toronto; Sydney; Auckland: Currencey/Doubleday, 1999) Garth Saloner, PhD., Michael Spencer, PhD., and Eric Marti, Siebel Systems Inc., (Graduat School of Business, Stanford University, 2000) Wayne Eckerson, Q&A From the Expert, (What Works, The Data Warehousing Institute, vol.12) Julie Murphree, Global Enabled Supply Chain Map Series: Order Management, (isource), available at: http://www.isourceonline.com/article.asp?article_id=1692, accessed: 10/14/2001 Specialty Retailing Industry Industry Analysis, U.S. Business Reporter, available at: http://www.activemedia-guide.com/specialtyretailing_industry.htm, General Retailing Industry Industry Analysis, U.S. Business Reporter, available at: http://www.activemedia-guide.com/retailing_industry.htm, SIC Division G Division G: Retail Trade, OSHA, available at: http://www.osha.gov/cgibin/sic/sicser3?g, Wholesaling Industry Industry Analysis, U.S. Business Reporter, available at: http://www.activemedia-guide.com/wholesaling_industry.htm, www.bensplace.com Page: 9 of 9