The Hindu Business Line : Customer discrimination as strategy

Customers are the raison d’être for any business. Without customers, there is no business. While business-to-business markets may have a few hundred customers, the number may run into millions for consumer markets. Not all customers are, however, created equal.

It is common wisdom that businesses generate a large percentage of their revenue and profits from a small base of customers. A quick review of customers’ purchasing pattern will reveal which customers are creating value for the business and which ones are causing a drag on profitability. Managers, however, adopt a ‘one size fits all’ approach in serving all customers by providing the same level of service, customer support and pricing. As a result, they give away a large amount of value to those customers who do not deserve it.

Businesses ranging from retail to mobile telephony and from financial services to industrial goods experience the phenomenon of varying levels of customer profitability. Let us look at an example of a retailer to explain the phenomenon. Customer profitability analysis for the company showed that only 40 per cent customers generated 100 per cent profits. Another 30 per cent produced modest profits while the bottom 30 per cent generated negative returns and so nullified the profit produced by the middle 30 per cent, as in the figure on the left.

The finding obviously came as a surprise to the retailer. However, it was easy to understand the differences in customer profitability. While customers generated different levels of revenue, the company ran its business by ‘we treat every customer in the same way’ dictum and therefore incurred more cost for marginal customers. The implication is therefore clear: not all customers are equal, so treat them differently.

Segment by value

Segmentation lies at the heart of an effective customer strategy but companies seldom go beyond demographics to understand differences in their customers. The first step towards developing effective strategy is to understand customer behaviour and determine the value they add now or can add in the future. While revenue is sometimes taken as a proxy to measure customer value, it is profits that businesses strive for. Moreover, there is little point in generating revenue if it does not lead to profitability either now or in future. There are some exceptions, however, when revenue could serve as an effective indicator of customer value. An example is when adding more customers leads to economies of scale or provide a steep learning curve in the start-up phase of a business and thus bring down costs over longer term.

Companies can also estimate customer value by what we call the MRF method where M stands for monetary value of customers; R for recency of purchase and F for frequency of purchase. The MRF method provides a better view of customer value over a period and can help in predicting future customer behaviour. Once a company has determined customer value by using a relevant measure, the next step is to understand customer fit with company strategy. It can be done by profiling current customers on the basis of segmentation criteria and matching their profiles with company’s target customers. Finally, customer value is mapped against customer fit for developing effective strategies to deal with segments in a differentiated manner. Customer value and fit give us four strategies to discriminate among customers.

Reward

Customer groups who have high level of fit and add maximum value to the company are the best ones to keep. By rewarding these customers, businesses can generate greater lifetime value and use resources effectively.

Upsell/cross-sell

Low-value customers who have a good fit with the company need to be understood for the reasons of low value. It may happen that their current needs are not met effectively and they may require a different value proposition. After careful analysis, companies can think of upgrading these customers to high-value products. It is also possible to sell products from other categories to these customers. For example, if a fashion store sells a wide variety of goods but finds that some customers are buying only apparel, it can target these customers for footwear, accessories and fragrances also. By cross-selling to customers, the company will reap economies of scope and move the customers to the high value zone.

Raise prices

Customers who neither have a good fit nor add any value are the real cause of worry but the hardest to deal with as companies keep them hope that they will turn profitable some time in future. However, lack of customer fit with company strategy makes it unlikely that these customers will turn more valuable in future. The logical alternative for these customers is to raise prices in steps to make them look for other suppliers and at the same time avoid any alienation. Axis Bank adopted this strategy to customise its fee structures and charges on a case-by-case basis according to customer profitability.

Monitor behaviour

High-value customers who do not have a good fit with the company need to be monitored for their purchase pattern over a period. The questions to ask are whether they use automated channels or they buy in bulk but less frequently. At the same time, it is important to analyse their profile in more detail and ascertain whether they really have a lack of fit with company strategy. By discriminating between the best and the worst customers, companies not only stop the value loss but also create more satisfied customers who really matter to their business.

(The writer is a partner at consulting firm Kanvic where he leads strategy practice.)

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