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Not all customers are created equal. Not all customers are profitable. Not all customers are top priority. Yet all customers can be treated well, just differently—when treated according to their contribution to profit, potential for profit improvement, and strategic importance. These profitability tradeoffs have been understood on the product/service side of the business for a long time, but only more recently have companies been proactive about customer profitability. Now new research suggests that understanding customer profitability is more important than product profitability for performance. Customer Profitability Trumps Product Profitability. As the authors of the study note, “Profit contribution information can provide an important segmentation tool for companies…It’s the starting point for making better decisions and charting long-term strategies for success. If you don’t know which customers and which products are contributing the most, you’re leaving dollars on the table. Underperforming products and customers represent missed opportunities. The resources and efforts needed to handle them should be shifted to other products and customers with greater potential for positively impacting the bottom line.” Click to read about the study by Religence’s own Bob Sabath, Patricia Daugherty of The University of Oklahoma, Daniel Mattioda of the Air Force Institute of Technology, and Haozhe Chen of East Carolina University in their article “Who—and What—is Profitable?”. Click to learn more about the profit matrix used in the study or check out method six in the following table. Customer Profitability Segmentation Methods.
Thought leaders from Robert Kaplan to Martha Rogers to Frederick Reichheld and Religence’s own Bob Sabath and George Fruehan have put forth a number of ways to approach profitability segmentation to help organizations focus their efforts and identify the biggest potential rewards. There are many levels of sophistication and many levels of marketing, operations, and finance integration. But using any of these methods will help you get started aligning your organization for profit—from senior executives to middle managers and then from middle managers and their group leaders to the people on the frontline with customers. The following table summarizes leading approaches and what’s next. You can scroll down more for a broader description. There are also links to more on the topic in our extensive Religence Framework CRI Reference Section including
Another excellent resource is our CEO’s new book Customer Relationship
Intelligence: A Breakthrough Way to Measure and Manage Sales and
Marketing, which explains how real-time operational customer profitability data helps achieve real-time operational control.
1. Customer Satisfaction Research Because customer retention is the path to real money, satisfaction is a good place to start. But the problem with satisfaction as a measure alone is that what people SAY isn’t always what people DO. Too often in answering typical satisfaction research questions, customers will say they are “satisfied,” but unfortunately, this can be shorthand for “It’s not worth discussing.” or “Until I see a better offer.” And since most satisfaction research doesn’t ask, “Why?” or drill down very deeply, customers are placed in this catch-all, “Everything’s okay” category that doesn’t give much forewarning of potential disasters. Since the mid 1990s as more attention was paid to why “satisfied” customers stopped being customers, attempts have been made to at least categorize these customers. Are they willing customers? Is it price that drives them? Are they antagonistic towards your company? Such categories are helpful. They begin to answer, “Why?” We think a customer focus and asking customers “Why?” is a business imperative. We’ve pioneered Voice of the Customer research using in-depth, one-on-one interviews to knowing what customers really think—why they buy, why they stay, and why they leave. With this greater depth, we feel more comfortable in using satisfaction as a method for profitability segmentation. But we prefer to combine Voice of the Customer research with the more sophisticated financial approaches described in methods four through seven. 2. Net Promoter Score (NPS) In his view, you would measure your success by how many customers like these you grow. To him, profits from customers like these are “good” profits. Profits from customers who are not inclined to give you a score of at least 7 out of 10 in recommendation are “bad” profits. He has created a metric he calls Net Promoter Score which subtracts the percentage of customers who detract (those who would give a recommendation score of 0 to 6) from those that promote (those who would give a recommendation of 9 to 10) to signify a company’s growth potential based on the strength of its relationships. 3. Recency, Frequency, Monetary (RFM) Transactional Analysis 4. Customer Lifetime Value (CLV) The Religence Framework for Customer Relationship Intelligence also uses an estimated CLV calculation, but one based on profit in its strategy decision models. Yet with the Religence Framework, you can move to an operational level beyond estimated CLV, because what actually happens is tracked, and the operational data on profit is fed back to the strategy decision models for continuous improvement. With this operational control, revenue, estimated CLV, and satisfaction scores don’t have to be your proxy for effectiveness any more. You can evaluate effectiveness with what happens. 5. CLV to Contribution to Profit to Date Matrix
