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The Importance of Focus for Generating Customer Value

Abstract

It is essential to carefully choose your Customer Value Proposition. Both value creation from the customer as well as the corporate viewpoint gain from consistent and deliberate focus on key market segments and core competences. This results in a mutual exchange of value, which will stabilize and strengthen your competitive position.

Introduction

The term customer value is typically used in one of two ways. Either customer value is used to describe the benefit a customer gets from using a product, or, customer value is the profit a customer generates for the company. In this paper we embrace both the “soft” (satisfaction) and “hard” (profitability) approach to value creation.

It is somewhat of a paradox to consider the value for the customer as if this were in some way opposed to the value for the company. There really should not appear to be a conflict of interest between value for versus from the customer, since this is not a zero sum game. For example, a customer that is getting excellent service is therefore less likely to shop around, compare prices, and maybe churn. Great service and satisfied customers are necessary to avoid your product being perceived as “merely” a commodity. How else can you command a premium price?

There is no reason to suggest that value created for the customer is in any way antipodal to value generated from the customer. The trick lies in matching the offer to the customer needs, or, finding the “right” customer given a company’s offering[1]. To achieve this goal, it is essential that a purposely chosen Customer Value Proposition (CVP) be pursued.

Measuring Customer Value

There are many possible criteria to measure corporate performance like market share, turnover, profit, number of products sold, etcetera. Aggregate turnover, sales volume or market share do not necessarily provide a reliable picture of the (financial) performance of a company. For example, a large market share could have been acquired at too high cost, and as a result the profit per customer may be dangerously low.

Rather than only rely on aggregate performance figures, it is better to also capture characteristics at the individual customer level. The question then is: what are the most useful performance criteria to determine how a company is doing? Such performance criteria should ideally also provide guidance on how to change course “in mid-air”, to offer help with tactical decision making. In general, aggregate numbers are not very useful to help everyday decision making at the operational level.

Not all customers are created equal, some are more profitable than others. For this reason, you want some kind of measure for profitability. Often, the hardest part in determining individual customer profitability is dealing with the fixed costs. You need to set up an allocation scheme that takes into account how fixed costs should be allocated across customers. This is not easy, but necessary to establish an individual profitability calculation. As an example, suppose hardware is needed to host a new VR system. If only 10% of customers have started using this system in the first year, it seems hardly reasonable to “charge” these customers with the full hardware costs. Then users of essentially a more efficient system would all “become” terribly unprofitable!

Measuring customer profitability is vitally important to target the right prospects. Companies want to spend their marketing resources where this will generate the highest payoff. This requires insight in cross- and up-sell potential. It is not just current profitability, but also the development of customer profitability over time that is important. Insight in both is necessary to evaluate the ROI of marketing spend.

A New Paradigm: From Aggregate to Individual Customer Data

Businesses are increasingly run “by the numbers”. CRM, the new marketing paradigm, has helped to shift the focus from aggregate company sales to the individual customer. It is not enough anymore to know that your market share went up. The underlying “quality of growth” needs to be monitored as well. Numbers like the percentage of new customers and attrition of the existing base can have a huge impact on bottom line figures, and further potential for growth[2],[3]. According to many[4],[5], CRM has failed in many respects. Even if this were true, it has nonetheless brought about a lasting change in focus on the kinds of numbers that are used to steer businesses.

In this new marketing paradigm, the focus is now on customer lifecycle management, on developing and maintaining customer relations. Marketing spend is seen, not just as an expense, but rather as an investment in the relation with the customer.

Value From or For the Customer?

Sometimes the debate on value creation is treated as a zero sum game: by doing more for the customer the company is earning less. This is only an apparent paradox[6]. Sustainable value can only be created if the supplier can afford to offer the current service level and still maintain profitability.

From the customer perspective, they consistently need to get a better overall deal than they could get from the competition[7]. If dealing with the current supplier does not generate excess value, customers will leave. Value for the customer means more than just offering a better price. As an example: the Ritz-Carlton hotel chain is not cheap. But the service is excellent. As long as the “total experience” is better, the Ritz-Carlton still provides more value to those who can appreciate this superior service.

For the corporation, value creation comes in the form of a steady cash flow, which can be counted on to extend into the future as well. Value is created in marketplaces where both suppliers and customers are in a win-win relation. Only then will the supplier be able to sustain its market position, and only then will it be in the customer’s best interest to maintain the relationship with this supplier.

Loyalty is not something that can be bought, at least not profitably for prolonged periods of time. In fact customers cannot even be owned. Customers can be rented from the marketplace. But this comes at a price, namely acquisition and retention costs. Loyalty is a privilege one can earn by consistently delivering superior value to the customer.

