Articles - Written by Arthur Hughes - 847 Comments
Target Potential Analysis
How can we use our existing customer database to tell us where to look for new customers? You might look at Target Potential Analysis. Your customer database contains a lot of valuable clues. There are several steps you should take.
- In the first place, you should compute your customer lifetime value and rank your customers by quintiles. You will find that 80%, or some high percentage, of your profit comes from the top 20%. You will also find that your lowest 20% are not profitable, or actually may be costing you money. Attribute LTV to each of your existing customers based on the performance of customers with similar purchasing habits. As most readers know, a LTV table looks like this:
Revenue Year 1 Year 2 Year 3 Referral Rate 5.00% 6.00% 7.00% Referred Customers - $1,500 $1,620 Retention Rate 85.00% 88.00% 90.00% Retained Customers - 25,500 23,760 Total Customers 30,000 27,000 25,380 Spending Rate $21,000 $24,000 $27,000 Total Revenue $630,000,000 $648,000,000 $685,260,000 Costs Direct Percent 75.00% 65.00% 60.00% Direct Costs $472,500,000 $421,200,000 $411,156,000 Acquisition Cost $630 $18,900,000 0 0 Retention Building Program $450 $13,500,000 $12,150,000 $11,421,000 Referral Program Costs $800 $0 $1,200,000 $1,296,000 Total Costs $504,900,000 $434,550,000 $423,873,000 Profits Gross Profits $125,100,000 $213,450,000 $261,387,000 Discount Rate 1.21 1.31 1.51 Net Present Value Profit $103,388,430 $155,802,920 $173,103,974 Cumulative NPV Profit $103,388,430 $259,191,349 $432,295,323 Customer Lifetime Value $3,446.28 $8,639.71 $14,409,84
Here, Weldon Instruments is tracking 30,000 customers who spend an average of $21,000 per year with them. They have a retention building program that costs $450 per customer per year, and a referral program that costs them $800 per referred customer – a bargain when you realize that the average newly acquired customer is worth about $14,400 to Weldon in the third year.
This chart is looking at all Weldon customers as a group. Subsequent charts should be developed that determine the LTV for profitability segments, and for Standard Industrial Classification (SIC) groups.
- The second step is to score all your customers by eight digit Standard Industrial Classification (SIC) code. You can get help in doing this from Dun & Bradstreet or iMarket.
- Third: determine your penetration ratios. A penetration ratio is the percentage of customers that you have of all the firms in a given SIC code. To determine this, you need to know how many companies there are in each SIC code. Again, D&B or iMarket can help. The rule is this: you can acquire customers more easily in industries where you are well known, than in industries where you are less known. The penetration ratio is determined by dividing the total number of companies in an SIC code into the total companies that you have as customers in that SIC code.
- Finally, determine the target potential index for each SIC group. The target potential is derived by multiplying the LTV by the Penetration ratio for each industrial group. To illustrate how this is done, consider Weldon Instruments. The following chart shows how Weldon went about it:
Where are Weldon’s Prime Acquisition Targets? Weldon
Rank Metal Production 254 2,433 10.44% $145,067 $15,144.68 3 Light Manufacturing 15,442 162,009 9.53% $5,914 $563.70 4 Heavy Manufacturing 44 1,288 3.42% $988,145 $33,756.51 2 High Technology 612 1,453 42.12% $127,675 $53,776.39 1 Total 29,198 167,183 17.46%
In this chart, Weldon has broken their 29,198 customers into four broad SIC groupings. They have determined the lifetime value and penetration ratio of each group. Most of Weldon’s sales are to Light Manufacturing companies, where they have 15,442 customers. Their customer group with the highest lifetime value is in Heavy Manufacturing companies, where the average customer has a lifetime value to Weldon of almost a million dollars. But in looking at acquisition, Weldon has an interesting situation. Their products are widely known and used in the High Technology industries. They have a penetration ratio of 42.12% which is far higher than any other of their four major SIC customer segments. By multiplying LTV times the Penetration Ratio, you create a Target Potential index which shows that Weldon should put their acquisition dollars into High Technology? Why? Because they are better known in this industry. Every customer acquired has an average lifetime value of $127,675 and their chance of capturing one of these customers is greater than that of any of their four major SIC customer concentrations.
Target potential analysis is not the only way of determining your acquisition strategy. The strategy may be based on the type of product you are promoting, etc. But, in the absence of compelling reasons to the contrary, I would look closely at target potential analysis as the best way to determine where to put my acquisition dollars.
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