Because the Religence Framework for Customer Relationship Intelligence measures variable costs of interactions with customers, a more complete picture of profit can be achieved than what is done in either traditional accounting or even in an Activity-Based Costing accounting approach. That means, with the Religence Framework, you can track a customer’s contribution to profit to date. And within the strategy decision models for each channel/product group combination for customer segments, an expected CLV is calculated and then embedded in the profiles of individual customers within the segment. Anticipating, and then calibrating, CLV based on profit is difficult without a cohesive framework for the entire customer lifecycle like the Religence Framework. 6. Profitable Customers to Profitable Products Matrix Analysis The math here is that generally 20 percent of customers account for 80 percent of revenue and often more than 100 percent of profit. In financial services, the numbers are more dramatic. There, 20 percent of customers typically account for as much as 250 percent of profit. The huge discrepancy in financial services is caused by the incredible number of unprofitable customers these companies typically carry on their books. This profit matrix analysis approaches profitability segmentation by correlating the most profitable customers with the most profitable products, in terms of total contribution to profit. Considering the total contribution to profit puts the focus where it should be. Bob prefers to use a four-by-four matrix instead of the more commonly used three-by-three matrix of profitable, marginally profitable, and not profitable. We’ve adopted his approach in the Religence Framework. We break the commonly looked at “profitable customers” into two parts, to distinguish the highly profitable franchise customers from the other profitable customers. There are usually only a small percentage of franchise customers. The categories on the “whale” curve below are then franchise customers, bread and butter customers, okay customers, and losing customers. Segmenting customers this way greatly expands the options in setting business rules on how to serve them and in developing strategies for high-profit revenue potential. Please see Align for Profit: Profit Matrix for an example of how to use the matrix.
If you pay special attention to those customers who generate the most profit, they are more likely to generate even more. Maintaining these “platinum relationships” and adding a customer to this level every few years can help you achieve spectacular growth levels—but only if the existing relationships are in fact retained. Please see our Next-Generation Thought Leadership Paper on Strategy Execution for how to take the next step once these potentially profitable customer segments have been uncovered in the profit matrix. 7. Activity-Based Costing (ABC) to Balanced Scorecard Matrix Analysis
Their table above summarizes management actions to optimize profitability by seeing “where opportunities exist to transform attractive, but money-losing customers into long-term profitable relationships.” The Balanced Scorecard is a strategy mapping approach created by Kaplan and David Norton also of Harvard and both now with the consulting firm Palladium. ABC is a more realistic way to account for indirect costs than traditional accounting which adds a broad percentage onto the direct costs to represent the indirect costs. See the next section for Kaplan’s involvement with ABC, which in its own right is a critically important profitability segmentation method. Activity-Based Costing The same Robert Kaplan of Harvard mentioned with profitability segmentation method seven above was instrumental in popularizing the ABC approach in the 1980s. Used most extensively in manufacturing, ABC’s use elsewhere has been stymied because of the time and money necessary to set up and use the models. But now working with Steven Anderson, CEO of Acorn Systems, Kaplan has updated ABC with a time-driven approach that is similar to the approach used in the Religence Framework for monetizing interactions. Their book is Time-Driven Activity-Based Costing. The new time-driven approach greatly simplifies traditional ABC, requiring only two parameters—the unit cost of the supplying capacity, and the time required to perform a transaction or an activity. In the Religence Framework variation on this useful approach, the variable costs of interactions are based on estimated time and materials directly related to the performance of the activity, for example, capturing the time in handling a mailing and the postage required. It is a variable cost in that it does not include the fixed costs necessary to be ready to perform the interaction. In the mailing example, variable cost would not include the creative work to set up the mailing or the costs of printing it. The use of this example also illustrates a difference between most ABC implementations and the Religence Framework. Most ABC implementations use only the cost-to-serve individual customers and don’t include the cost-to-acquire. Without Religence, cost-to-acquire, including head count and fixed tactical budgets in sales and marketing, is usually spread as in traditional accounting—hiding just how profitable (or not) a customer really is. Just as there are various approaches to ABC, there are a variety of ways to calculate variable costs of the interactions. What is important is being consistent and staying relevant to the customer-focused drive to increase profits. What’s Next is Real-Time Profit. What’s next is moving beyond these static, high-level, snap-shot methods to dynamic, real-time operational control at the channel/product group level where the action is,
