January 21, 2006

The Value of Customers

by Brian Turner

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Valuing customers

Every good business knows that it needs to profit from its customers.

However, not every business uses the same method to calculate profit from customers.

Often companies value customers on a per sale basis.

This is especially common in the business-to-consumer industries, where companies often work on short-term targets only, and do not factor in repeat business as a goal.

This is changing as awareness of New Marketing principles becomes more ingrained into company practice.

With narrowing profit margins, coupled with the ease of communications between consumers, there is a growing shift away from calculating customer value simply on a per sale value.

Customer Lifetime Value (CLV)

Customer Lifetime Value is a more forward-thinking way of assessing sales and profits, by taking longer term issues into account.

Essentially, a calculation is made of future profits expected from the customer’s buying lifetime from the company.

Calculating Customer Lifetime Value (CLV) is fraught with assumptions, but the underlying principle is that high customer retention relates to increased profitability.

For example, Earthlink calculates that it costs $100 to acquire a customer, but then that customer provides $11 net revenue per month. So for the first 10 months the company makes a loss with that customer.

However, with an average retention of 31 months per customer, that means 21 months of profit.

Of course, if they can increase customer retention, profitability would soar.

So it’s not enough to simply attract new customers - retention is important, too, for the generation of repeat business, sales, and continued profits from those customers.

Customer satisfaction

A business that looks at Customer Lifetime Value will need to take customer satisfaction very seriously indeed.

After all, if the business is making a loss on acquiring new customers, then they will need to ensure that they hold onto that new customer long enough to make the acquisition profitable for the company.

Additionally, the ease by which customers can communicate with one another means that attracting new customers doesn’t simply mean providing good service - but ensuring that bad service issues are dealt with, otherwise face threats to customer acquisition and retention.

This has led to extreme forms of customer policies being set up.

For example, LL Bean, a mail-order catalogue company, offers the following to its customers:

100% Guarantee

All of our products are guaranteed to provide 100% satisfaction in every way. Return anything purchased from us at any time if it proves otherwise. We will replace it, refund your purchase price or credit your credit card, as you wish. We do not want you to have anything from L L Bean that is not completely satisfactory.

Accordingly, they balance this with the following message prominantly displayed around their offices for staff to read:

What is a customer?

A Customer is the most important person ever in this office…in person or in mail.

A Customer is not dependent on us…we are dependent on him.

A Customer is not an interruption of our work…he is the purpose of it. We are not doing a favor by serving him…he is doing us a favor by giving us the opportunitity to do so.

A Customer is not someone to argue or match wits with. Nobody ever won an argument with a customer.

A Customer is a person who brings us his wants. It’s our job to handle them profitably to him and ourselves.

Customer Lifetime Value as Good Business Value

Some people reading this may already have objections - maintenance and support of existing customers can only get in the way of making sales to new customers, right?

According to Frederick F Reichheld in “The Loyalty Effect”:

2. Satisfied customers will return to make continued sales

3. The customer profit rate tends to increase over the lifetime of customer retention

4. A 5% increase in customer retention can increase profits between 25%-85%, depending upon industry

5. An average American company loses 10% of its customers each year.

Not only can a customer-focused approach help increase profits - it can maintain profits when everyone else is losing theirs.

Southwest Airlines in the US is a company that believes that customer satisfaction comes not from forcing staff to like customers - but from making staff happy so that helping customers is not a chore, but a pleasure.

It’s a policy that seems to work - the one year the company has not filed profits was it’s first, a record no other airline can match - and SouthWest Airlines was the only airline in the US to remain profitable after 9/11.

Conclusion

If the purpose of marketing is to increase the profits of a company, then a focus on customer retention can be of as much importance as customer acquisition.

While not every company may want to work on such a model, the benefits of calculating profits on a Customer Lifetime Value as opposed to on a Per Sale basis are significant.

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