Return on Customer: Wall Street

Most firms focus on short-term results, not long-term value.
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Although shareholders want long-term value, Wall Street tends to be driven by current-period numbers. As a result, many companies sacrifice long-term value to make their quarterly numbers. This, in turn, leads to bad management decisions and unethical corporate governance.

One of the main reasons Wall Street analysts are uneasy about Return on Customer is the fact that this metric requires you to track changes in the lifetime value of customers. In other words, you’re predicting how customers will behave in the future based on what you do differently today. At first glance, this would seem to make projecting ROC to be a haphazard exercise, but the reality is that some quite robust predictive modeling techniques can be used to determine this figure accurately. Any firm that maintains computerized records of customer transactions can predict a customer’s lifetime value with confidence.

While forecasting a customer’s lifetime value won’t be easy or trivial, you will actually get better at doing this with experience.

Keep in mind whether you realize it or not, you’re already basing many business decisions and actions on predictions about the future. For example:

You’ll be predicting market prices of the future

You’ll be anticipating where production logjams will arise

You’ll be predicting currency fluctuations, employee hiring rates, etc

You’ll have R&D timetables and investment return targets

You’ll know your likely delivery schedules and inventory losses

In many ways, the predictions that go into calculating ROC are actually more accurate and more stable than the predictions that you’re now making in other areas of your business. In essence, to measure changes in the lifetime value of your customers, you have to first identify and then track the leading indicators of lifetime value. To do this:

Go back through your transactional records or other customer data and calculate roughly what a customer is worth to you at present. Look at several years of data, factor in any repurchases or add-on purchases, and develop a baseline figure for the lifetime value of your average customer. Ideally, you want to be able to go through about ten years or more of data during this stage of your analysis.

Once you have a clearer idea of the lifetime value of each customer, try and identify what the most predictive variables are with respect to that lifetime value. Look for any correlations that may exist along the lines of “almost all of our best customers exhibited this kind of purchasing behavior.” This will be a matter of going through your transaction records and looking at frequency of purchase and other variables like age, gender, demographic characteristics, and so forth. Bear in mind that this is a statistical prediction, so your information won’t be perfect. Also keep in mind that various outside factors like the general state of the economy will also impact the lifetime value of your customers. There will also be challenges with the availability of data, analytical issues or considerations and various other factors that will cloud the analysis. However. However, the more you work at this, the clearer your vision will become over time of the general factors that impact the lifetime value of each of your customers.

In broad terms, leading indicators of changes in the lifetime value of customers tend to fall into four general categories:

1. Internally generated growth: where companies do things differently in an attempt to increase customer retention and facilitate additional purchases. As a rule of thumb, for each 1-percent improvement in customer retention rates, customer equity usually increases by 3 or 7 percent.

2. Lifestyle changes: where customers get married, have children, get a new job, retire or get divorced. Anytime a customer’s lifestyle changes their lifetime value will also change. If you can track these lifestyle changes in your customer base, you can predict by how much customer lifetime values are growing or declining.

3. Behavioral clues: whether customers are buying add-on products and product upgrades as they become available, their willingness to pay more for a premium product, or even whether they make a service call and get their complaint handled professionally. The trick here is to sift through all the customer information that is generated during your normal course of business and find the patterns of consumption embedded therein.

4. Customer attitudes: which will include satisfaction levels, willingness to recommend your product or service to their friends, etc. These attitudes are strong indicators of future behavior since attitudes influence behavior to a great extent. Customers are also influenced by the perception of whether or not a firm pays attention to their needs and treats them as individuals rather than as mere statistics.

The sooner you can see any changes in lifetime value, the better. Some smart companies develop small and exclusive clubs for their best high-value customers. New marketing or product ideas can then be offered to these club members first. The results can be tracked and then expanded to all customers at large. This type of premium customer club is an excellent source of leading indicator information. At the same time, a company can work at increasing its market value by increasing the customer equity represented by its highest value customers.

Some companies attempt to develop a business dashboard that indicates how successfully the company is increasing its ROC. A few firms find it helpful to come up with a mix of different indicators–a few key behavioral clues, a couple of measures of customer attitudes and one or two lifestyle indicators perhaps. Note, however, that ROC is quantitative rather than qualitative. Although non-financial leading indicators may be used, the lifetime value of a customer will be specified in dollars and cents.

The Return on Customer metric explicitly takes into account the two different ways customers create value for a business–by increasing the company’s current-period cash flows and by increasing its future cash flows. When a customer has a good (or bad) experience with a company, and decides on the basis of that experience to give more future business to it (or less), the firm has gained (or lost) value at that instant, with the customer’s change of mind. It doesn’t matter that the extra business a customer might give the company won’t happen few months or a few years–the customer’s intent has changed already, and so the customer’s lifetime value went up immediately, in the same way a share price would go up immediately if the company was suddenly expecting better profits sometime in the future.

–Don Peppers & Martha Rogers

The people who work for GE do so because…

The people who work for GE do so because they want to be about something that is bigger than themselves. People want to work hard, they want promotions, they want stock options. But they also want to work for a company that makes a difference, a company that’s doing great things in the world.

–Jeffrey Immelt Chairman and CEO, General Electric

For the last five decades, most thinkers…

For the last five decades, most thinkers have described business success in terms of competition. We talk about market share and competitive advantage, we use dozens of sports metaphors–all about winning and losing. The other line of thought–serving customers–has never had the intellectual cachet or hot press of the competition model. But the truth is, the customer service model is more profoundly right than the competitive model. For economists, the role of competition is to improve value to the customer. For business people, the only guaranteed way to win against competitors is to do a better job serving customers. In both views, customer acceptance is the cause; competitive success is the second-order effect.

