Chapter-5

Differentiating Customers: Some Customers are Worth More than Others

A company’s most valuable customers are frequently the ones responsible for keeping the firm in
business. So, really, it makes no sense to spend the same resources on all customers, as if they
were all worth the same.

Identifying each customer individually and linking the information about that customer to
various business functions prepares the customer-strategy enterprise to engage each customer in
a mutual collaboration that will grow stronger over time.
The first step is to identify and recognize each customer at every touchpoint. A company to see
each customer completely, as one customer throughout the organization, and enables the
company to compare customers—to differentiate them, one from another. By understanding that
one customer is different from another, the enterprise reaches an important step in the
development of an interactive, customer-centric Learning Relationship with each customer. To
an enterprise, the two most important and useful differences among customers are that they need
different things from the enterprise and that they have different values to the enterprise.
An enterprise’s financial objectives with respect to any single customer will be defined vy the
value the customer is customer is currently creating for the enterprise (her actual value) as well
as the potential value the customer could create for the enterprise. Changing a customer’s
behavior (which is the basic objective of all marketing activity) can be accomplished only by
appealing to the customer’s own personal motives, or need.

CUSTOMER VALUE IS A FUTURE-ORIENTED VARIABLE

Mail-order firms, credit card companies, telecommunications firms, and other marketers with
direct connections to their consumer customers often try to understand their marketing universe
by doing a simple form of prioritization called decile analysis—ranking their customers in order
of their value to the company, and then dividing this top-to-bottom list of customers into 10
equal portions, or deciles, with each decile comprising 10 percent of the customers. In this way,
the marketer can begin to analyze the differences between those customers who populate the
most valuable one or two deciles and those who populate the less valuable deciles.

A credit card company may find, for instance, that 65 percent of top-decile customers are
married and have two cards on the same account, while only 30 percent of other, less valuable
customers have these characteristics. Or a catalog company may find that a majority of
customers in the bottom three or four deciles have never before bought anything by direct mail,
compared to only 15 percent of those in the top two deciles.

But just how does a company rank-order its customers by their value in the first place? The value
a customer represents to an enterprise should be thought of as the same type of value any other
financial asset would represent. The primary objective of a customer-strategy enterprise should
be to increase the value of its customer base; that is, it should strive to increase the sum total of
all the individual financial assets known as customers. But this is not as simple.

Suppose a company has two business customers. Customer A generated $1,000 per month in
profit for the enterprise over the last two years, while Customer B generated $500 in monthly
profit during the same period. Which customer is worth more to the enterprise? we can say it’s
probable that Customer A is worth more than Customer B, but this is not a certainty. If Customer
A were to generate $1,000 in profit per month in all future months, while Customer B were to
generate $500 per month in all future months, then certainly A is worth twice as much to the
enterprise as B. But what if we know that Customer A plans to merge its operations into another
firm in three months and switch to a different supplier altogether, while Customer B plans to
continue doing its regular volume with the company for the foreseeable future? In that case, our
ranking of these two customers would be reversed, and we would consider B to be worth more
than A.

A customer’s value to an enterprise, as a financial asset, is a future oriented variable. Therefore,

it is a quantity that can truly be ascertained only from the customer’s actual behavior in the
future. We mortals can analyze data points from past behavior.

To think about customer valuation, therefore, we need to use two concepts:

Actual value is the customer’s value as an asset to the enterprise, given what we currently know
or predict about the customer’s future behavior, assuming there are no major changes in the
competitive environment.

Potential value is all the value that this customer could represent if we were to apply a
conscious strategy to improve it, by changing the customer’s future behavior in some way.

CUSTOMER LIFETIME VALUE

The actual value of a customer is equivalent to a quantity that is frequently called the customer
lifetime value (LTV), or the net present value of the stream of expected future financial
contributions from the customer. Every customer of an enterprise today will be responsible for
some specific series of events in the future, each of which will have a financial impact on the
enterprise—the purchase of a product, payment for a service, remittance of a subscription fee, a
product exchange or upgrade, a warranty claim, a help-line telephone call, the referral of another
customer, and so forth. LTV is, in essence, the sum of the net present values of all such future
events attributed to a particular customer’s actions.

