How Much Should Be Spent on CRM?

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Everyone is installing customer relationship management systems. Millions of dollars are being spent on software, hardware and CRM personnel.


Few companies have done any significant cost justification. If they did, their spending patterns might be quite different.


CRM usually consists of building a massive data warehouse that is accessed by expensive CRM software such as E.piphany or Siebel. Many companies have spent more than $20 million on the warehouse and another $1 million or more on the software. The software is supposed to use the database to select prospects and customers for promotions at strategically crucial moments in the customer's life cycle.


CRM is supposed to have two tasks: customer acquisition and increased sales to existing customers. CRM is often justified by the phrase, "Make the right offer at the right time to the right customer."


CRM can do this by collecting demographic and behavioral information about each prospect and customer and using that to create actionable customer segments. This leads to communications that make relevant offers, which will strike responsive chords in the recipient's mind and will result in sales.


The following is an example of what happens when you do not use CRM. Someone at Chevy Chase Bank called me at dinnertime a few years ago to tell me that as a very good customer, I was being offered free life insurance for two months, after which the cost would only be $14 per month. I asked the value of the life insurance. The sales woman replied, "$2,000."


This was a ridiculous offer because I already had $300,000 worth of life insurance. Why would I want $302,000? It was a CRM failure because Chevy Chase knew that I had $300,000 worth of life insurance.


The bank was aware of my life insurance because I had to tell them that on the home equity loan application I had filled out in connection with getting a loan. I signed a statement saying the bank could use the information provided. The bank did not use the information it already had to make a relevant offer. Instead, it took a list of bank customers and gave it to a telemarketing firm. With a properly used CRM data warehouse and CRM software, Chevy Chase could have made me an offer that would have been worth listening to and possibly profitable for us both. But it did not. The bank did not have a warehouse and did not use the information it already had in its marketing activities.


If CRM success is in using customer information to create profitable customer communications, how can you measure CRM effectiveness or return on investment?


To do the measurement, you have to recognize that almost all of CRM's effects are incremental. If successful, CRM results in higher response rates, higher conversions and increased sales. But the original sales are seldom a result of CRM itself. Almost all companies already sell products and services before they add CRM. The CRM is financed out of the profits from their existing operations. The hope is that the CRM will make those operations more profitable.


So the expectation is that current sales of $100 million will become significantly higher by using customer and prospect information to make more relevant and timely communications.


Could CRM increase sales by a measurable amount?


Perhaps, but only in certain unusual situations.


Those using CRM effectively will have higher conversion rates than those that do not. How much can CRM increase conversion rates?


First, it is necessary to determine current conversion rates. Assume that a corporation makes 50 million offers per year to the general public. These offers may be through television, radio, print advertisements, retail stores, direct mail, e-mail, etc. Assume that 3.5 percent of the offers result in a sale.


If CRM is to be successful, it must increase the conversion rate.


How much of an increase can we expect?


The rate will differ in each case.


So, make some generous assumptions and say that CRM will increase conversion rates by 8 percent. Next, you have to determine the cost of CRM. If you build a database for $20 million, it certainly has a shelf life of five years or less, making the annual depreciation about $4 million. Annual maintenance and upkeep (adding data, cleaning data, appending data, merge/purge, running reports) plus software and staff will cost about $2 million. The CRM warehouse is useless unless accompanied by customer communications, which will have a cost, say $2 per customer per year. The total cost of CRM will thus be $9.5 million per year.


So what will happen to net sales as a result of the CRM initiative?


Sales will go up, but net sales after deducting the cost of CRM will go down.


How realistic are these numbers?


Consider the views of Gartner Inc., Stamford, CT, which estimates that 60 percent of the CRM projects now being launched will fail by 2003. They will fail because the companies installing CRM have not done the analysis and are relying on unrealistic ideas about the effect of CRM on conversion rates.


Remember that corporations installing CRM are in almost all cases already profitable. They are doing everything they can to make a profit. They give points or miles. They hire advertising agencies to produce winning commercials. They have distributors and retail stores, salespeople with laptops and telemarketers with modern computer screens and call directors. On top of this, they are installing CRM to increase profits further. To assume that CRM will increase conversion rates by even as much as 8 percent is quite a stretch.


There is also the problem of whether the product or service lends itself to CRM success. For CRM to be successful, it must be assumed that the supplier can somehow learn enough about the customer to make a relevant offer and that the suggestion by the supplier is more important than the decisions being made independently by the consumer.


Will customers decide to rent a car because of a timely communication received from Hertz, or because they were planning a trip and need a car?


Will a law firm buy software because of a timely communication from a supplier or because it has decided to upgrade its system?


The right offer to the right person at the right time is important, but only incrementally important to the consumer. The decision to purchase anything is usually much more complex than opening your mail or e-mail.


So what should you do? The following are some simple rules:


• Before you install CRM, create the tables used in this column and make some realistic assumptions regarding the increase you expect in the conversion rate.


• Consider the possibility of building a data mart instead of a warehouse. Data marts can be built for $1 million to $2 million and can be maintained for $500,000 per year. They do not need million-dollar software, but they can produce the same results as CRM at a fraction of the cost.


• Communicating with customers is always a good idea and almost always profitable. You may not need a warehouse to do it. Think small. Think tests. Work with what you have to see how much impact you get from simple, inexpensive communications. Based on that experience, decide whether you need a warehouse.


• Think about Chevy Chase Bank. How much would it have cost the bank to enter all the data on its home equity customers into a simple data mart and use that information in creating its customer communications? It is doubtful that it would have cost the bank more than $100,000 to do this. Use the information you already have and see what you can do with it. Do not go into CRM until you have experimented with something simpler and are sure you need a warehouse.


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