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:
- 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.
- 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.
- 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.
Independent CRM Consultant
Interim CRM Consultant
Lehmann et al, Valuing Customers
Gupta et al, The Value of a Free Customer