The central thesis of Return on Customer by Don Peppers and Martha Rogers is that companies must optimize the mix between current-period cash flows and long-term customer equity, which is a function of the lifetime customer value (LTV) of a company's entire portfolio of customers.
The following equation for Return on Customer (ROC) was discussed in Part 1:
ROC = Πi + ΔCEi
Πi = Cash flow from customers during period i
ΔCEi = Change in customer equity during period i
CEi-1 = Customer equity at the beginning of period i
ROC equals a firm's current period cash flow from its customers plus any changes in the underlying customer equity, divided by the total customer equity at the beginning of the period.
The second half of the book reinforces and amplifies the first: that is, customers are a company's scarcest resource, and different customers should be treated differently to best maximize ROC. According to the authors, sometimes it is more beneficial to defer some profitability in order to boost future earnings and growth.
Treating Different Customers Differently
Most companies already treat different customers differently, but only at a relatively basic level. Understanding each customer's unique needs and values is the key to maximizing ROC. The more challenging the economy, the more important it is to know which customers to focus on and leverage.
Another key task, according to the authors, is to know what each customer could be worth. The authors define a customer's "potential value" as the maximum LTV that a company could realize from a customer if it were to execute the best possible strategy. The most straightforward way to estimate a customer's potential value is to look at the range of LTVs for similar customers. In the business-to-business (B2B) world, this process might entail comparing the LTVs of corporate customers in the same industry, with similar sales, profit, or growth patterns.
Peppers and Rogers go on to write about the two key factors for revenue growth: customer loyalty and revenue stimulation.
Most research supports the idea that loyal customers buy more, cost less to serve, and generate higher margins. The key with customer loyalty is to focus on the most profitable customers and to quantify the value created by the increase in loyalty.
For example, one study found that a 1%improvement in the customer-retention rate could increase customer equity 3-7%. According to the authors, the goal is increased lifetime value, not customer loyalty per se, since that could be achieved, for example, by selling products below cost.
The revenue stimulation piece, according to the authors, is all about selling additional offerings to customers, above and beyond what they would otherwise be expected to buy. The authors point out that in many industries there is a strong correlation between the number of offerings bought by a customer and their loyalty. For example, a bank customer who buys three or more offerings is more likely to stay loyal than a customer who buys only one or two offerings.
The following are key questions to help determine potential value:
- How much of your customer's business currently goes to your competition?
- Why do some of your customers buy more offerings than others?
- How can you identify latent needs of your customers?
- How can you reduce the cost of serving your customers while still maintaining satisfaction?
- Why are some of your customers more likely to provide referrals or be "referenceable"?
Predicting the Future
The art and science of business is about prediction, whether about market growth, diffusion of innovations, or pro forma profitability. LTV is no exception. It's important to look for leading indicators of LTV changes. The authors outline two steps for predictive modeling:
- Devise an equation for LTV with several years of transactional data that looks at customers' actual spending patterns and other characteristics that might be predictive and meaningful. This process will involve some assumptions and judgment, as all models do.
- Identify the best currently available predictive variables and determine correlations and relationships with the calculated LTVs. The included data could be demographic, firmographic, and/or psychographic.
Peppers and Rogers write that the leading indicators of LTV change fall into four categories:
- Lifetime value drivers: The elements of the LTV equation that help determine how much value the customer creates for the company over time.
- Lifestyle changes: When a customer takes a new job, gets married or divorced, or is involved in a merger or acquisition—that is, when there is a significant change in the customer's situation, there is likely to be an LTV impact.
- Behavioral cues: What does the customer do—more complaints, more or fewer touches or offerings purchased? At the end of the day, behavior trumps intentions.
- Customer attitudes: These include such areas as satisfaction, willingness to recommend your company or offerings, and likelihood of repurchase. These indicators, along with lifestyle changes, are likely to be predictive of behavior.
Behavioral cues are important in predicting future customer behavior. According to the authors, a customer that begins to subscribe to an email newsletter or begins to refer other customers is typically less likely to defect.
One caveat, however, is that most of the statistical models are relatively predictive in aggregate, but break down as the numbers decrease. At the individual customer level, most models are subject to randomness, noise, and false negatives/positives. At that level, the most useful information is from direct interaction with customers.
Strategy and Execution of Roc
The authors spend some time discussing the strategic landscape of an ROC world. As much as your company attempts to improve its own ROC, many competitors are trying to do the same. It's often a zero-sum game. Competitors may use their promotions or prices to lure away your customers and then try through various means to lock them in and gain their loyalty.
