One of the keys to building profitable relationships with customers is to be able to collect and practically use customer data, particularly for lifetime value analysis, according to Anthony Coombes, senior consultant at The Logic Group in the UK, who explains here how to really put customer data to work.
The first step in building profitable relationships is to understand the value of your customer base, and this can be achieved through lifetime value analysis. The information gleaned from this analysis enables the marketer to produce more appropriate marketing communications and to know how much to spend on marketing to each customer.
There are two main dimensions of customer profitability that are of interest to organisations: first, a customer's current value based on their historical behaviour and, second, their future value, which can be calculated by predicting what type of products and services they are likely to purchase in the future and how long they will remain with you.
The measurement of a customer's future value is considerably more complex than measuring their historical value, especially in dynamic markets such as retail and financial services, where there are a number of factors outside the control of the marketer. These factors include:
- Strength of the competitors' marketing strategy;
- Saturation of the market for a particular product;
- Changing public perceptions;
- Macro-economic trends.
Predicting customer value
The most appropriate time frame for predicting a customer future value time should reflect the competitive nature of the market. For some industries it may only be one year while for others it could be as long as five years. The prediction also depends on the quality of the data you have available for building the analytical models, as well as the intended use of the analysis (i.e. whether it is for strategic or tactical planning).
Turning to historical value, the steps in calculating this figure involve identifying your key income and cost drivers, and then quantifying them. The income stream is typically the revenue produced from products and services.
Revenue calculations are normally based on data extracted from the company's financial or sales systems, and then matched against the marketing database. Because a customer's worth is based on the length of time they have been with you, it is essential to keep historical revenue data going back at least five years in a format that can be easily analysed.
On the other hand, the customer cost side of the equation is generally more difficult to quantify accurately and, in some cases (e.g. in the absence of historical cost data) it may be necessary to make some assumptions.
Typically, the costs you would include are:
- Acquisition cost: This has a significant effect on a customer's short-term profitability. For example, it is cheaper to recruit a customer from a mailing or via the web than through a retail outlet. Interestingly, analysis has also shown that how a customer is recruited often affects their subsequent behaviour, such as the length of time they are likely to stay with you before defecting.
- Sales management costs: These should also include commissions, discounts and so on.
- Retention costs.
- Upgrading and cross-selling costs.
- Risk costs (such as the cost of claims, in the case of an insurance company).
In measuring lifetime value you will be incorporating data from a number of functional areas not just marketing. So, for the analysis to succeed and be implemented with confidence, it is vital to build a cross functional development team representing marketing, finance, risk management, and systems. This will help to reduce some of the internal political challenges faced along the way.
Predicting a customer's future value can potentially be a long and complex task. It involves bringing together predictions about a customer's likelihood to purchase further products and services from you, what channels they are likely to use in carrying out these transactions, what referrals they are likely to make, and of course how long they are likely to stay with you.
Improving the customer base
Armed with this information, marketers can begin to apportion their budgets to those areas of the customer base that are most likely to produce the best return on investment (ROI).
Typically, the four ways they can improve the profitability of the customer base include:
- Increasing retention: There are a number of industry statistics that suggest a small improvement in retention can have a marked effect on a company's profitability.
- Increasing sales volume: Existing customers tend to buy more products (e.g. upgrades, companion products, and new products).
- Reducing marketing costs. This can be done through the use of propensity models to help target marketing campaigns more accurately and concisely.
- Recruiting less risky customers - such as those who are less likely to default on payments or make claims, and so on.
As with all good marketing, it is important that reasonable targets are set for improving the profitability of the customer base, and that progress in changing customer behaviour is monitored and reported on over time.
In today's competitive marketplace it is essential that the benefits of lifetime value analysis are well understood by marketers, and that the information is used as a foundation for effectively managing your customer portfolio.