Two of biggest questions when approaching any technology investment should be: How much more money can my organization make? and What is the return on my investment (ROI)? There are two ways to justify an investment in customer relationship management (CRM) – increase revenues or reduce costs. Costs can only be reduced so much, but that is generally where most people focus their attention because it is easier to quantify. The really large paybacks in CRM will occur from increasing the revenues of the organization – which some people also refer to as top-line growth. When reduced to the simplest terms, increasing revenues and profits can only be derived from three sources – better customer management, targeted selling efforts and focused customer retention. For this analysis, we will create an illustrative organization called Innovative Company which has $100 million in annual profits and 1 million customers. On the surface, this organization is performing well, and its baseline plans are to grow their customer base by five percent in the next year (with a 15 percent increase in customer growth and a 10 percent reduction due to customer attrition). They have average profits of $100 per customer and are not sure what steps they should take to improve overall profitability. Innovative Company has recently calculated detailed customer profitability for each of its 1 million customers. They have also segmented their customers into 10 profitability deciles, or buckets, to make it easier to focus their attention. The top segment represents the top one percent of the customers with the highest profitability, and the bottom segment represents the 10 percent of customers with the worst profitability results. While the average customer profitability at Innovative Company is $100, profitability ranges from an average $1,150 in the top segment to an average $300 loss in the their bottom segment. This skewed distribution of profitability is typical for most companies in the financial services, telecommunications, utilities and other business-to-consumer industries.
|Profitability Segment||% of Customers||Number of Customers||% of Profits||Average Customer Profits||Total Profits $Millions|
People generally point to the 80/20 rule when discussing the distribution of customer profitability. In actuality, the distribution of profitability in most industries is worse in that more than 100 percent of the profits are typically generated by less than 10 percent of the customer base. In his book, Information Masters, John McKean conducted a study of 35 firms (across financial services, telecommunications and retailing). In those firms that started to measure basic profitability, the highest percentage of profitable customers was 25 percent, the low was two percent and the average was 15 percent. Innovative Company acknowledges that that it cannot simply “fire” its bad customers – since there is really no such thing as a “bad” customer. Most of the blame for the poor profitability results stem from internal policies and past management practices. Instead, Innovative Company will focus on three initiatives to improve overall profitability: better customer management, targeted selling efforts and focused retention efforts.
Better Customer Management
First, we will examine the impact of better customer management. Customer management should be a no- brainer mainstay in organizations today. However, many organizations cannot begin to improve the management of their customers because they lack the information about where to start and where to focus their efforts. Innovative Company has a slight advantage – they know the profitability of each customer and can segment customers by profitability decile. Instead of striving to fix all customers equally, what happens if Innovative Company grows the top customers’ profits by only three percent, the next four groupings of customers by five percent and decreases the losses on the less attractive customers by 10 percent? While the purpose of this analysis is not to focus on how to improve profitability, there are many avenues that can be pursued. The major courses of action are: upsell additional products or services, use more of existing products, increase fees, stop waiving fees or discounting revenues, migrate customers to less costly distribution channels and cut excess capacity and channel costs. With relatively minor efforts, Innovative Company can potentially increase average profits by 11 percent, or $11, per customer. The results are displayed in Figure 2.
|Profitability Segment||% of Profits||Average Customer Profits||% Change in Avg. Profits||New Average Profits|
For roughly 60 percent of the customer base, these changes amount to around $5 or less per year. For the best customers, Innovative Company would need to increase profits by $35 and reduce losses for the worst customers by $30. These improvement goals are relatively modest and should be achievable for most organizations.
