Customer profitability, also known as customer equity or customer lifetime value, is the topic du jour among the myriad media outlets touting the importance of understanding each customer or customer group’s effect on a company’s bottom line.
Customer profitability is the means for marketing to a consumer culture that includes: an understanding of the volume the customer purchases at a product level; assurance of brand identity and loyalty; knowledge of how to allocate resources (people and money); and metrics to measure customer growth.
Without a vision for customer profitability, a company risks spending scarce marketing dollars to retain its least-profitable customers.
Before a company can look at its customer profitability quotient, there are essential upfront activities to ensure that once the information is captured, it can be used fully.
These activities include: defining customer profitability and why it is important to the specific organization; profitability information needs and quality; ownership of customer profitability; organizational alignment to support customer profitability; how profitability will be strategically leveraged in an organization; integration of customer profitability into business processes; and ongoing management of profitability resources.
The relative importance of each activity depends on the type of organization responsible for execution and which industry is supported. I will focus on the first three activities.
What is customer profitability? Many organizations cannot define customer profitability for their business. When a large hospitality company decided to measure customer profitability, it brought representatives from various business lines together to devise a common definition.
A one-hour meeting turned into an all-day, off-site meeting as reps brought different perspectives of what profitability meant to their group. Finance believed profitability should conform to a revenue and cost model, broken down by customer segment. Marketing thought profitability should look only at acquisition and retention costs. Sales thought profitability should depend upon recency and frequency of purchases.
Bringing together representatives from each group let the company develop an agreed-upon definition of profitability that crossed all business unit lines.
A good baseline definition of customer profitability is the revenue a customer generates minus the costs needed to acquire and retain a new customer. The definition of the revenue and costs associated with a customer will be company-specific. If your company sells products through resellers, the revenue generated may be accounted for differently.
It’s all about data. At the heart of profitability calculations is the determining data. Once customer profitability is defined, the next step is to identify what pieces of data are needed for the calculation(s). Many components of profitability are explicit: revenue generated, costs allocated to a particular customer or group of customers, etc.
But there may be implicit components, depending on the organization, and these may include referrals or purchases through resellers, among other variables. Identification of these variables is company-specific, but generally related to financial numbers. Perhaps a customer’s profitability rating takes into account some percentage of the revenue that is collected from a referral they provide.
Identifying the data is the first step when examining the informational needs of profitability. Once the data are identified, look at the sources of that information to identify gaps and choose alternatives or eliminate extraneous information. This activity is the cornerstone to the profitability roadmap that lays out a timeline for the maturation of profitability calculations.
Even when the data are identified, there may be issues with its quality, leading to incorrect calculations of customer profitability. A publishing company wanted to look at a common customer profile across its business units. One element of this profile was profitability. However, it undertook a data quality assessment and identified that before it could use profitability data, it would need to clean up its existing data. As a result, it was able to identify a major impediment to rolling out a profitability model and planned the appropriate activities to resolve the data quality issues.
Who owns customer profitability? This is a central question that needs to be answered as part of the profitability development process. The answer drives the practical decisions needed to determine the components of profitability, how profitability should be used and who is responsible for ongoing support. The following defines the pros and cons associated with ownership by the three groups typically involved with profitability:
· Sales pros: Closest day-to-day contact with the customer base; best understanding of the costs associated with closing a particular sale; and direct involvement with negotiating contracts and other revenue-related items.
· Sales cons: Lacking cross-business unit view of customer acquisition and retention costs; adoption more difficult because it takes away from sales-oriented focus; and tendency for a myopic view of each sale rather than a long-term view of the customer.
· Marketing pros: Access to the acquisition and retention costs for a customer; biggest stake in accurate profitability data as marketing often is held accountable for budget dollars; and direct involvement in pricing and other product development decisions that affect profitability.
· Marketing cons: Lack of knowledge regarding costs involved in servicing a customer after the sale is made (i.e., how often a customer calls the contact center). Marketing organizations usually are less focused on financial results than the other two groups.
· Finance pros: Closest to accurate financial numbers; access to financial data and understanding of its use; and understanding effect of profitability on corporate financial performance.
· Finance cons: Less awareness of non-financial variables needed for complete profitability calculations; and no direct use or implementation for profitability information.
The comparison above illustrates that there is no clear-cut recommendation for one group to own customer profitability. It is advisable to consider a committee-based approach collectively engaged in identifying and calculating profitability.
A committee offers the ability to leverage each group’s strengths while allowing different points of view. It should have representation from corporate and customer service, as these groups also may be able to provide perspective as to how profitability decisions affect the customer and organization.