Notes

Importance of Customers - Marketing

Creating value through acquiring and retaining customers. Customers are import assets for companies. Companies try to satisfy customers by providing superior customer value higher customer satisfaction. However, maximizing customer satisfaction comes at cost.

• How much should a company invest in customers? Should a firm spend $10 million to increase its customer satisfaction from 8 to 9 (out of 10)? Or maybe $100 million?
• The classic case of Hoover, a sales promotion: free airline tickets within Europe as a reward of buying $100 worth of a product.
• Significantly positive response and additional promotion of free airline tickets between UK and US as a reward of buying $250 worth of a product.
• The promotion was successful: generated additional sales, helped Hoover acquire customers, resulted in higher market shares.
• What about the profit and cost?
  • Cost: almost $50 million
  • Profit declined
  • The executives in the UK division were fired!

What is the problem? And How should we manage this? Customers are important assets, but... Acquiring and retaining customers requires costs. It is important for companies to manage customers profitably. Probably, not all customers are valuable.

Two Sides of Customer Value

"Marketing is to create value through customer acquisition and retention". It is important to provide superior value to customers. Then, what about the other side of value?

• The Hoover case suggests it focused on the one side of customer value, but ignore the other side, i.e., it gets value from customers.
• The challenge Balancing between the two sides of customer value.

Which customers are worth keeping on both dimensions?

• Star Customers
  • Most desirable customers
  • Loyal and satisfied customers who deliver long-term profits
• Lost Causes
  • They cost more than they worth
  • Frequently complain or return products, spread negative word-of-mouth.

What can companies do for those customers in this case?

• Free Riders
  • Hoover case
  • Companies may be providing more than customers pay for.

What can companies do to improve profitability?

• Charge higher prices to get more value from the customers (Vodafone MM4M).

• Reduce services to the customers (Vodafone limitations on hotspotters).

• Vulnerable Customers

  • They are valuable but vulnerable for switching brand.
  • They might stay due to the lack of alternatives or high switching costs.
  • But competitors could identify and attract these customers.
  • US Airways in 1990's
    • 41% of market share - Baltimore - Washington
    • High price for poor service
    • The market share significantly dropped (i.e., 6%) after Southwest airlines entered the market.

How to Identify Valuable Customers? Valuing Customers

• Customer Lifetime Value (CLV)
• Customer Referral Value (CRV)
• RFM Analysis (Recency, Frequency and Monetary Value)

Which Customer is the most valuable?

Customer Lifetime Value (CLV) The net present value of all future streams of cash flows that a customer generates in the life of the business relationship with the company.

• CLV is based on profits, not revenue, taking into account costs.
• CLV is a measure of long-term profitability.
• CLV helps identify valuable customers.

Calculating CLV. The simplified form of CLV is:

Assumptions of the simplified CLV:

• Customers have a constant profit margin M over time.
• Customers have a constant retention rate r over time.
• The discount rate is constant over time.
• Value is estimated over an infinite horizon.

These assumptions are reasonable and can be modified.

Margins = Annual Revenue - Product and Service Costs What is the implication of the Margin Multiple? What determines CLV (i.e., important factors)?

Calculating CLV: Netflix Case Suppose the following:

• The monthly retention rate for premium: 80%
• The monthly discount rate is given: 1%
• The average monthly revenue for a premium customer: 17.99$
• Variable monthly costs for each premium customer: 1.50$
• Acquisition cost: 30$
• Acquisition cost is incurred at month 0 and the revenue is generated at month 1. What is CLV? (Assume the discount rate is zero (0.01)) $32.82.

How does CLV help make decisions on customer management?

• Helps set the limit of acquisition cost.
• Provides a template for customer segmentation (e.g., high vs low profitability customers).
• Helps companies understand the driver of customer profitability.
• Helps marketing managers invest in customers (e.g., linking customer satisfaction to retention rate).
• Provides an estimate of customer equity.

Managing Customer Value: Drivers of Customer Profitability

• Many companies realize not all customers are valuable.
• Bargain Hunters in Best Buy Stores.
• Sprint cancelled contracts with customers who were costly to serve.
• However, firing customers should be done carefully.

• Does customer retention matter? Yes. Let's go back to the calculation of CLV: it is the function of retention rate.
• Increasing retention rate suggests a company gain margins for the longer periods Customer retention is the main driver of CLV.
• A small increase in retention rate result in larger increase in CLV.
• One study finds 5% increase in retention rate could increase CLV by 35% to 85%.
• It costs 5 times as much to attract a new customer than to keep an existing one.

