The Hindu Business Line : Better vaguely right than precisely wrong

ARE you spending more on your customers than they are worth? What a repulsive question, you may exclaim as a customer, but the poser stares at you from the cover page of a new book by Sunil Gupta and Donald R. Lehmann: Managing Customers as Investments, from Pearson Power (www.pearsoned.co.in) .

Customers are assets, the authors agree; yet, they caution that most firms are caught in a trap of spending tons of money in customer-oriented programmes — "from satisfaction measurement to CRM, where investments of $100 million or more are not uncommon." When managers find it tough to show a tangible impact of massive spends, companies tend to lapse into "proven short-term strategies, such as promotions, cost-cutting, or financial re-engineering."

Is there an alternative? Yes, according to the authors; you can identify the key levers that drive customer value, they assure. "We bridge the gap between marketing and finance by providing a common language and specific metrics," they promise, and base their work on the premise that it is better to be vaguely right than precisely wrong.

"CLV or customer lifetime value is the present value of all current and future profits generated from a customer over the life of his or her business with a firm," explains the book, and looks at "two key pieces of information" typically required for estimating CLV customers' profit patterns and their defection rate. It is easy to track defection in contractual arrangements such as insurance, phone and cable; but in non-contractual services such as what Amazon provides, customers don't call up to say they are defecting.

"Even companies with contractual services only track average defection or churn rate, which is simply the number of customers lost in a period divided by the total number of old and newly acquired customers," point out the authors. A simpler approach that they propose is captured in the equation CLV = m(r/(1+i-r)) where `m' is the margin or profit from a customer per period, `r' is the retention rate, and `i' is the discount rate. Three assumptions are: "Constant margin and constant retention rate over customer lifetime, and an infinite time horizon for estimating CLV."

All animals are equal but some are more equal than others, said George Orwell in Animal Farm. Citing this quote, the authors state that the same is true for customers. Ever wondered, "Who are the best customers for a casino?" Conventional wisdom says you can bet on "gold-cuff-linked, limousine-riding high rollers," but Harrah's Entertainment discovered that customers with high lifetime value included "middle-aged and senior adults with discretionary income who enjoyed playing slot machines." Moral of the story is that "customers' value not only depends on how much they spend on a single occasion but also their purchase frequency and longevity," infer Gupta and Lehmann. Don't miss the `customer-based costing' discussion where the authors cite a McKinsey study that `pocket prices' varied by as much as 500 per cent in very price-competitive and commodity-oriented industries.

Customer focus, in the place of being product-centric, can impact your organisation structure. "A product manager knows whether a customer buys or does not buy his or her product but does not know the firm's share of that customer's wallet." As a consequence, the firm loses cross-selling opportunities. "A pricing policy that may be sub-optimal for each individual product may actually be very profitable from a firm's perspective, because it may induce a customer to buy multiple products and lead to a higher retention rates."

Look at the `share of wallet,' by getting to know what your customers spend with competitors; don't stop being company-confined. Define your competition broadly, for the purpose. Visa's competitors are not only MasterCard and American Express, but also cash and cheques, explain the authors. "While defining competition narrowly leads to larger share values and a sense of pride, it also can lead to missing key trends, new competitors, and emerging opportunities," advises the book.

A book that deserves a share of your wallet and time too.

BookMark@thehindu.co.in