Leveraging Lifetime Customer Value

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In an economy where products, marketing campaigns and even sales channels are transitory, customer relationships are now recognized as the key to enduring profit. The best-selling book "The Loyalty Effect: The Hidden Force Behind Growth, Profits and Lasting Value" by Frederick F. Reichheld with Thomas Teal demonstrates how a 5 percent increase in retention translates to a 25 percent to 95 percent increase in profits.


Companies are evolving from campaign-centric to customer-centric marketing as they recognize customer value as a crucial and ever-endangered asset. An emerging set of best practices called customer value management takes a lifetime approach to increasing customer profitability.


CVM means managing each customer to achieve maximum lifetime profit from the entire customer base.


CVM shifts the focus of the enterprise from managing products or marketing campaigns to maximizing the lifetime profitability of each individual.


While CVM can and does lead to more targeted campaigns, it is customer-centric. Instead of asking, "Who will respond to a 10 percent off promotion," a customer value manager is driven to understand "Who is George, and what can I offer to increase his lifetime value?"


To make this shift, your company must go beyond lip service to one-to-one and develop the analytical and operational capabilities to address changing individuals. But the reward is increased profits for years to come.


CVM can be broken down into three stages:


• Right customers (acquisition).


• Right relationship (development).


• Right retention (keeping valuable


customers).


Focusing on high-value customers at each of the stages naturally feeds the next to maximize overall value.


Right Customers


The CVM cycle starts with acquiring individuals who will be the most valuable to your business. Because it may take a year or more to break even on a new customer, the right customers are those who provide long-term, repeat business.


All customers are not equal, and a customer who is high-value to a competitor might well be unprofitable for you. An insurance company that is structured to serve safe drivers would acquire the wrong customers through an advertisement in a hot rod magazine.


How can you identify the customers you want? By deeply analyzing the ones you already have - the people on whom you already have extensive data.


Fine-grained analysis of your customer base reveals hidden characteristics that affect value. If you've assigned a low value to customers who make small purchases, finer segmentation on purchase frequency may reveal a subset who have a very high lifetime value because they've purchased every week for 10 years.


Vintage analysis of customers who joined at different times adds insight into where your best customers come from. This time-based analysis ranks acquisition strategies based on quality, not just quantity of conversions.


Deeply understanding current customers enables you to acquire the new ones you can profitably serve.


Right Relationship


For any business, the right relationship with a customer is one that maximizes that customer's lifetime value. Even the best-chosen customers need development to realize their profit potential. Those who don't receive the right touch lose rather than gain value. Just because Jack and Frank live in the same ZIP code does not mean they are both in the market for home office furniture at the same time. Ideally, marketers would spot these differences, targeting Jack with the right offer at the right time without annoying Frank with another promotion for something he does not want.


A simplified view of customer lifetime value is: LTV equals purchase size times frequency times duration.


So the business goal of customer relationship management is to increase the size and frequency of purchases and extend how long the customer continues to buy.


Customers do repeat business with vendors that understand and respond to their individual needs and respond when those needs change. To improve customer value, you must understand differences among customers and track how each evolves over time.


For high-value customers, work to cement loyalty, extending the length of an already profitable relationship. The LTV of a customer who makes large purchases regularly for 10 years is significantly more than that of a customer who makes the same purchases for only five years.


Less obvious are low-value customers with high-growth potential. Identifying and developing them represent an analytical challenge. But companies that fail in this overlook diamonds in the rough or waste development efforts on customers who will never grow.


One often ignored group is downshifters, former high-value customers who are now providing less business. Assigning a value to customers at a point in time fails to identify downshifters. To find them and restore the relationship, you have to assign individual value through time and respond quickly to changes.


Right Retention


Right retention means retaining the right customers, not every customer. While no one enjoys losing customers, you should match the intensity of your retention efforts to the value of each individual.


Right retention is, therefore, rooted in knowing which individuals are most valuable. Accurate lifetime valuation helps managers take the long view, giving equal weight to customers who are already doing a high volume of business and those whose purchases are modest, but whose actions indicate loyalty and profitability over time.


Right retention also means using strategies that maintain customer value, not erode it. Heavy discounting tends to teach customers to chase price, while special recognition and premium service levels tend to maintain value.


CVM offers a road map to acquiring, developing and retaining your most valuable customers. Taking the journey shown on this map is not free. To be truly customer-driven, you need the analytical capability to understand customers as individuals and the operational integration to respond immediately to each customer's changing behavior and value.


The rewards for these efforts are sustained and increasingly profitable relationships. CVM lets you increase revenue from your customer base, even as products and sales channels continue to evolve.


• Jeffrey Pease is director of worldwide product marketing at Ithena Inc., San Jose, CA.
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