Customer Reviews

Managing Customers as Investments: The Strategic Value of Customers in the Long Run

5 star:		(12)
4 star:		(3)
3 star:		(1)
2 star:		(0)
1 star:		(0)

 

 

Understanding that a businesses customers are one of it's greatest assets is not a new or novel idea. After all these are the people that pay the bills. But how can you fairly asses what the true value of any one customer is? Is it all based on total revenue, profit margin or market share? Questions that are difficult to answer and not really a black and white issue. This book teaches the readers how to see the link between customer value and firm value. It also does a great job of showing you which aspects of customer management are the most critical. One of the rules they want you to look at is long term relationships and strategies and not just the short term fix.

There were two great aspects of the book that made it one that can easily be used. First the authors made the decision to keep the approaches simple. You did not have to work through some multiple step process with NASU like calculations. The authors theory is that simple and intuitive concept can be implemented by almost all management thus insuring a better adoption rate. The second aspect I felt was valuable was that the book was full of real life examples. It was far easier to see how the process worked when you could relate to the examples provided. Overall I really enjoyed the book. It was informative, had great ideas and is one that can make a difference in any organization.

Ultimately a business is worth only as much as the value of its customers.

Sunil Gupta, and Donald Lehman, both Columbia Business School Professors of Business, present a practical view of marketing that weaves both its financial and customer aspects.

The concept of lifetime value of a customer is presented in a straightforward way. The information is useful to anyone charged with improving financial accountability and managing ROI.

Although the concept of customer value is not new, the two professors argue it is better to be "vaguely right, than precisely wrong" when getting started. The book shows how to use publicly available information and a simple formula to estimate the lifetime value of a customer for a publicly traded firm.

Unlike the internet age, the two professors show that for most firms, the lifetime value of a customer rarely exceeds 4.5 times his or her annual margin.

By the time you finish this book you will think of customers as assets and be convinced that expenditures directly related to acquiring and maintaining them be treated accordingly.

The need for a company to be customer-oriented is today a widely accepted idea, not just by marketers but by all executives. By my count, in 2004 alone, there were at least 15 major books published on the importance of managing all organizations with customer focus. But that's easier said than done. Thankfully now, in 2005, a new book can help you close the gap between knowledge and results by using vocabulary, processes and metrics to drive a customer-centric strategy. It should be on the very top of your reading list.

Managing Customers as Investments, by Columbia Business School marketing professors, Sunil Gupta and Donald Lehmann, and published by Wharton School Publishing, is practical and accessible. Rare among academics, the authors, who have published many papers in scholarly journals where complexity and precision are revered, have the ability and wisdom to make their subject simple, clear and useful to marketers in all industries. With examples and case studies, they make it easy to understand how to apply their models to your business. Read it and you will learn invaluable systems to demonstrate to your CEO and CFO that Marketing is the engine of the enterprise.

Gupta and Lehmann argue that if customers are the primary source of cash flow for all organizations, Marketing must be managed in three dimensions: customer acquisition, customer profitability and customer retention. These are the three Cs of Marketing with financial consequences -- not to be confused with the three Cs of market analysis, including customer needs, company (core competencies) and competition, and very different from the traditional four Ps of marketing management, including product, price, promotion and place where the focus is purely on sales or market share. Indeed, customer acquisition, customer profitability and customer retention are significant parts of the CEO and CFO agenda because they are the dimensions that drive the entire business strategy. And, ultimately, managing Marketing with these three Cs as the focus will lead to a position of power in the executive suite. The authors show you how.

Ever since The Loyalty Effect was published, some companies have been reorienting their focus to gain more loyal customers and to retain them longer. In many cases, this potentially valuable focus has been diluted by an overestimation of the value of a long-term customer. This temptation was magnified during the dot-com boom when spending money got you more money to spend. But in today's leaner times, marketing and acquisitions to add customers have to pay off. Managing Customers as Investments will provide common sense relief to miscalculations in many of these misdirected firms. In addition, those who have been daunted by calculation difficulties will welcome the rule of thumb suggestions in this book.

Gupta and Lehmann look at how you can quantify a customer's value as an asset, what the present value of a customer is, how a customer-based strategy can help you avoid value-destroying customers and actions, how customer value contributes to enterprise value (stock and debt for the whole company), how to pursue customer-based plans and how the customer-based organization needs to be organized.

I came away with four key lessons from this book:

1. It's a rare customer who is worth more than four times the annual contribution margin you earn;

2. Adding to prices and customer retention are much more valuable than other ways to add profits;

3. You need to avoid customers who cost you more than they are worth by doing enough work with customer-based costing to discover who they are; and

4. Optimizing customer profits requires a different organizational and data structure than most companies have now.

The book has a number of quantitative examples in it which many readers will find to be valuable (as The Loyalty Effect was valuable for the same reason). The most revealing example is the work done at Harrah's to increase share of wallet among its gaming customers.