The Religence Framework is a sophisticated, all-inclusive system to measure the progress in the development of customer relationships and what it costs to develop them. We measure interaction by interaction throughout the entire customer lifecycle from acquisition through retention. The cost data feeds our strategy decision model for strategy effectiveness and ABC models to refine costing layers in our profit matrix. The Religence Framework approach includes not just cost-to-serve as most ABC implementations do, but acquisition costs in detail as well. Building intelligence into the process and measuring interactions in real time measures how strategy is working in real time and gives you a frame of reference with operational data to show how they became profitable. It lets you see what works with different types of customers, and what the relationship development patterns need to be for success. This relevant intelligence about customer relationships helps you optimize customer outcomes to realize high-profit growth and anticipate future success with our leading indicator for profit. To get started now learning who your most profitable customers are and why, what’s important to them, what to promise, and what to deliver to “develop” the relationship, we invite you to contact us. Our team of senior people is ready to help you listen to your customers, deliver more value, and identify the customers you should cultivate—not only who the most profitable customers are, but what their potential is for profitable growth. __________ For More Information: Take a look at our papers Next-Generation Voice of the Customer Research, Next-Generation Strategy Execution, and Next-Generation Operational Control. You may also be interested in our other Thought Leadership Papers in our Next-Generation series. For more on building profitable customer relationships, see our extensive Religence Framework CRI Reference Section for these topics:
Another excellent resource is our CEO’s new book Customer Relationship Intelligence: A Breakthrough Way to Measure and Manage Sales and Marketing, which explains how real-time operational customer profitability data helps achieve real-time operational control. __________ About the Authors and Religence: Bob Sabath is Chairman of the Board of Religence, Inc. A master at helping clients find quick ways to cut costs, while growing revenues by recognizing how sales and operations can build upon each other, Bob Sabath has more than 30 years experience directing some of the world’s largest consulting operations practices, where he received broad recognition for building supply chains that understood varying customer needs and economics, and responded with segmented service packages that dramatically grew market share and profits. As President of L.B. Knight & Associates, leader of the Global Supply Chain consulting practices at Mercer Management Consulting and A.T. Kearney, he dramatically grew the multimillion-dollar practices by establishing responsive, sensitive client relationships. He has a B.S. Industrial Engineering and an MBA Marketing and Management Science. He is a Certified Management Consultant (CMC) and Fellow of the Institute of Management Consultants (FIMC) and teaches Marketing and Operations at the MBA level at Cardinal Stritch University. George Fruehan is CFO of Religence, Inc. With George numbers talk. He has spent his career introducing and extending the use of accounting and operations information from board-level and senior managers to line employees in order to change behavior and increase performance. He has over 25 years in management and consulting. While at Price Waterhouse, he pioneered valuing intangibles in decision making when he worked in the financial and professional services industries for major players. In studying service-product profitability, he developed a precursor to activity-based costing. As an expert witness in Federal and state courts, his opinion is sought on what the numbers mean in economic gain or loss and on systems performance. He earned a BA in Biological Sciences and Engineering and an MBA in Operations Management at UC Berkeley. Religence is a customer-focused performance management consulting firm specializing in Customer Relationship Intelligence. The Religence Framework links strategic planning to operational execution and customer relationship metrics to profitability for breakthrough business-to-business sales and marketing performance.
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