Economics of CRM

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G. SHAINESH
Professor of Marketing
Indian Institute of Management Bangalore
[email protected]
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Session Coverage

• Share of Customer

• Lifetime Value of Customers

• Customer Profitability Analysis

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… Share of Customer Vs Share of Market
Needs Satisfied

Needs Satisfied

Customers Reached Customers Reached

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… Customer Lifetime Value

• Net profit over the Life-Time of an Individual

Customer

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… CLV – Example

Expected Profit from a New Retention

Customer Rate 60.00%
Year 1 Year 2 Year 3 Year 4
New Customers 1,000
Expected No. of Customers 600 360 216
Average Profit for Each Customer 1,000 1,000 1,000 1,000
Profit 1,000,000 600,000 360,000 216,000
Expected Profit from New
Customers 1,000,000 1,600,000 1,960,000 2,176,000
Average Profit from Each of the
New Customers 1,000 1,600 1,960 2,176
Use Discount rate 1,000,000 480,000 230,400 110,592
Cumulative 1,000,000 1,480,000 1,710,400 1,820,992
Per Customer 1,000 1,480 1,710 1,821
Discount Rate 25.00%
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Customer Life-time Value
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7000

6000

5000

4000
NPV

3000

2000

1000

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50

55

60

65

70

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80

85

90

95
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Retention Rate

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… Customer Value Segments

Source : Prof. Sudhi Seshadri, IIMB

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… Customers Are Profitable over Time

Profit from price

premium
Profit from references

Profit from reduced

op. costs
Profit from increased
usage
Base Profit

1 2 3 4 5 6 7
Year Source: Reichheld and Sasser

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… Are all Loyal Customers Profitable?

% Customers % Customers
Corporate service provider 20% Corporate service provider 30%
High
Profitability Grocery retail 15% Grocery retail 36%
Mail-Order 19% Mail-Order 31%
Direct brokerage 18% Direct brokerage 32%

% Customers % Customers
Corporate service provider 29% Corporate service provider 21%
Low
Profitability Grocery retail 34% Grocery retail 15%
Mail-Order 29% Mail-Order 21%
Direct brokerage 33% Direct brokerage 17%

Short Term Customers Long Term Customers

Source; Reinartz, W. and V. Kumar (2002), ‘The Mismanagement of Customer Loyalty’, Harvard Business Review, July.

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… Loyalty Strategy

Butterflies
• Good fit between offerings & customer needs True Friends
High • high profit potential Good fit between offerings & customer needs
Profitability Actions : Highest profit potential
• Transactional satisfaction Actions :
•Milk the accounts as long as they are active Communicate consistently but not too often
•Key challenge - cease investing soon enough Build both attitudinal & behavioral loyalty

Strangers Barnacles
•Little fit between offerings & customer needs •Limited fit between offerings & customer needs
Low •Lowest profit potential •Low profit potential
Profitability Actions : Actions :
•Make no investment in these relationships •Measure both size & share of wallet
•Make profit on every transaction •If share of wallet is low, focus on X & Up selling
•If size of wallet is small, impose strict controls

Short Term Customers Long Term Customers

Source; Reinartz, W. and V. Kumar (2002), ‘The Mismanagement of Customer Loyalty’, Harvard Business Review, July.

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Guests and Contributions - Hilton
% Guests % Revenue % Net
Profits
Diamond + Gold Hilton HHonors 1 6 28
Members
Silver Hilton HHonors Members 2 5 18

Blue Hilton HHonors Members 6 7 10

Nonmember Business travelers 25 21 6

Convention & Resort Travelers 66 61 49

Bell et al (2002) ‘Seven barriers to Customer Equity Management’, Journal of Service Research, August, 77-85
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… Customer Cost Analysis

• Why do we need separate customer cost analysis?

– Customers include end-customers or dealers/distributors
– Customers are not identical in terms of cost e.g. product manufactured
in Bangalore but sold in Delhi or Calcutta; cost of transportation,
insurance, packing needs, etc. differ
– Sales terms of customers differ -discount, credit period,..
– Customers demand on after-sale service differ
– Customers may require different product mixes or specification

Product cost may be same at the factory gate

but may differ at the customer’s door
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… Customer Differences

Customers differ mainly on four accounts

• Revenue Differences
– Discounting and credit terms
• Cost Differences
– packing, distribution, after-sale service, specification
– Delivery schedule (just-in-time)
• Distribution Channel Differences
– industrial customers vis-à-vis individual customers
• Service Level Differences
– on-site service, full service, etc.

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… Profitable Customers

• Who are profitable customers?

– Are all large customers profitable?
– Are all small customers unprofitable?
• Are there loss making customers for the same product?
– Where do we incur loss? Is there any way to cut cost or increase price?
• A customer may be less profitable today but may be a major profitable
customer in the future
– e.g. Overseas customers

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… Characteristics of high cost and hidden profit

High cost to serve customers Low cost to serve customers

• Order custom products • Order standard products
• High order quantities
• Small Order quantities
• Predictable order arrivals
• Unpredictable order arrivals • Standard delivery
• Customized delivery • No Change in delivery requirements
• Change delivery requirements • Electronic Processing
• Little to no pre-sale and post-sale support
• Manual Processing
• Replenish as produced
• Large pre-sale and post-sale
• Pay on time
support
• Require Company to hold inventory
• Pay slowly (high account
receivables)

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… Options for Managing Customers
Customers above the
cost-plus diagonal are
Types of Customers more profitable
Profits
High
Passive Costly to Service,
-Product is Crucial But pay top dollar
-Good Supplier Match
Net Margin
Realized
Price Sensitive and few Aggressive
special demands Leverage their buying power
Low price and lots of
customised service and features

Low

Low High
Cost to serve Losses
Profitability depends on whether and how much the net
product margins recover the customer specific costs
Source: Shapiro, Rangan, Moriarty and Ross, " Managing Customers for Profits (Not Just Sales)", Harvard Business Review, September - October 1987.

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Managers follow strategic ABM principles by...

• protecting existing highly profitable customers

• re-pricing expensive services, based on cost-to-serve
• discounting, if necessary to gain business with low cost-to-serve
customers
• negotiating win-win relationships that lower cost to serve with
cooperative customers
• being patient with currently unprofitable customers that provide other
non-quantified benefits to the company
• attempt to capture high profit customers from competitors

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… CRM Programs
Customer Types
Business to Business
Mass Markets Distributors
Program Types
Program Types Markets

•Continuous Special Sourcing

Continuity •After-Marketing
•Loyalty Programs Replenishment Arrangements
Marketing •ECR Programs
•Cross-selling

•Key Account
One - to - One •Permission Customer Business
Marketing Development •Global Account
Marketing
•Personalization Programs

•Affinity •Logistics •Strategic Partnering

Partnering/
Partnering Partnering •Co-Design
Co-Marketing
•Co-Branding •Joint Marketing •Co-Development
Source : Sheth & Parvatiyar, 2001 18
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Thank You
More Questions?

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