Dynamics of growth

Providing value to the customer leads to growth in the market. This in turn leads to a better understanding of the reasons behind success (customer feedback and research), which then shows the way to providing even more value. This cycle can continue growing. It is a self-reinforcing cycle.

Focus on the right kinds of customers is a leverage point in that it can make or break success. A loss of focus will cause this same cycle to gradually break down over time.

The risk of success is that it can blind you. Success in the marketplace should come from a match between your CVP and meeting needs of customers. What is it about the service that customers value the most? Dell is an example that might apply here, They had years of stellar growth, and pioneered innovative distribution and supply chain management methods. Currently they are wandering, their service and quality are dropping because they appear to be too many things to too many customers. By putting effort where this is most appreciated by your customers, you stay “lean and mean”.

It is crucial to determine your core competencies. You need to define exactly what the benefits are for the customers. Then you need to specify the needed processes, systems and communication that are required to deliver these unique benefits. Why is it that (high value) customers like you? Then, focus all energy towards meeting those goals.

Given an organization’s infrastructure and value proposition, certain customers can be profitably targeted, others maybe not. The constellation of organization structure, systems in place, and the value proposition a business is working with (its “capabilities”), together comprise the most important elements that will influence the costs of an organization. Moving outside of these core competences entails a risk of inefficiencies.

Risks of an undifferentiated approach

What are the risks of an undifferentiated growth strategy? This will result in a loss of value in four places:

1 – There is less of a match between the value proposition and your new customers. As a result, you become increasingly dependent on customers choosing you, instead of the other way around. This risks devaluation of your brand for two reasons. Firstly, for many customers you cannot deliver what they expect. And secondly, you loose your differentiated position. Your brand becomes an “average”, there is no longer a way to differentiate yourself from the competition[8].

2 – You loose focus on your core competencies, given the CVP-segment match. Because of heterogeneity in new customers, a pressure arises to diverge activities, to fulfil more different kinds of needs (similar to the problems Dell is currently facing). For example, there will be more processes to manage, more different kinds of questions and requests from customers, and you risk running into service and communication problems. It is inevitable that lack of a clear priority of service and value will lead to higher operating costs. As a result, you can expect more errors in fulfilment because you are being been forced to offer more diverse services.

3 – Once “the wrong” customers have entered the base, it becomes much harder to cross- and deep sell. Also, developing new products becomes much harder: whom to develop them for? This will then further amplify the difficulties in cross-selling.

4 – The leverage on the market goes down, costs go up, and therefore there is even less competitive power. You don’t “know” your customers, simply because there is no “typical” customer (anymore). And the customers don’t know you, due to lower average tenure. Your service costs are likely to go up when your customers are less familiar with your services[9].

Because of these four reasons higher costs will be inevitable, thereby making it even harder to compete. Margins have eroded and more cumbersome operations negatively affect your nimbleness to move into new market segments. Heterogeneity in customer needs will lead to a mismatch with the CVP. Therefore, it will become harder to satisfy existing customers. In particular, loyalty and referral rates will go down, leading to a downward spiral.

How to measure progress

How do you establish the match between CVP and customer needs? This will require tracking some key metrics. To monitor developments over time, you compare successive cohorts in terms of cross-sell, profitability, and tenure. This means comparing groups of customers that entered in successive years, and “normalizing” their profile. By “normalizing” we mean comparing all groups at their start, after being a customer for 1 year, 2 year, etcetera.

When analysed in this way, a new perspective on the portfolio of customers arises. Over time, growth in the total number of customers may lead to slightly lower cross-sell and tenure figures. It is important to strike a balance here, and any steep drop in cross-sell, tenure or profitability should be cause for concern.

Another important source of input is customer feedback. Ask customers how and when they find value, in particular your most profitable customers. Of course, you should focus effort where the cost/value payback is highest. Customers’ needs are a moving target, and aligning with customer desires requires continuous innovating and adapting[10].

Which customers to target

In the remainder of this paper we will demonstrate why value for the customer is in large part the result of quality and appropriateness of customer acquisition. Although the misfit between CVP and customer cohort only shows after a while, it originates at the moment when customers enter into a relationship. The “right” new customers to try and acquire, are those that have the potential to buy your extended offer. That means not just taking the basic core product, but also the extended products and services. This is essential because it is well established that only customers that you can cross sell to successfully, are the ones who are likely to become profitable[11].

How do you determine which customers should be targeted? There are two essential ingredients needed here. The first is an Activity Based Costing (ABC) scheme. It is important to break down customer profit into the constituent components. This allows an analysis of relative contribution of profit per product category. The second ingredient is a longitudinal breakdown of cross-sell. What this implies is that customer data need to be represented relative to their origination date. This way, you can display profiles of customers after 1, 2, 3 years of tenure, etcetera, but also make comparisons relative to when the relation began (start year 2005, 2004, etcetera). Customers you can cross-sell to effectively are the ones to target for.

