The Future: on Customer Value Analysis

By Brian Hopkins, director of CRM consulting firm Brain Box, South Africa.

Ouch!  Increasing competition really hurts!  Cellphones, casino’s, the lotto, huge increases in petrol prices and the cost of home security, these are just some of the things, apart from direct competitors, being blamed by South Africa’s retailers for their disappointing sales and sagging share prices.  Add a sluggish national economy and the picture looks even worse – and not just for retailers.  

Little wonder that so many companies are embracing the concept of Customer Relationship Management (CRM) as if it was a newly discovered lifeline for distressed marketers!  After all it is easier, and cheaper, to keep the customers you have now than it is to recruit new ones.  But is that true of all customers and all markets?  Not according to those companies that have taken advantage of low cost computing to build large-scale customers databases, and have realised that there is no such thing as an average customer. 

Not all customers are the same

Having a customer database is the first requirement for building true one-to-one customer relationships.  That is why so many companies have invested in customer identification programmes.  Airlines were among the first to do this in the 1980’s with frequent flyer programmes, followed by hotel and car rental, furniture and clothing credit retailers and more recently by cash businesses such as supermarkets, filling stations, book and record stores.

Analysis of some of these databases by customer value has produced some amazing statistics.  For example, in the USA, just 0,2% of car rental customers account for 25% of all rentals (and that’s the equivalent of 130 spectators out of a capacity crowd of 65,000 at Ellis Park Stadium in Johannesburg!). 

Local business-to-consumer and business-to business case studies closely model the international perspective.   Clicks have nearly three million members of their ClubCard programme, of which 450 000 (around 13%) are high value members who qualify for gold card status.  10% of Exclusive Books Fanatics club members contribute 50% of turnover.  SAA knows that less than 10% of Voyager frequent flyers earn the majority of free air miles.  One of the big four banks has calculated that the top 5% of its customers account for 150% of its profits, with the rest costing them money. 

Even some companies without databases have identified significant differences among customer groups.  For example, in the United Kingdom, 6% of cola drinkers consume 60% of volume and 15% of households (the ones with young children) make up 45% of Heinz sales each year.  There is nothing new in this. Average statistics like these just reinforce the problem experienced by Lord Leverhume, who knew that 50% of his advertising was wasted, but didn’t have the tools to identify the 50% of consumers that represented the best prospects for his company’s products.

Congratulations Vilfredo!

If Vilfredo Pareto were alive today, he would be delighted that proof of his principle, that wealth is not distributed evenly, could be found in so many business situations.  Satisfied, qualified customers making regular repeat purchases frequently account for 80% of a company’s profits.  But for almost every business the core group of high spending, high profit customers is made up of much less than 20% of the total number.  More importantly, they represent an even smaller, sometimes microscopic proportion of prospects in the target market. 

Strange then, that so many marketers spend so little on the customers who contribute the bulk of profits, but continue to spend vast amounts each year trying to attract new customers with unknown potential value.  This perverse form of mass marketing socialism could have been used to great effect by Pareto when he set out his principles in the Cours d’Economie Politique published in 1896.

Assuming that you do track customer purchases in a database, a practical method for checking to see if the Pareto Principle applies is to take the most recent 12 month’s turnover and to rank your customers from top spending to bottom spending in the period. Then divide the total turnover into ten equal groups and starting from the top-spending customer, find out how many made up 10% of turnover.  Then repeat this for each of the remaining ‘deciles’, as shown in the table below. This presents an analysis of a business with 545,961 customers and annual turnover of R109 million.

The table shows that the top three deciles contain 5,999 high spending customers who contribute 30% of turnover while at the other extreme 404,786 customers (74,1% of the base) contribute just 20% of turnover.  Depending on the size of your customer base, grouping customers into three value tiers (high, medium and low spending or low profit) is a good starting point, but it is a good idea to drill down further when any single decile exceeds 40% of turnover.

Getting to grips with churn

The next step in customer value analysis is measuring customer retention, or the more sobering opposite, customer attrition.  For some reason, very few companies seem to measure even average retention.  Perhaps exposing attrition rates of 25% to 30% could be rather career limiting, but these percentages are not unusual for South African companies or their global counterparts.  An average retention rate of 75% means that for each 1,000 customers you have currently, only 75 will remain at the end of ten years.  But again, looking at averages can be highly misleading. 

It is essential to find out how many of last year’s high value customers remained high value this year.  If you are losing customers at this level, you have a serious problem.  High value customers are most involved in the brand. They should be your most profitable customers and with the lowest levels of attrition.  One top-spending customer would have to be replaced with many new, low spending customers just to stand still (in the table, 490 new customers in decile 10 would be needed to replace one lost decile one customer).

But even the loss of low value customers can be staggering.  Take the example of a convenience store that loses one customer each day who spends on average R25-00 a week.   Over a year the value of lost business totals R241,150!     [R25-00 x 7 customers a week x (52 + 51 + 50…+1)] = 175 x 1,378 = R241,150.   If these are unprofitable customers, and they have not responded to previous efforts aimed at making them profitable, the best plan could be to ‘retire’ them and instead concentrate on developing the more profitable customer segments.

Back to the future

Understanding a customer’s previous buying behaviour provides a good indication of their future behaviour, and a useful analytical tool is customer lifetime value analysis (CLTV).  CLTV brings together a picture of the customer’s previous buying behaviour, factors in the retention rate, and projects purchase value over a specific period into the future, usually five or ten years.  Then to calculate customer profitability, variable costs (for example of the cost of regular customer mailings) are deducted to arrive at net profit, and the sum is brought back to net present value using an appropriate discount rate.

Lifetime value calculations can be highly complex, especially if you make allowances for new customers joining during the year and their individual future lifetime potential.

Unlocking customer value

Differentiating customers by value and determining the levels of retention are the first tentative steps on the CRM journey.  But the real challenge is to use the information to unlock the potential profit that lies dormant in almost every business.  Here are four action plans that will help.

Start by determining the level of customer retention for each of your value tiers (high, medium and low).  The retention rate is the most important number in projecting future customer profitability.  If high value customers are leaving or spending less than last year, it is essential to find out why.  Local and international research exercises repeatedly highlight poor customer service as the number one reason for customer defection, not product or price issues.  Whatever the reasons, implement corrective measures to address any problems that are under your control.  Then identify the customers you would like to win back and tell them what changes you’ve made.  A customer’s second lifetime value can be even greater than the first.

Then introduce programmes aimed at locking in your high value customers. Encourage regular feedback and two-way dialogue. Find out what they like and dislike about doing business with your company.  Set up customer and staff panels to review and improve on service levels.  Allocate a greater proportion of your budget to this group and develop customised offers, communications and recognition programmes.

Next devise and test market different strategies for increasing the share of wallet of your middle value customers.  Compared to the high value customers, these are less loyal and purchase less frequently, spreading their purchases in the category between your business and your competitors.   Secure a greater share of their spend by introducing frequent customer, loyalty and recognition programmes.

Finally be more selective about the customers you recruit.  Use the profiles of your high value customers to identify high value prospects.   Research how well their needs are being satisfied by your competitors, then use targetted campaigns with strong reasons and incentives for them to sample your business.

Note that three of the four action plans involve existing customers – and that is exactly where your business should be focussed.  Stop worrying about your competitors, both traditional and new ones, and concentrate your efforts into building lasting, profitable, one-to-one relationships with your customers.  That after all, is the primary purpose of customer relationship marketing.