–Charles Green coauthor, The Trusted Aduisor

Return On Customer: Scarcity

Customers are any company’s scarcest resource.
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In this era of globalization, capital is exceptionally mobile and costs have been reduced as far as they can go. There is an excess of most products and most services. In today’s business environment, nothing is as scarce as customers.

In many markets and product categories, there are too many products chasing a finite pool of customers. Traditionally, it was assumed that availability of capital was the limiting factor in growing an enterprise. Today almost anyone can get access to all the capital they need, and it is customers that are difficult to find and hard to keep. To remain competitive, businesses have to figure out:

How to keep customers longer

How to grow small customers into bigger customers

How to make each customer more profitable

How to serve customers more cost effectively and efficiently

How to get more customers

In essence, the key challenge in business today is to get customers to trust your firm. The more a customer trusts you will act in his or her best interests, the more business they will give you both in current-period transactions and likely future transactions. Traditional marketing treats each new customer transaction independently whereas in the real world, customers have long memories. Their future intentions are influenced heavily by how a company has treated them in the past. Trust is the glue that binds a customer to a firm, and makes those customers predisposed to do more business in the future.

Trust flourishes whenever a firm looks at its value proposition from the customer’s perspective instead of solely from its own point of view. This principle of reciprocity, sometimes described as “the Golden Rule,” in practical terms simply means firms should treat customers the they would like to be treated it the roles were reversed.

Note that to earn and retain customer trust, you can’t just limit your recommendations to your own product or service. You also have to tell customers about how they can address their needs using the products and services provided by other parties. If you fail to do that, you’re in effect hiding your head in the sand and hoping your customers will do the same long enough to give you their money.

Sometimes it’s difficult to build customer trust. For example, airlines have very complex business models where passengers on the same flight can be paying a variety of different fares. This pricing flexibility is great for the airlines because of the fact that their seats are perishable–an airline seat flying empty generates no revenue but is still subject to the airline’s high fixed costs. From a customer perspective, however, it’s confusing to try and find just what is the best deal. For this reason, airlines have a difficult job earning the customer’s trust.

To summarize, the biggest challenge in business today is to create the kind of culture that maximizes your value to your customers. If you do this, you also maximize the amount of customer trust, which in turn maximizes the amount of customer equity you create. This kind of culture is also a more satisfying place for your employees to work. Furthermore, this type of corporate culture also introduces some checks some checks and balances into the management–it will be impossible for a firm to act unethically if everyone is focused on serving the best interests of customers, shareholders and employees.

Quarterly reporting of financial results has certainly created a highly competitive business landscape. But it also drives executives to pursue contradictory business goals. Company managers are expected to strive for long-term value and growth in order to increase true shareholder value, even while they are also pressured to deliver against more and more aggressive short-term goals. Moreover, as financial systems become more sophisticated, we measure performance with continually shortening yardsticks. Some companies now boast about their ability to close a quarter in one day. Stock market analysts focus on short-term results as a proxy for long-term potential. The problem is that the more short-term a company’s focus becomes, the more likely the firm will be to engage in behavior that actually destroys long-term value. The obsession with current revenue and earnings at many firms has generated a pervasive culture of bad management.
–Don Peppers & Martha Rogers

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Return on Customer

October 29, 2008 by office  
Filed under Customer Service, Sales

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Creating Maximum Value From Your Scarcest Resource
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Most people are familiar with the concept of return on investment–how well a firm creates added value from a given investment. There is, however, no equivalent metric that measures how well a company creates value from its most scarce and therefore most valuable asset–its customers. Return on Customer (ROC) is a new business metric that is designed to measure the amount of value a business creates by acquiring, retaining and then growing its customer base. It is calculated in this way:

Return on Customer = Current period cash flow + Change in customer equity = Total customer equity at the beginning of this period where:

Current period cash flow is the revenue the company will generate in this period through the sale of products and services.

Customer equity is the net present value of all cashflows the company expects to generate from customers over their lifetimes.

Change in customer equity is the increase or decrease generated in this period by the actions of the company.

When ROC is positive, your firm is creating value from your customer base, either by increasing sales in the current period or by enhancing the likelihood the customer will do more business with your firm in the future. This lifetime value of future business is captured by changes in customer equity, which in essence is the current discounted-cash-flow value of a customer’s future business. Conversely, when ROC is negative, your firm is destroying customer equity or customer lifetime value, making it less likely you will be able to generate profits from your customer base in the future.

Return on Customer represents the costs and trade-offs that are inherent in business. For example, if a firm carries out an aggressive telemarketing campaign, it might increase current period sales but also erode the likelihood customers will buy again in the future. That harm to the customer lifetime value won’t be captured by any other established business metric, and yet it might even exceed the boost in current sales that was achieved. Conversely, if a firm always focuses on customer equity, it may not generate enough profit on a current basis to stay in business. To maximize Return on Customer, companies need to optimize their mix of short-term profit and long-term customer equity created.

The arguments in favor of return on capital as a management metric are:

The seven key arguments for using Return on Customer (ROC) as a management metric

1. Scarcity: Customers are any company’s scarcest resource

2. Well Street: Most firms focus on short-term results, not long-term value.

3. Balance: ROC helps firms optimize trade-offs and make good decisions.

4. Perspective: To increase ROC, firms must take the customer’s perspective.

5. Personalization: To maximize ROC, treat different customers differently.

6. Leverage: ROC creates great leverage for your competitive strategy.

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