Not all customers are alike; they differ in their real profitability.
Marketing is the art of attracting and keeping profitable customers. It involves making use of the 80– 20 rule, and in extreme cases see the most profitable 20 percent of customers may even contribute as much as 150 to 300 percent of profitability.
A profitable customer is a person, household, or company that over time yields a revenue stream exceeding the company’s cost stream for attracting, selling, and serving that customer. The emphasis is on the lifetime stream of revenue and cost, not the profit from a particular transaction.
Metrics that are commonly used to count customers and track customer activity irrespective of the number of transactions:
- Customer Counts: These are the number of customers of a firm for a specified time period.
- Recency: This refers to the length of time since a customer’s last purchase. A six-month customer is someone who purchased from the firm at least once within the last six months.
- Retention Rate: This is the ratio of the number of retained customers to the number at risk.
Customer Profitability Matrix provides some generalised guidance for strategic direction.
Achieve an Increase in Profitability
To become even more profitable firms need to develop integrated programmes that address activities – such as cross-selling and up-selling – that can improve customer lifetime value.
One approach for reviewing profit opportunities is the ACURA model. ACURA is an acronym for ‘acquisition, cross-sell, up-sell, retention and advocacy’.
For each element of ACURA, companies can usefully review potential strategies to improve profitability by market segment and then identify their potential profit impact.
Customer Lifetime Value (CLV)
Customer Lifetime Value (CLV) is a measurement of the total expected revenue from a customer over their entire relationship with a company.
Customer lifetime value metric assesses the financial value of each customer (Peppers and Rogers, 1997)
CLV takes into account the following aspects:
- How much the customer spends on each purchase with the firm and the resulting profit
- How often the customer purchases from the firm
- How likely the customer is to remain a customer in the future
- How much it costs to serve the customer
- The organization’s discount rate (for calculating the net present value of the future purchases
CLV helps you make important business decisions about sales, marketing, product development, and customer support.
The focus on relationship management makes it extremely important to understand CLV
Because CLV models are a systematic way to understand and evaluate a firm’s relationship with its customers.
Advantages of CLV
There are several advantages of using CLV
It forces the business to manage customer relationship as an ‘asset’.
It helps monitor the impact of management strategies and marketing investments on the value of customer assets.
It helps determine of the optimal level of investments in marketing and sales activities.
It encourages marketers to focus on the long-term value of customers.
Implementation of customer ‘sensitivity’ analysis in order to determine getting impact by spending extra money on each customer.
Related: CRM strategy explained
Characteristics make CLV special
- CLV looks forward and not backward regarding a customer’s value.
- CLV includes all of the elements of revenue, expense, and customer behaviour that drive profitability.
- CLV focuses on the customer as the driver of profitability and not the product.
- CLV can be used to include the value of prospects.
- CLV helps marketers adopt the appropriate marketing activities today to increase profits in the future
CLV calculations considers “other benefits” such as referrals and customer development. Satisfied customers provide referrals and positive word-of-mouth advertising to their friends and associates. Some referrals will become profitable customers of the firm.
A customer’s CLV for a company is not only the profits he or she contributes but also the profits resulting from people the customer influences.
Related: Customer Acquisition and Retention strategies
Customer Equity
Customer equity can be defined as the sum of CLVs of all the company’s individual customers minus company expenditures discounted to a net present value.
Customer equity puts customer value at the core of the company. It is can be used to measure the effectiveness of alternative marketing strategies.
Customer Equity v CLV
Customer equity calculations take non-directed acquisition costs into account (for example, expenditures on mass-media advertising and sales promotion that cannot be identified with specific prospects), Whereas calculations of CLV may or may not do so.
To determine customer profitability, the measures that include acquisition costs are preferred to measures that do not.
A firm should calculate both CLV and customer equity in order to focus resources on high-value customers and reduce resources aimed at low-value customers. CLV and customer equity can measure effectiveness among various marketing strategies.
Managing the CLV process
All customers go through a lifecycle process with a firm.
A firm, by investing resources, first acquires customers and it expects to make reasonable profits by offering products and services to these customers. Over a period of time, the firm also experiences customer attrition.
This cycle goes on with different customers entering and exiting at different times.
The process of growing the value of the customer base to the fullest can be represented as the strategic impact of managing the CLV process in the course of a customer’s lifetime with the firm.
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