Managing Customers for Profits. Skander Esseghaier Koc University

Transcription

1 Customer Selection Metrics: Managing Customers for Profits Skander Esseghaier Koc University

2 The Importance of Customers 2

3 Creating or Destroying Value? In the United States, top executives lose their jobs when their companies sell too little. In Britain, it can happen when their companies sell too much.. The New York Times, March 31,

4 The Rule The common belief is that 80% of a firm s profits come from the top 20% of its customers: the usual rule Several companies have found that 20% of the customers provide 220% of the profits A large number of customers destroy value 4

5 Kanthal Swedish manufacturer of heating systems Case study by HBS professor Robert Kaplan: The two largest-volume customers of Kanthal were found to be the least profitable to the company p p y Analysis of accumulated profitability per customer: 20% of all customers generated 225% of total profits 70% were on the balance point 10% generated a loss of 125% of total profits 5

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7 Pocket Price Waterfall (prices in dollar per square yard) Manufacturer of Linoleum Flooring $6 List price 0.10 order 0.12 $5.78 size competitive 0.30 discount discount payment terms discount invoice price 0.37 annual volume bonus 0.35 offinvoice promos 0.20 co-op ad 22.7% off-invoice 0.09 freight $4.47 pocket price *from Harvard business Review, September 1992

8 Pocket Price Band Not all customers are equal: Can we justify these differences? Percent of Volume *from Harvard business Review, September $5.80 $5.40 $5.00 $4.60 $4.20 $3.80 Pocket Price (in dollars per square yard)

9 The Two Sides of Customer Value Customer Profitability High Vulnerable Customers Star Customers Capturing value from Customers Low Lost X Causes Free Riders Low High Customer Experience Delivering i value to Customers 9

10 The Profit Chain WHAT YOU GET FIRM VALUE WHAT CUSTOMERS DO CUSTOMER PROFITABILITY WHAT CUSTOMERS FEEL CUSTOMER EXPERIENCE WHAT YOU DO INTERNAL RESOURCES 10

11 Customer Profitability Defining and measuring customer lifetime value 11

12 What is Customer Lifetime Value (CLV)? Customer Lifetime Value is the net present value of all future streams of profits that a customer generates over the life of his/her business with the firm 12

13 Calculating Lifetime Value Inflows volume of purchases per period margin on those purchases duration of the relationship Outflows Acquisition costs Development costs Retention costs Duration Time horizon is long-term cash flows are discounted

14 Calculating Lifetime Value Acquisition Investment Spending First Purchase T=0 T=1 T=2 T=3 T=4 T=5 Marketing activities to retain and develop the customer

15 Conceptual Model of Lifetime Value Lifetime Value (CLV) Volume of purchases per period (S) % Margin per unit ( Probability of Purchase in period t (P) Development & Retention Costs (D, R) Discount rate (d) Initial Investment for Customer Acquisition (A) CLV N t 1 (S t π t )Pt - 1 (D d t t R t ) A 0

16 Customer Value of a Tennis Club Member You own a tennis club where the annual membership fee is $ An average club member spends $100 a year at the club (tennis balls, drinks, snacks). Average percent contribution margin on these expenditures is 60%. In addition the club spends annually $40 per member in marketing costs - On average people who join the club have a playing career of 6 years. - Historically, 80% of the members in a given year rejoin in the following year. - It costs the club $175 to acquire a new member. What is the expected net present value of a customer that joins today? (assuming a discount rate of d=15%)? What is the customer value of a tennis member?

17 Customer Value of a Tennis Club Member Revenue Gross Cost of Annual Cash flow Probability Expected per profit acquiring retention from member of being cash flow member per a new cost per if retained retained from member member member member Year 0 ($175) ($175) ($175) 1 $400 $360 $40 $ $320 2 $400 $360 $40 $ $256 3 $400 $360 $40 $ $205 4 $400 $360 $40 $ $164 5 $400 $360 $40 $ $131 6 $400 $360 $40 $ $105

18 Customer Value of a Tennis Club Member Total Gross Cost of Annual Cash flow Probability Expected revenues profit acquiring marketing from Member of being cash flow per per a new cost per if retained retained from member member member member member Year 0 ($175) ($175) ($175) 1 $400 $360 $40 $ $320 2 $400 $360 $40 $ $256 3 $400 $360 $40 $ $205 4 $400 $360 $40 $ $164 5 $400 $360 $40 $ $131 6 $400 $360 $40 $ $105 Customer Value =????

19 Customer Value of a Tennis Club Member Total Gross Cost of Annual Cash flow Probability Expected revenues profit acquiring marketing from Member of being cash flow per per a new cost per if retained retained from member member member member member Year 0 ($175) ($175) ($175) 1 $400 $360 $40 $ $320 2 $400 $360 $40 $ $256 3 $400 $360 $40 $ $205 4 $400 $360 $40 $ $164 5 $400 $360 $40 $ $131 6 $400 $360 $40 $ $105 Customer Value =????