• Once customers are acquired and retained, a company needs to put effort in developing the customer relationship Increasing customer margins.
  • Increasing share of wallets.
  • Cross-selling and upselling
    • Cross-selling: selling other products of the company to the existing customers (e.g., Apple, Telecom subscription plans).
    • Upselling: selling the premium products to the customers who buy non-premium products increasing margins (e.g., Netflix, Spotify, Telecom companies).

CLV and Customer Equity

• Is CLV enough and relevant for senior executives such as CEO and CFO?
• CLV is applicable to the individual customer only.
• We can calculate Customer Equity, i.e., the sum of all CLVs across all existing and potential customers.
• Customer Equity (CE) is a good proxy for firm value.
• CE suggests the long-term value of an organization.

Customer Referral Value

• Who is the most valuable customer in terms of CLV? C
• Who are you going to invite as your customer given the following additional information?

• What are potential drawbacks of CLV?
  • Customer Acquisition, we can take into account the effect of customer acquisition better.
  • Social Interaction Effect, word-of-mouth and social media, etc. Customer referrals are crucial.
  • Valuable Free Customers, CLV focuses exclusively on paying customers and ignores nonpaying ones.

Reality and Challenges?

• What have companies been doing? Most firms use consumer willingness to make referrals.
• Most good intentions may not necessarily be related with the action.
  • One financial service firm> 68% of customers expressed their intention to refer the company to other people, but only 33% did.
  • One telecom firm: 81% of customers expressed the intention to recommend the company, but only 30% did.

Any Alternatives?

Customer Referral Value (CRV): A sum of the values of all customers acquired by the referred customer. It is important to distinct two types of acquired customers!

Customer Referral Value as an Alternative Metric

Combining CLV and CRV Surprisingly, CLV is not necessarily related with CRV. The most loyal customers are not necessarily good marketers.

Implications of Affluents, Advocates and Misers

• Overlooking the importance of social interaction might underestimate customer profitability.
• Customers with high CLV are not necessarily the same customers with high CRV.
• The customers in each cell should be evaluated differently. To migrate the customers in each cell, the company needs different marketing programs.

Misers

• Low CLV and Low CRV
• Need to improve both
• At least the company may migrate them to one of the other three cells.

Affluents

• High CLV and Low CRV
• Need to encourage these customers to refer new customers using referral incentives.

Advocates

• Low CLV and High CRV
• Need to encourage these customers to spend more.

What would be the goal of marketing campaigns for each group of customers? Marketing Campaign - Results of the campaign

Marketing Campaign ROI To evaluate whether the marketing campaign was successful, we need to compute the ROI (Return On Investment).

• The results seem to be successful, but we don't know the cost and profit implications.
• Total marketing costs: $31,500 for 7,821 customers ($4 per customer).
• Overall profit: $486,090
• ROI: 15.5

How do you evaluate the marketing campaign? Social Influence CRV approach allows managers to take into account social influence in valuing customers.

• Friends influence our purchase behavior.
• This effect is stronger in the age of online social media and social network.
• Social influence affects not only customer acquisition but also retention.
  • Customer acquisition likelihood increases by 9 times to 15 times if somebody in the consumer network already adopted the product.
  • A customer's risk of cancellation increased by 80% if one friend canceled.

RFM Analysis Recency - How recently did the customer purchase?

• A measure for the time elapsed since a customer last placed an order with the company. Frequency - How often do the customer purchase?
• A measure of how often a customer orders from the company in a certain time period. Monetary value - How much do the customer spend?
• A measure of the amount that a customer spends on an average transaction.

71% of the firms use RFM in their direct marketing efforts.

Computing RFM Score

• Compute each variable, R,F,M.
• Determine the relative weight.
  • Directly determined by managers.
  • Or by using simple regression techniques.

Example: Bocconi café wants to select the best customer to invest its marketing budgets. The customer with the highest RFM score will be selected. Relative weight for R, F, M = 50%, 20% and 30% respectively.

RFM score for each customer?

What does the score mean? Customer A: 41.2 Customer B: 38.2

Discussion on Different Metrics - What are the differences? RFM

• Incorporate some aspects of customer buying behaviors
• Backward looking measure
• Does not provide the key information such as profits
• Relative measure
• Depending on relative weights.

CLV

• Forward looking measure
• Provides the information about customer profitability, it has the elements of revenue, cost, and customer behavior.

CRV

• Forward looking measure
• Provides the information about customer profitability
• Incorporates the impact of social interaction.