Take Three Bites at the Customer Value Cherry

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As I suggested in a recent post on What Private Equity Teaches Us About CRM in a Recession, organisations who want to survive the recession will have to focus on the bigger value equation. Not just on the customer experience, not just on loyalty, not just on profit, but on mutual value creation for customers and shareholders.

Part of understanding the bigger value creation is in knowing which of your customers are the most valuable and which have the greatest growth potential. That way you can focus your resources on those customers who bring the greatest returns.

The value of customers is measured by calculating customer lifetime value. Recent advances in customer lifetime value have identified three different components:



  1. Customer Transaction Value – This is what we have always measured as customer lifetime value. As Lehmann et al, have shown, it is calculated as a net present value (NPV) from the annual margin of the customer’s transactions multiplied by the customer’s lifetime, adjusted by the organisation’s cost of capital (to take account of the risk markets associate with the organisation). This is the first bite on the customer lifetime value cherry. But taken by itself, it may significantly underestimate the customer’s true lifetime value.
  2. Customer Referral Value – This is the value that the customer creates through recommending the organisation to new customers. Research by Kumar et al showed that a telecoms or financial services customer’s referral value my be up to four times (400%) of their transaction value. But transaction value isn’t related to referral value; so a low transaction value customer can be a high referral value customer. This is the second bite of the customer lifetime value cherry. Most organisations have not yet got round to calculating their customers’ referral value yet, but many are just starting to. With customer recommendations now one of the most used and most influential sources of customer information, the use of referral value is clearly going to increase.
  3. Customer Network Value – Recent estimates suggest that up to 60% of the revenues of the 100 largest companies come from so-called multi-sided markets like those found in telecoms, credit cards and internet retailing. In a multi-sided market, an organisation provides a ‘platform’ where many sellers come together to offer products to many sellers (who would not normally transact with each other). The organisation usually makes money by charging the seller a commission on each sale. The buyer usually pays nothing. The more sellers, the more attractive the market is to buyers. And the more buyers the more attractive the market is to sellers. Research by Gupta et al shows that adding an additional on-line auction buyer, (even one who never actually buy anything), is worth more to the auction than adding an additional seller. This network effect is the third bite of the customer lifetime value cherry. As organisations expand their use of multi-sided markets, particularly on the internet or mobile internet, they will have to calculate their customers’ network value too.

Many companies routinely calculate their customers’ transaction value. But this is no longer enough. As the popularity of the Net Promoter Score has shown, organisations need to measure their customers’ referral value and network value too. Organisations that don’t are in danger of seriously miscalcuating their customers’ lifetime value. And of investing their scarce resources in the wrong customers. In a prolonged recession, this might be the difference between survival and bankruptcy.

What do you think? Are your taking all three bites at the customer lifetime value cherry? Or don’t you really know which customers to invest in?

Post a comment or email me at graham)dot)hill(at)web(dot)de and get the conversation going.

Graham Hill
Independent CRM Consultant
Interim CRM Consultant

Further Reading:

Graham Hill, What Private Equity Teaches Us About CRM in a Recession

Lehmann et al, Valuing Customers



Kumar et al, Customer Referral Value: The Other Side of Customer Lifetime Value

Gupta et al, The Value of a Free Customer

1 COMMENT

  1. Customer valuation is not a complex concept. And carrying out a customer valuation is actually a quite easy process. So is deciding how to use the insights it generates. But unfortunately, for one reason or another, it has developed a reputation for being ‘difficult’.

    Here are a number of good books that show how to do it step-by-step. Now you have no excuse not to get started.

    Kumar
    Managing Customers for Profit: Strategies to Increase Profits and Build Loyalty
    This is the only book that also looks at the referral value of customers as well as their value through their purchases

    Gupta and Lehmann
    Managing Customers as Investments: The Strategic Value of Customers in the Long Run
    Another great book on customer management for long-term value

    Kumar & Reinartz
    Customer Relationship Management: A Databased Approach
    Werner Reinartz is one of the other powerhouses of customer valuation

    Blattberg, Getz & Thomas
    Customer Equity: Building and Managing Relationships as Valuable Assets
    Quite an old book but still a great one to use

    Rust, Zeithaml & Lemon
    Driving Customer Equity: How Lifetime Customer Value is Reshaping Corporate Strategy: How Lifetime Customer Value Is Reshaping Corporate Strategy
    Looks at three different components of customer equity

    Aksov, Bejou & Keiningham
    Customer Lifetime Value: Reshaping the Way We Manage to Maximize Profits
    Brings together a number of papers by leading customer value thinkers

    And a new book that I have on order:

    Ryals
    Managing Customers Profitably
    Ryals is at Cranfield Business School, the premier marketing school in Europe

    Do you have any other favourites?

    Graham Hill
    Independent CRM Consultant
    Interim CRM Manager

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