20 Customer Value of a Tennis Club Member Total Gross Cost of Annual Cash flow Probability Expected revenues profit acquiring marketing from Member of being cash flow per per a new cost per if retained retained from member member member member member Year 0 ($175) ($175) ($175) 1 $400 $360 $40 $ $320 2 $400 $360 $40 $ $256 3 $400 $360 $40 $ $205 4 $400 $360 $40 $ $164 5 $400 $360 $40 $ $131 6 $400 $360 $40 $ $105 Customer Value =????

21 Liquidity Premium : Time Value of Money A dollar we receive today has more value than a dollar that we receive a year from today: this is the liquidity premium that a company has to pay to have money available to it now as opposed to one-year from now If I borrow one TL today for a one-year period from a lender at a rate d, I would have to repay this lender (1+d) TL from my next year cash flow to repay the principal + interest The discount rate d is firm specific; it depends on the firm s opportunity cost of money for the firm

22 Discount Factor Accounts for the Liquidity Premium A dollar we receive today has more value than a dollar that we receive a year from today $ 1 Today $ (1 d ) a year from Today A dollar we receive one year from today has less value than a dollar that we receive today $1 a year from Today 1 $ 1 d Discount factor n years from today: Today 1 1 d n

23 Customer Value of a Tennis Club Member Cash Flow Probability Expected Discount Net Present Value from Member of being Cash Flow Factor of Expected Cash if Retained Retained from Member Flow from Member Year 0 ($175) ($175) 1 ($175) 1 $ $ $278 2 $ $ $195 3 $ $ $135 4 $ $ $93 5 $ $ $64 6 $ $ $45 CLV = - $175 + ( $278+$195+$135+$93+$64+$45) Customer Value = $635

24 N-Year Value of a Tennis Member $ 320 1YV $ $ 103 $ $320 2YV $ (1 0.15) $298 $320 YV $ $320 $175 2 (1 0.15) (1 0.15) 3 3 $433

25 Measuring CLV A Simple Approach CLV = Net Present Value Acquisition Cost CLV 2 m m r m r AC 2 1 d (1 d ) (1 d ) 3 Assumes constant margin (m) and constant retention rates (r) CLV 1 1 d r m AC Net Present Value = Profit Margin * Margin Multiple

26 Measuring CLV A Simple Approach CLV = Profit Margin * Margin Multiple Multiple Acquisition Cost Margin Multiple l 1 1 d r Rate (r ) 10% 12% 14% 16% 60% % % % Assumes constant margin and retention rates 26

27 Economics of Customer Acquisition average margin per customer per year = $255 customer acquisition cost = $315 average margin per customer per year = $25 customer acquisition cost = $10

28 Customer Retention Rates 34% 60% Guess who s gone? 72%

29 Measuring CLV Profit Pattern Defection Pattern Annual Profit Customer Tenure Accounts Remaining Customer Tenure CLV AC AC ($42)x(.82) (1 0.1) ($ m )x( s (1 d) ) ($66)x(.76) (1 0.1) ($ m2)x( s 2 (1 d) )......

30 Drivers of CLV Financial Value FIRM VALUE Customer Profitability PROFITS & CASH FLOW CUSTOMER PROFITABILITY Drivers of Customer Value CUSTOMER ACQUISITION CUSTOMER RETENTION CUSTOMER EXPANSION 30

31 Customer Acquisition Choosing the right customers 31

32 All Customers are Important, But Cumulative Profits Profits s: % of Total Cumulative % of Customers 32

33 Some are More Important than Others Customer Profitability Profit ($) Customer Number 33

34 Customer Profit Pattern in Life Insurance Profit per Customer Over Time ) Profit per Customer ($ Age of Account (Years) Source: Frederick Reichheld (1996), The Loyalty Effect, HBS Press. 34

35 Best Buy Decides Not All Are Welcome Retailer Aims to Outsmart Dogged Bargain-Hunters, And Coddle Big Spenders Wall Street Journal, Nov 8,

36 Best Buy: Angels vs. Devils Angels (80%) vs. Devils (20%) Angels segments Jill (soccer-mom type) Buzz (the young tech enthusiast) Barry (the wealthy professional man) Ray (the family man) In Retail, Profiling for Profit, Washington Post, August 17,

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38 Customer Acquisition Strategies Scale up volume Spend more on existing channels Develop new acquisition channels Improve performance Decrease cost per acquisition Shift mix towards high-value h customers 38

39 Customer Acquisition Strategies: Develop new acquisition channels Identify complementary channels What channels out there have contact with our target customers? Will our target customers be open to engaging with our product/service within those channels? 39