Any model that attempts to calculate individual customer LTVs should employ some or all of the
following data, quantified and weighted appropriately:
• Repeat customer purchases
• Greater profit and/or lower cost (per sale) from repeat customers than from initial customers
(converting prospects)
• Indirect benefits from customers, such as referrals
• Customer’s stated willingness to do business in the future rather than switch suppliers
• Customer records
• Transaction records (summary and detail)
• Products and product costs
• Cost to serve/support
• Marketing and transaction costs (including acquisition costs)
• Response rates to marketing/advertising efforts.4

The objective with LTV modeling is to use these data points to create an historically quantifiable
representation of the customer and to compare that customer’s history with other customers.
Best on this analysis, the enterprise can begin to build a statistical model of the customer’s route
with the enterprise, and project the customer’s future route—including how much he will spend
and over what period.

For this purposes, it is sufficient to know that:

• The actual value of a customer is equivalent to the customer’s lifetime value—the net present
value of future cash flows associated with that customer.

• LTV is a quantity that no enterprise can ever calculate precisely, no matter how sophisticated
its models are.
• Nevertheless, every enterprise has an interest in understanding and positively affecting its
customers’ LTVs to the extent possible.

Assessing a customer’s potential value

In trying to assess a particular customer’s potential value, some of the following questions you
want to answers:

 How much of the customer’s business currently goes to your competition but might be
pried away with the right approach or relationship?
 How much of the customer’s business could you capture if you modify your treatment of
him?
 How many more product lines might the customer buy from?
 What additional value would capture if you could prevent the customer’s defection?
 The customer has needs you know about. How can you identify the needs you don’t yet
know about?
 How much could you reduce the cost of serving this customer, while maintaining his
satisfaction?
 How much could this customer be worth in terms of referrals and other non-monetary
contributions?
DIFFERENT CUSTOMERS HAVE DIFFERENT VALUES

Increasing a customer’s value encompasses the central mission of an enterprise: to get, keep, and
grow its customers. When it understands the value of individual customers, relative to other
customers, an enterprise can allocate its resources more effectively, because it is quite likely that
a small proportion of its most valuable customers (MVC) will account for a large proportion of
the enterprise’s profitability.

This is an important principle of customer differentiation, and at its core is what is known as the
Pareto Principle, which states that 80 percent of any enterprise’s business comes from just 20
percent of its customers. Obviously, the percentages can vary widely among different businesses,
and one company might find that the top 20 percent of its customers do 95 percent of its
business, while another company finds that the top 20 percent of its customers only do 40
percent of its business. But in virtually every business, some customers are worth more than
others.

IN addition to LTV variable, enterprise want to another variable called Proxy variable. A proxy
variable is easy to measure, but it obviously will not provide the same degree of accuracy when it
comes to quantifying a customer’s actual value.

For instance, many direct marketers use a proxy variable called recency, frequency, monetary
(RFM) value to rank-order their customers in terms of their value. The RFM model is based on
individual customer purchase histories, and incorporates three separate but quantified
components:
• Recency. Date of this customer’s most recent transaction
• Frequency. How often this customer buys
• Monetary value. How much this customer has spent in the most recent specified period

For example- An airline, in contrast, might use a customer’s frequent-flier mileage as a proxy
variable to differentiate one customer’s value from another’s. The mileage total will be a good
indicator of the customer’s value, but it won’t be entirely accurate. For instance, it won’t tell the
airline whether the customer usually flies in first class or in coach, and it won’t tell whether the
customer always purchases the least expensive seat, frequently choosing to stay over on
Saturdays, and taking advantage of various other pricing complexities and loopholes in order to
guarantee always obtaining the lowest fare.

Proxy variables can be important tools for helping an enterprise rank its customers based on
value, and with this ranking the company can still apply different strategies to different
customers, based on their relative worth.