For those who are quantitative, this book will be a snap (there's more advanced math in the back for those who want more). For the quantitatively challenged, give the book a try any way. You'll understand most of it.

Are you spending more on your customers than they are worth? That is the question these authors attempt to answer in this book. Whether it is acquisition cost or retention cost many businesses may be spending too much on their customers. As with all investments there is a time to increase investment, a time to hold them, and a time to let them go. This is a detailed analysis of how to develop metrics for your company that help determine customer value. With increasing customers there are increasing costs. Once you have developed your metrics they show how to use that information to determine things like customer lifetime value. Once you know their lifetime value you can make effective marketing and management decisions related to your customers. You have to manage your customers in order to manage your business. Now you can determine how to best manage your customers. A practical approach to managing customers that is both effective and easy to apply while providing real results. Managing Customers as Investments is a recommended read for all marketing and customer-centric managers as well as all corporate executives.

It is a fallacy to blindly state that the customer is always right. That is not the case; some customers are so costly that it is much cheaper to simply disallow their activities. The key is to have a way to quantify the value of your customers, so that you can differentiate between those that are worth spending the extra effort to keep them and those who will simply cost more than they could ever be worth. If you know how much you will earn from a customer over time, then you will know how much money you can spend up front to keep them as a customer.
The authors do an analysis of the average cost of acquiring a customer and the lifetime value of the customer. On page 57 there is a chart of these values for Amazon, Ameritrade, Capital One, eBay and E*Trade. The values differ widely, both in the absolute and relative senses. For Amazon, the acquisition cost is $8 and the lifetime value is $26. Clearly in this case, a $20 coupon for a new customer is not cost effective. However, for Ameritrade the acquisition cost is $203 and the lifetime value is $1,126. In this case, offering incentives such as coupons is a sound business strategy. While these figures are helpful, one must not take them too seriously. The average value of a customer is an important fact to know, but what is really important is being able to differentiate the customers with the lowest lifetime value. If even the customers in the lowest ten- percent of lifetime values can be filtered out, then it is possible to dramatically increase profits. Doing this requires that you be able to model the behavior of your customers.
While a model certainly has value, the execution must also be reasonably priced. For the vast majority of businesses, the profit margin is so low that spending even one percent of the revenue per customer on modeling the behavior of the customer may be unreasonable. Marketing strategies targeted at the points of significant interest are also of value; once again the question is determining what the points of significant interest and value to the customer are.
All of these problems and more are dealt with in depth in this book. One of the most illuminating studies cited is one performed by McKinsey and Company that compared the relative impact on profits when there is a 1% improvement in fixed cost, volume, variable cost and price. A 1% improvement in fixed cost raised profits 2.3%, a 1% improvement in volume increased profits by 3.3%, a 1% improvement in variable cost raised profits by 7.8% and a 1% increase in price without a change in volume caused an 11.1% increase in profits. Clearly, the most effective marketing strategy would be one that would allow you to increase the price and the best place to cut expenses is in the variable costs.
This is a book packed with valuable knowledge on how to run your business by treating your customers as assets to be managed. However, customers are like retirement investments, not all are suitable for you. By concentrating on those that will give you the desired return over time, your long-term success is assured. The advice in this book will help you select and manage the high quality customers necessary for every business to succeed.

The book's co-authors quote management guru Peter Drucker, who just passed away at the age of 95, in the opening paragraph of the acknowledgements: "Innovation and marketing are the only two valuable activities of a firm. The rest are costs." It's a predictably strong insight from the high priest of business principles and a tenet upon which Sunil Gupta and Donald R. Lehmann, both professors at the Columbia Business School in NY, base their treatise here. In fact, since the dot-com bubble burst five years ago, marketing was deemed dispensable when it came to valuating this responsibility in the eyes of Wall Street and its dominions. However, the co-authors have come to recognize the value of marketing in fortifying customer retention since it is no longer enough to view customers as intangible assets in need of periodic nurturing.

Their book specifically focuses on the issue of calculating customer equity (or as they put it, customer lifetime value) and examines what positively impacts it. According to Gupta and Lehmann, in order to calculate customer value, companies must capture three pieces of related data. First, they need to track the financial and other interactions with specific customers. Companies must then understand how profitability margins may vary over a customer lifetime with the hope that a customer becomes more profitable over time. Finally, they must track customer defection rates, which is the most difficult calculation given that most retail businesses have customers in non-contractual relationships. At the same time, it is this last factor that presents the greatest opportunity. The co-authors provide calculations that show improving customer retention by 1% improves customer value by almost 5%. Moreover, they show how retention is a virtuous cycle, i.e., the higher the current retention rate, the higher the impact of improving retention.

There are numerous tables worth examining which show how increasing the margin multiple increases the lifetime value. Here is an example - given the margin multiple for a company with a 60% retention rate and a discount rate of 10% is only 1.2, that translates into the lifetime value of a customer generating profits of $100 annually is only $120. Increasing the retention rate to 90%, however, with the same 10% discount rate, makes the multiple jump to 4.5 and consequently translates the lifetime value to be $450.

