Know the True Value of Customers

A fundamental tenet in customer relationship management is that companies win by attracting and keeping their most valuable customers. This is a simple concept if you know who your most valuable customers are. But many companies take a simplistic view of measuring customer value. To really understand what your customers are worth, you need to think broadly about the ways in which customers add value to your company. And you need to create more sophisticated approaches to quantifying the value of customer relationships. Knowing the true value of your customers will lead to better decisions about how you deploy your technology resources in offline and online sales channels.

The most common way to measure the value of a customer is the Customer Lifetime Value. Customer Lifetime Value is defined as the net present value of the revenue stream from a customer relationship. It measures how much business the customer is expected to do with your company during the lifetime of your relationship. But few large companies know how much business they do with a customer today, let alone how much they expect to do in the future. Customers may buy several different products from different business units within a company, but the silos that separate divisions don’t allow for accurate accounting of the total value of each relationship. For instance, Procter & Gamble found that many households spend almost 50 percent of their consumer packaged goods dollars on P&G products. However, P&G doesn’t know which customers are buying what because the company is organized around brands, not customers.

Know Customer Potential and Profitability

Even if you knew the customer’s lifetime value, you may be missing an important point. The measurement focuses on the value of current revenue from customers and ignores the option value of your customer relationships?how much business you potentially could do with a customer. Included might be potential revenue from products and services you could offer in the future, as well as additional spending by customers on existing product lines. Consider how Amazon.com has relentlessly expanded the number of product categories and services it offers. Each new category creates new revenue streams and increases the potential lifetime revenue from a customer. Despite initial concerns about Amazon overextending itself, its approach to becoming the “Wal-Mart of the Internet” seems to be paying off. It has become more profitable recently, and its stock price doubled between January and November 2002 in a terrible market. Similarly, brokerage firms that value customer relationships based on the current size of their assets may miss the fact that younger customers may be just getting started on their peak investment years. For that reason, Fidelity Investments considers young professionals under 35 among its “core customers” with the most future potential.

But big is not necessarily beautiful in measuring the value of customers. Your largest customers are not necessarily the most profitable customers. One IT services company I spoke with did a cost-to-serve analysis and discovered that some of its largest customers were actually unprofitable because they were also the most expensive accounts to serve. Sales cycles for larger customers were significantly longer, profit margins were significantly lower and larger customers were extremely demanding of service. The next tier of customers, which had lower revenue potential, was actually more profitable because the cost to serve these customers was significantly less. By using activity-based costing approaches to allocate marketing, sales and support costs to specific customer accounts, you can create a more accurate picture of what your customers are really worth. Once you know the revenue and the cost to serve specific customer accounts, you can align sales-force incentives around customer profitability, as opposed to customer revenue. You can even use this information to improve customer profitability by shifting customers who seek lower prices to online sales and service channels, where your service costs might be lower.

Leverage Early Adopters

But profits aren’t the only measure of the value of a customer relationship. There are customers you earn from, and there are customers you learn from. Companies in markets where products are relatively complex or where customer needs (such as for technology) are poorly understood should be careful to distinguish between those two types of customers. In those markets, there usually is a small set of “lighthouse customers”?knowledgeable customers who can offer feedback on new products and marketplace trends. Those customers tend to experience market trends early, so they can serve as valuable listening posts in emerging markets. For instance, when the e-procurement company Ariba was getting started, it landed Cisco as an early customer and Peter Solvik, Cisco’s former CIO, as a board member. Cisco not only helped Ariba understand what features would be important for e-procurement software, it gave Ariba some procurement software it had written in-house. Those contributions were crucial in Ariba’s early development, and helped it land new customers.

Finally, some customers are valuable not because of the direct value of their relationships, but because they may be opinion leaders or influencers who open doors to other customers. For instance, when Texas Instruments launched its TI-92 calculator in 1996, it worked closely with a large group of high school teachers who developed a sense of ownership over the design. Each teacher in turn influenced the purchasing decisions of hundreds of high school students, despite the fact that the teachers themselves may not have bought a single calculator. Companies such as Microsoft also recognize the importance of “elite” customers and enthusiasts. Microsoft seeds its new products like the Pocket PC and Tablet PC with these elites, and bets that word of mouth or mouse will take over. Beth Goza, who manages the elites and enthusiasts program for the Mobility group at Microsoft, doesn’t share numbers, but says the returns from this seeding program have exceeded Microsoft’s expectations. Microsoft has even succeeded in converting Jim McCarthy, an expert reviewer of Palm devices, to such a Pocket PC enthusiast that he now runs a website dedicated to the handheld device (www.pocketanywhere.com).

Five New Approaches to Customer Value

So when you think about focusing on your most valuable customers, make sure that you value customers based on:

• The total value of their relationship with your company
• The potential value of their relationship
• The profitability of their relationship
• The insights they can provide your company
• The influence that they wield over other customers

By thinking more insightfully about what your customers are really worth, you can focus your resources on attracting and keeping the right type of customers. This focus, in turn, will improve the productivity of your CRM efforts and will position you better for innovation and growth.