The authors write about some common methods of creating a strategic advantage: providing added value, understanding and anticipating customer needs, and exploiting structural and information advantages. Taking a page from the well-known business strategist Michael Porter, the authors write, "Narrowing your focus is the essence of strategy." Understanding what you're not going to do is as important as the converse. Also, determining why customers buy from your firm versus another will never go out of style.
The authors present a fascinating study by two Canadian marketing professors who asked more than 2,000 seniors executives from around the world the following question: "Why do your customers choose to buy from you rather than from your competition?"
As a whole, the executives said the most important drivers of customer choice were things such as trust, confidence, relationships, convenience, ease of doing business, and support.
As the authors point out, these drivers are often misaligned with where the executives are spending their time—namely, improving and perfecting their products rather than their customer relationships. The key is to develop a "learning relationship" with your customer that includes a lot of direct, one-to-one interaction. As a company executes its strategy, it can use ROC to get down to the customer-specific implications and LTV impacts.
Executing a customer-focused, ROC-based strategy is not without some challenges: rigid mindsets, long-held traditions, cultural assumptions, and change-management hurdles, among other barriers. Peppers and Rogers suggest how a leader can improve the likelihood of success in adopting an ROC approach:
- Become fluent in customer-focused strategies and relationship management. Never stop learning about the approach.
- Sponsor pilot projects. A leader should provide sponsorship to proof-of-concept projects and help to make their success visible.
- Measure success differently. One of the tenets of changing behavior is changing the incentive and measurement structures.
- Cross boundaries. Exceptional customer relationships are typically found when a company integrates touchpoints and has a 360-degree view.
- Directly interact with customers. As the authors prosaically state, there is "no substitute for direct experience" with the customer.
- Communicate and live by customer-oriented values. In essence, the leadership team needs to "walk the talk" when it comes to aligning behavior and communications around the customer's perspective.
And last, a key piece that is implied, but isn't directly expressed, is that to be a customer-centric business you first need to be employee-centric (a JetBlue manager said this to the authors). This relationship, which is espoused by such companies as JetBlue and Southwest, two profitable airline companies in a very difficult industry, is at the heart of building trust and loyalty internally, in order to be known for it externally.
Building Customer Enterprise Value
With today's proliferation of channels, as well as offerings, it's important to ask who is managing the customer relationship. Sometimes it's a salesperson or a relationship manager. Regardless, it needs to be someone who can see the "whole" customer and not just a single product line or facet of the relationship.
The authors use the term customer portfolio manager, someone who can be thought of as a kind of "traffic cop" who coordinates a firm's interactions and transactions with customers in their portfolio. Peppers and Rogers say a portfolio is a non-overlapping group of customers that has its own customer equity and generates current-period cash flows.
This idea is similar to a portfolio of stocks (or bonds), with the stock being a customer who could be growing, shrinking, or staying the same while also throwing off some income (e.g., current-period cash flows) in the form of dividends or interest. Each customer, like a stock, is a value-creation unit.
The authors make the distinction between a segment and a customer portfolio: the latter is often a type of the former, but the former is rarely one of the latter. In the endnotes, the authors write that segments tend to be the responsibility of marketing, while customer portfolios are a boardroom issue. Also, customer portfolios are typically trackable down to the customer level, whereas segments may not be.
One of the first steps in creating greater levels of customer enterprise value is to rank customers into tiers based on the amount of value they represent, as well as their needs. By better understanding and anticipating their needs, you can have better insight into their behavioral triggers in order to create incremental value. Peppers and Rogers unequivocally state that if you don't know customers' needs, then you have no way to motivate them to change their behavior. If you don't know a customer's value to you, then you have no way to prioritize your activities or measure your success.
And last, the authors present a couple of methods to effectively make the transition to a customer management model—the picket-fence strategy and segment management:
- Picket-fence strategy. Essentially, you "fence-off" a few of your customers and place them into portfolios to be managed. As the transition progresses, the number of customers behind this fence will increase. The goal of this strategy is to extend and automate the idea while codifying the business rules that are being applied.
- Segment management. This method involves identifying groups of customers and giving segment managers more authority and responsibility with regard to their segments. This transition strategy may be appropriate if you are in a business in which it is difficult to track customers individually: for example, consumer packaged goods or any company that has less-than-perfect visibility into the end-customer/user.
In this summary of Return on Customer, I have not covered many cases and concepts. Because the authors themselves distill and summarize a relatively large body of research, it's next to impossible to include all of their corroborating examples and illustrative models.
And a final note: The book's appendices on calculating LTVs and on the economics of customer equity are quite interesting, as are the well-written and informative endnotes. Though a good book summary should provide readers with some valuable information and insight, it should also motivate them to go to the primary source to further explore and more fully wrestle with its ideas, models, and assumptions.
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