Obviously the greater the number of retained customers, the better corporate profitability will be given the collective impact on the bottom line. This is a good theoretical framework, but certainly market conditions change frequently enough to render the formula somewhat simplistic. If margins change as costs of capital and ongoing expenses change, then the formula becomes more of a guesstimate of how profitable the lifetime value will be. In fact, much of the book is plagued by such fluctuating and invariably uncontrollable factors.

While Gupta and Lehmann acknowledge the nebulous nature of their tenets, they provide a counterbalance in the form of sound business logic, specifically that companies need to start moving toward customer-based accounting and a customer-based organization. This means numbers such as customer satisfaction, churn, loyalty, same customer sales/revenue, new customer acquisitions, and acquisition, expansion, and retention costs need to be consistently and frequently assessed and displayed. Because customer equity is so vital to profitability and even stock market value, Gupta and Lehmann assert quite correctly that it is not as important to pinpoint the accuracy of these calculations as it is to start instilling these determinants of long-run profitability into mainline performance reporting.

The co-authors aren't entirely consistent in their approach as they still discuss intangible assets such as awareness and brand equity without attempting to quantify them in the same way as customer value. This may be worthy of another book entirely, but it seems like a gap to me. They also seem intent on excessively discrediting the more qualitative thinking during the dot-com period without acknowledging the lack of incentive in moving to this direction at the time. However, their point is really to show how much money customers could give you over the years, and to that degree, the book is invaluable as Gupta and Lehmann profess, it's better to be "vaguely correct" than "precisely wrong". I would agree.

This is a particularly thought-provoking book which, as have so many others, came from Wharton School Publishing. Columbia professors Sunil Gupta and Donald Lehmann have written regularly on the subject of Customer Value and Marketing over the last 20 years. Their articles and books have been standard texts for many MBA students interesting in customer value management for some time. Sunil and Donald have produced a jewel: it is so well written and convincing that, after reading it, you will rethink your customer relationships in terms of value creating opportunity and not in terms of expense.

Only once in a while a book comes along that open whole new areas of thinking, this is one of them.

We all know, although sometimes it seems that people forget, that any business depends on customers. What is not done very often is to look at customers as assets. Particularily it has been difficult to come up with metrics to set a customer value.

This book takes the view that a customer can be viewed as any other asset, he (or she of course) has a cost to acquire, a value (that may or may not be more than the acquisition cost), a life (that perhaps can be managed). None of these calculations are easy and simple. An illustration that the book uses is the value of a customer that buys a Toyota has a different value to the salesman getting a commission than it does to the dealer who may get service revenue and additional Toyota sales, and different yet to the Toyota corporation who may sell this customer a Lexus later on.

Valuing a corporation by the asset value of its customers is another novel approach the authors used in evaluating some of the [...] companies during their heyday. It might be considered that the value of the customer base is the only value that many companies have.

The customer value approach facilitates several courses of action that I hadn't considered. Of course there is database marketing, where the customer who bought a TV is a prospect for a DVD player. They also discuss things like growing up with the customers, changing the product offerings as the customers get older, and referral sales by one customer recommending a product to friends.

This is one of the more significant developments in marketing analysis I've seen in years.

This book argues a customer based metric to understanding not only firm value, but for making more realistic decisions about investing in new customers or even company acquisitions. The authors are quite frank about the vague nature of some of the components of the equations they develop because you have to make some assumptions about the future. I really like their statement that it is better to be vaguely right than precisely wrong. Upon close examination that statement actually sounds better than it really is, but it gets the point across.

The basic idea is that your customers represent a series of cash flows. Using the tools provided in this book you can make reasonable assumptions and make an estimate of their value to your firm. This can help company executives make better decisions about marketing spends, acquisitions, and in targeting customer segments. It can help investors and analysts double check company predictions and market valuations.

Since we have been through a period of corrupted financial reports by too many companies, it is great to have another tool to check the value of a corporation, no matter how rough. In fact, the measure is so easy to run, it would be great to make a range of assumptions to create a bounded "realities check" in order to see what would need to occur for a given investment or management scenario to be a good decision or realistic outcome.

The one tiny area where I think the authors head off into the world of making the whole world a nail for their new hammer is their idea of a CMO, a Chief Marketing Officer. There are too many Chief whatevers in companies nowadays. I think the reality is that if this turns out to be a useful and predictive tool that executives would be foolish to not use it. The role of marketing within a corporate structure has more to do with the role of marketing in the nature of the product. For example, Proctor & Gamble is a marketing firm and has to emphasize it much more than a captive auto supplier. It is not something that can be uniformly prescribed.

Far from being an abstract exercise in quantification, this is a lively and concise book with many case studies to illustrate the authors' points. Just beware that every new idea cannot really be proven with past data because of the danger of fitting the data to the needs of the tool. You will have to work with these ideas and see how they work in your organization. My guess is that these ideas will yield good results if used well.

Good business book.