Targeted Selling Efforts
Our next improvement source analyzes the impact of targeted selling efforts. Most organizations are still focused on volume goals with little or no regard to the quality of customers acquired. Innovative Company wants to increase their customer base by 15 percent, or 150,000 customers. If they continue to focus on volume goals, they will undoubtedly cast their wide net into the pool of potential customers and get their fair share of good and bad customers. In other words, they will likely acquire customers who generally look like their current customers equally distributed over all segments, and those new customers will have similar profitability profiles to existing customers. What if Innovative Company can slightly modify their distribution of new customers because they have started to target prospects? Since they are new to these targeting techniques, let’s analyze what happens if they can acquire a few more profitable customers and a somewhat fewer customers with an unprofitable profile. The status quo and targeted customer percentages by profitability segment are shown in Figure 3.
|Profitability Segment||Average Customer Profits||% Distribution for Status Quo Selling||Status Quo Selling Total Profits $Millions||% Distribution for Targeted Selling||Targeted Selling Total Profits $Millions|
Without targeted selling, Innovative Company will add 150,000 customers with an average profitability of $125 – which is worth $15 million. By slightly tweaking their distribution of customers, the same number of customers will be added, but they will have an average profitability of $263 – worth more than $39 million. This results in a difference of more than $24 million and a 163 percent increase over the status quo scenario. Is targeted selling worth it? You bet it is.
Focused Retention Efforts
The final improvement source is focused retention efforts. All companies will lose customers to attrition. Innovative Company traditionally loses 10 percent of their customer base every year due to customers moving out of the service area, customer satisfaction issues and other reasons. We can also speculate that Innovative Company will lose customers randomly distributed across all profitability segments. Therefore, as they lose 10 percent of the customer base, or 100,000 customers – they will also lose the $10 million in customer profits from those customers. What if Innovative Company could use the same techniques they used to target new customers to focus their customer retention efforts? Granted, they will not be able to retain all customers and probably will still lose 10 percent of their customer base – but with a different profitability distribution. Let’s look at what happens if they can lose fewer of their more valuable customers and more of their less valuable customers. Without focused retention, Innovative Company will undoubtedly lose 10 percent of their customer base equally spread across all profitability segments – the impact would be losing profits of $10 million annualized. However, this loss can be turned into a profit by focusing retention efforts on their better customers and attrition efforts on their less desirable customers. While it runs counter to intuition, Innovative Company could actually realize a $500,000 increase in profits because the customers lost to attrition represented more losses than profits.
The Bottom Line
Now that we have looked at three initiatives to increase revenues, what is the final impact on the bottom line? If Innovative Company continues operating as they have in the past, their bottom line will grow by 5 percent because the customer base grew by five percent and their distribution of customer profitability remains unchanged. On the other hand, by paying attention to customer management, selling and retention, Innovative Company will still grow their customer base by five percent but has the potential to grow total profits by 10 times that amount with relatively incremental effort. Even if Innovative Company can only achieve 50 percent of this goal, we are still looking at a five-fold increase.
|Profitability Segment||Average Customer Profits||Status Quo Customer Attrition Distribution||Status Quo Retention Lost Profits $Millions||Focused Customer Retention Distribution||Focused Retention Lost Profits $Millions|
While this analysis may appear to be somewhat simplistic, it does highlight several important points:
- All organizations have variability or skewness in their customers’ profitability and overall value.
- Customer profitability is the critical factor for generating payback on CRM initiatives.
- Incremental changes in dealing with customers can leverage into large payoffs.
Another quote from John McKean’s book Information Masters summarizes the major issue at most companies today. “As ridiculous as it may sound, most firms execute only very crude profitability measures in customer relationship initiatives.” How can organizations start to generate these types of returns? In a nutshell, they need to build a strong foundation of customer intelligence which must include detailed customer profitability, data mining and predictive modeling; they need capable marketing tools to measure and manage interaction programs; they need people with strong marketing and analytical backgrounds to plan and execute their sales, up-sales and retention programs; they need to be able to manage and distribute customer intelligence to those who need to transform it into action; and, ultimately, they need to tie this customer knowledge into all customer-facing applications. Tom Humbarger is the founder of thcg, llc – The Humbarger Consulting Group. thcg helps companies navigate the complex and confusing analytical CRM landscape. More background information can be found on the corporate Web site at www.thcg.biz.