There is one minor complication. The way customers “look” after successful cross- and up-sell might be quite different form the way they looked when they first became customers. Yet their initial appearance is what the targeting should be aimed at. You search for look-alikes of prospering customers, the way they looked when they first became customers. The fact that these customers prospered under the current value proposition is living proof that these are the kinds of customers for which the offering has the most appeal. There is a good match between the CVP and inherent needs.

What to do when there is a mismatch between customers and CVP?

Suppose you conclude there is a mismatch between the CVP and new customer acquisition. This becomes clear when too many new customers are not developing well. What can you do to get back on track?

There are basically three approaches you can take now:

1 – Install barriers; prevent certain (low value) customers from entering. For example, one could establish a business rule that Private Banking customers can only enter into a relation with the bank with a minimum starting deposit of at least 2 Million Euro. This effectively prevents the “wrong” kind of new customers from entering.

2 – Demarketing; employ a cost control strategy. Freeze all marketing investments and simply stop making offers. You can cut down on customer service, for instance by giving these customers a lower service priority at the call center. This part of the tactics is meant to prevent more waste on customers where the investment will bring insufficient returns.

3 – Differentiate on price; when some customers only use part of the proposition (buy only few product categories) then you can adjust the price/service strategy. One way to do this is by offering bundled service packages at a discounted price. What this effectively does is make the overall CVP more interesting for the customers you are seeking (with a large share of wallet), and make the offering more expensive for customers who are only “cherry picking”. Such a strategy kills two birds with one stone because it mitigates the costs low value (low wallet share) customers are creating, and it communicates the appeal of a “full deal” to customers you aim to attract.

Conclusion

In this paper some arguments have been put forward to demonstrate why focus on a purposely chosen CVP, and targeted acquisition of new customers are key to sustainable success in the market. Purposely choosing and shaping your CVP is an ongoing strategic process. The choice for a given CVP should come from an assessment of core competencies[12], in combination with existing market needs and financial potential.

Constantly reshaping your CVP should be the result of evaluating customer feedback. Make the best possible use of what customers say they particularly like about your service, implicit or explicit. Implicit feedback is displayed, for instance, in higher response rates. A high response rate implies relevance of your marketing offer. Explicit feedback can be gathered either in dedicated research, or at moments of customer interaction (for instance in the call center).

Another important point we made is the central importance of the customer acquisition process. Customer acquisition is not something to undergo, it is an activity every company engages in. We asserted how important it is to target for customers who have high potential for future growth. New customers are rarely very profitable at the outset. What’s important is that their customer value be managed throughout the lifecycle.

The risks of an undifferentiated growth strategy, of not selectively acquiring new customers are pernicious. This is mainly because the consequences are usually only felt much later. Due to the time lag between cause and effect, the relation with inappropriate acquisition may not become evident. Also, the diagnostic measures (cohort analysis) needed to improve profitability may not be obvious and easy to obtain.

The good news is that a consistent focus on customer value, whether seen from the customer or the company, will drive towards a mutually beneficial optimum. By acquiring the right customers in light of the chosen CVP, cross-sell will go better, and therefore market leverage is greater, service will be better, and less costly. Create value for the customer, make sure your CVP and “chosen” segments match well, and keep a sharp eye out for future profitability of your customers. This is exactly why it is so important to deliberately choose and shape a CVP in such a way that customers will engage in a full-blown relation, and can therefore become highly profitable to the company.

References

[1] Michael Porter (2001) Now is the Time to Rediscover Strategy, European Business Forum, Vol. 8

[2] Patricia Seybold (2001) The Customer Revolution, Crown Business,

[3] Frederick Reichheld (2001) The Loyalty Effect, Harvard Business School Press, Boston, MA

[4] Jennifer Rigley (2003) Overcoming CRM Failure in Financial Services: What’s (Not) Working, Fair Isaac

[5] Richard Boardman (2004) Doomed from the Start? Why 90% of CRM Implementations Fail to Achieve Their Potential, http://www.mareeba.co.uk

[6] Robert Wayland & Paul Cole (1997) Customer Connections. Harvard Business School Press, Boston, MA

[7] Michael Lanning (1998) Delivering Profitable Value, Capstone, Oxford, UK

[8] David Aaker (1995) Building Strong Brands, Free Press, New York, NY

[9] Martha Rogers & Don Peppers (1997) Enterprise One to One: Tools for Competing in the Interactive Age

[10] Peter Drucker (1985) Innovation and Entrepreneurship, Harper & Row, New York, NY

[11] Frederick Newell (2000) Loyalty.com. McGraw Hill, New York, NY

[12] Michael Porter (1998) Competitive Advantage: Creating and Sustaining Superior Performance, Free Press, New York, NY

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