40 Customer Acquisition Strategies: A channel story Top 3 US discount store Big gap in performance vs. competition in terms of sales per store in children s apparel How should they close this gap? 40

41 Understand customers how to buy needs Your customers seek a range of service oriented how-to-buy benefits beyond the product-oriented what-to-buy benefits Customers differ on how important different how-to-buy benefits are to them They differ across people and across buying occasions 41

42 Redefining Your Business 42

43 Customer Acquisition Strategies Develop new acquisition channels Design new channels Understand customers how to buy needs, by segment Identify channel alternatives and their fit vis-a-vis these needs 43

44 Customer Retention Importance of retention and its drivers 44

45 Customer Churn Churn Rates for Major Wireless Telephone Carriers - Q Verizon Cingular AT&T Wireless Sprint PCS 2.2% 3.2% 3.1% 3.0% 31% 34% 37% 31% VoiceStream 5.0% 46% Nextel 2.1% 28% 0% 10% 20% 30% 40% 50% Annually Monthly 45

46 Retention is a key driver of CLV Impact on ROI from 25% under spending on -3% Acquisition Budget Allocation 21% Acquisition B2B -55% Retention 79% Retention 14% Acquisition Reinartz, Thomas & Kumar (2005) based on 12,000 prospects of a B2B technology firm Pharma 86% Retention 46

47 Impact of Retention on Profitability nt Value Advertising Agency Auto/Home Insuranc nce Auto Service Branch Bank Deposi sit Credit Card Industrial Brokerag ge Industrial Distributio tion Industrial Laundry Life Insurance Office ebuilding Manageme ment Publishing ing Software Increase in Customer Net Prese Industry Source: Reichheld and Sasser (1990), Zero Defections: Quality Comes to Service, HBR, Sep-Oct. 47

48 Impact of Retention on Firm Value 1% improvement in creates % improvement in firm value of Retention Rate Margin Discount Rate 0.9 Acquisition Cost Source: Sunil Gupta, Donald R. Lehmann, and Jennifer Stuart (2004), Valuing Customers, Journal of Marketing Research, February,

49 What Drives Retention and Loyalty? CUSTOMER RETENTION & LOYALTY Experience and Satisfaction Loyalty Programs Cross-selling Whiskey Blue Destination Bars Whatever/Whenever Service Business travelers with a sense of style can't get enough of the W Hotel chain - Entrepreneur Magazine 49

50 Sources of Customer Value Psychological Value Economic Value Functional Value 50

51 Value Drivers: Economic Value to the Consumer? 51

52 Value Drivers: Functional & Psychological l Value 52

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54 ipod + itunes 54

55 Tablets: TouchPad vs. IPad 55

56 ipod + itunes + ipad: An Integrated Media Platform 56

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58 Starbucks I d like a tall Toffee Nut Latte with non-fat milk, no whipped cream, extra hot, to go 58

59 Starbucks: The Price of Experience $5 Starbucks Frappucino $1 Bulk Beans Ground Coffee Cup of Coffee No Brand Traditional Brand Starbucks 59

60 Challenge for Starbucks 60

61 Brand Resonance Pyramid 4. RELATIONSHIPS = COLD Consumerbrand RESONANCE Consumer Consumer JUDGMENTS FEELINGS HOT What about you & me? 3. RESPONSES = What about you? Brand PERFORMANCE Brand IMAGERY 2. MEANING = What are you? Brand SALIENCE 1. IDENTITY = Who are you? 61

62 Community Building 62

63 Community Building 63

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66 Community Building Skip used to be a Mac person, but switched. I found this morally reprehensible... He s kind of a Mac turncoat. 66

67 Loyalty y Programs 67

68 Loyalty/Frequency Programs Are they effective? Do they give a competitive advantage? Have they become a competitive necessity? 68

69 Retail Sector Study (McKinsey & Co.) It costs up to $30 million in the first year, and annual maintenance costs can total $5 to $10 million a year thereafter Retailers need to increase store sales by about 6% on average, just to break even 69

70 Airline Sector Studies 92 million travelers (73% of them American) are members of at least one of the 90 worldwide frequent flier programs and many Americans belong to five or more Business Lifestyle Survey of 5,000 frequent travelers in the United States, Britain, France, Germany, Italy, Singapore, Hong Kong, Japan and Australia nine-out-of-ten business travelers are frequent flyer program members 70

71 Latin Pass Fiasco In January of 2000, it offered a one million mile bonus to customers who, by July 1, 2000: flew at least one international segment on each of its member airlines, plus took three flights on partner carriers, stayed three nights in partner hotels, and rented a car for five days from a partner rental agency Reference: Keiningham, Vavra, Aksoy and Wallard (2005), Loyalty Myths 71