Enterprises must understand that the goal of value differentiation is not a historical
understanding, but a predictive plan of action. RFM and other, similar, proxy-variable methods
show that while differentiating among customers can be mathematically complex, it is still
fundamentally a simple principle.
CUSTOMER VALUE CATEGORIES

It is frequently the case that an enterprise will want to categorize its customers by their different
types of value—high value, low value, high growth potential, and so forth.

Customers could easily be assigned to four different categories:

1. Most valuable customers (MVCs): These may or may not be the traditional “heavy users” of a
product; the MVC may, for example fly a lot less often, but always pays full fare for first-class
tickets. The objective of an enterprise with respect to its MVCs is retention, because these are the
customers keeping the enterprise in business in the first place.

2. Most growable customers (MGCs): These are the customers who have the most growth
potential; growth that can be realized through crossselling, through keeping the customer for a
longer period, or perhaps by changing customers’ behavior and getting them to operate in a way
that costs the enterprise less money. Here the company’s objective will be to change the
dynamics in some way so as to achieve a higher share of each of these customers’ business.

3. Low-maintenance customers (LMCs): These customers have little current value to the
enterprise and little growth potential. But they are stil worth something. The enterprise’s
financial objective is to streamline the services provided them and to drive more and more
interactions into cost-efficient, automated channels.

4. Super-growth customers: Many enterprises will have just a few customers who have
substantial actual value and also a significant amount of untapped growth potential. This is more
likely to true for B2B firms. They are likely already high-value customers. No matter what size
B2B firm an enterprise is, if sells to Microsoft, or Intel, or Nissan, or GE, or any other corporate
customers with similarly large financial profiles, chances are these customers are super-growth
customers. The objective here is not just to retain the business already achieved but to mine the
account for more.

3. Below-zeros (BZs): These are customers who, no matter what effort a company makes, will
generate less revenue than cost-to-serve. That means that not only is their actual value below
zero, but their potential value is also less than zero. Nearly every company has at least a few of
these customers— the telecommunications customer who moves often and leaves the last month
or two unpaid at each address, the high-maintenance customer who buys little but needs lots of
service, the giant business customer who bullies prices down so low that the vendor’s margin is
repeatedly demolished.
The enterprise’s strategy for a BZ should be to create incentives either to convert the customer’s
trajectory into a breakeven or profitable one (for instance, by imposing service charges for
services previously given away for free) or to encourage the BZ to become someone else’s
unprofitable customer.
Dealing with tough customers

Sometimes, because of the structure of an enterprise’s own industry or its distribution network,
or simply because of the type of market it has to deal with, it will have to cope with very
powerful customers- customers who have a great deal of negotiating leverage in their
relationship with the vendors they buy from. Four tactics can be used to improve and maintain
the value of even the toughest customers:

1. Customization of services or products: An enterprise can build high-end customized

services around the more commodity-like products or services it sells, which creates
switching costs that increase a customer’s willingness to remain loyal, rather than bidding
out the contract at every opportunity.

2. Perpetual, cost-efficient innovation: The organizational mission must center on being

nimbler, more creative, and cost-efficient-all at the same time. But the value of such a
firm is really bringing to the customer here is innovation, not the products themselves.
Many tough customers’ motive is to regain their negotiating power in dealing with the
seller. So perpetual innovation is just that-perpetual. If a company can keep the wheels
spinning fast enough, and provided that it doesn’t lose control of costs, it can safely deal
with very tough buyers.

3. Personal relationships within the customer organization: People are both rational and
emotional by nature. Therefore, the individuals within the enterprise need to have
personal relationship with the individuals within the customer’s organization. Thus in the
high-tech or automotive arena, this might mean developing relationships with the
engineers within a customer’s organization who are responsible for designing the
company’s components into the final products. In the retailing business, it could mean
developing relationships with the regional merchandising managers who get promoted
based on the success of the programs the enterprise helps organize for them.

4. Appeals directly to end user: A highly desirable brand or a completely unique product
in heavy demand by the customer’s own customers will pull a seller’s products the
customer’s own organization more easily. The “Intel Inside” advertising campaign is
designed to create pull-through for Intel. Dell Web pages for enterprise customers not
only save money for the customers but also give Dell a direct, one-to-one relationship
with executives who actually have the Dell computers on their tasks.

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