72 The Pudding Guy David Phillips, the 35-year-old Davis, California, earned 1.25 million frequent flier miles by cleverly exploiting a Healthy Choice promotion that offered air miles for product purchases. Phillips ended up with $25,000 to $75,000 in free travel by spending only $3,140 on pudding cups, the least expensive product in Healthy Choice s brand family. Phillips achieved this remarkable reward by figuring out a way to earn one hundred American Airlines frequent flier miles for each 25- cent cup of pudding he purchased. He ended up with 1.2 million air miles - worth 48 free domestic airline tickets - and 12,000 desserts Reference: Keiningham, Vavra, Aksoy and Wallard (2005), Loyalty Myths 72

73 Product focused or Customer focused? Brand 1 Brand 2. Customer Customer Customer

74 Transformation at Harrah s From property focused to customer focused

75 Customer Focus at Harrah s Source:

76 Do Rewards Really Create Loyalty? An underlying product or service that provides value is a pre-requisite requisite to creating loyalty to the brand Loyalty programs won t salvage an inferior product However Loyalty programs that provide value other than monetary value (aspirational value) are valuable tool for building true loyalty O Brien, Louise, and Charles Jones (1995), Do Rewards Really Create Loyalty? y Harvard Business Review,, 73, no. 3 (May), 75

77 Designing a Valuable Loyalty Program Rewards need to be relevant to the customer Give choice to customers about how they want to use their rewards is critical Provide convenience in redeeming rewards

78 Customer Expansion Share of wallet and Cross selling 78

79 Inside: 23K Outside: 498K Top Quintile Large 4th Quintile Size of Wallet Small 3rd Quintile Inside: 2nd Quintile 34K Outside: 2K Bottom Quintile (0, 0.2] (02 (0.2, 04] 0.4] (04 (0.4, 06] 0.6] (06 (0.6, 08] 0.8] (08 (0.8, 1] Small Share of Wallet Du, Rex et al, Imputing Share of Wallet, Marketing Science Conference, June Large 79

80 Share of Wallet 80

81 Size of Wallet 81

82 Managing Customer Development Inbound Selling Attempt to sell only when the customer calls you (usually for something else) Bundling/Cross Selling Sell additional products to customer that sought you for a particular item Up Selling Switch consumers to higher margin items

83 Managing Customer Development Bundling/Cross Selling Offer a broad range of products Develop cross-selling marketing programs where target customers are contacted with the right offer at the right time 83

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85 Impact of Bundling on Churn Average Monthly Customer Churn 3.0% 23% 2.3% 22% 2.2% 1.9% 1.4% Video Only Video +HSI HSI + Phone Video + Phone Video + HSI + Phone Bundling reduces churn as much as 50% in 3 product homes! Source: Cox Communications 85

86 Managing Customer Development Up-selling Create a line of products with escalating benefits and incrementally higher price levels Possible strategies service (warranty, service support) wider product line (compromise effect) 86

87 Managing Customer Development Up-selling Beware of hard sell Hard sell could lead to customers spending more than they needed to and regretting it later Regret lead to customer dissatisfaction and churn 87

88 Why is Inbound Selling Effective? Focus sales efforts on customers who have entered the buying cycle Use of timely intelligence about prospects by sales people results in more successful customer engagement g Customer feels in control Telephone is the preferred contact point with banks 30% of the time 88

89 Return on Investment From customer value to firm value 89

90 The Profit Chain WHAT YOU GET FIRM VALUE WHAT CUSTOMERS DO CUSTOMER PROFITABILITY WHAT CUSTOMERS FEEL CUSTOMER EXPERIENCE WHAT YOU DO INTERNAL RESOURCES 90

91 CLV helps in better Customer Selection 32% customers were unprofitable - Niraj et al. (2001) based on 650 customers of a distributor Top 30% cross-selling prospects have predicted usage probability of greater than 80% - Kamakura et al. (2003) based on 5,500 customers of a Brazilian bank Revenue from top 30% customers based on CLV model was 33% higher than the top 30% customers selected based on RFM model - Reinartz & Kumar (2003) based on 12,000 catalog customers Profit from top 5% customers as per CLV model was 10-15% higher than the profit from top 5% customers from other models - Venkatesan and Kumar (2004) based on 2,000 B2B customers 91

92 and helps in better resource allocation Source: Thomas, Reinartz and Kumarv (2004), Getting the Most Out of All Your Customers, Harvard Business Review, July-Aug,

93 The Benefit of CLV Models 530% % ROI Field test on 3 groups of 24,000-50,000 customers Based on Bank s heuristic Based on purchased list - Knott, Hayes & Neslin (2002) -17% -30% Based on Cross-selling model 93

94 CLV provides a good proxy for Firm Value $ Billions A mazon A meritrade Capital One E -B ay E *Trade Customer Value MarketValue (as of March 2002) Source: Sunil Gupta, Donald R. Lehmann, and Jennifer Stuart (2004), Valuing Customers, Journal of Marketing Research, February,