Targeted Relationship Building Pays Off
by Arthur Middleton Hughes

For the last decade, more and more companies have been seriously looking into programs designed to build relationships with their customers that promote retention, referrals and increased spending. For some products and services, such relationship building activities work well, and can be shown to produce a measurable increase in customer lifetime value (LTV). Lifetime value is used as a measuring tool because it is the one index that combines into a single number the three sought after behaviors (increased retention, referrals and spending) and the key cost item (cost of the relationship building programs). What these companies have failed to do, however, is to take the next step: segmenting their customers by LTV and spending more money on the best customers, and less on the not so good customers. The purpose of this article is to show how this is done, and how to measure the impact of the segmentation.

There is no question that in some industries there is real value to both the company and to the customer in the relationship. This is not universally true. No one wants to build a relationship with the company that makes their paper clips or their light bulbs. Life is too short to be getting communications from the producers of the hundreds of products that we use in our everyday life. Since we don’t want to be bothered, it follows that the manufacturers cannot profit from contacting us. Relationship building only works if the customer feels that she benefits from it in some way.

On the other hand, we can gain by exchanging communications with our favorite airline, automobile manufacturer, bank or insurance company. In many cases, we build up an equity in these relationships. We have spent time training them in our special needs and preferences. We want them to remember these things and to use them in their communications and in the delivery of services. If they please us, then we will reward them in a way that costs us almost nothing: by being loyal and by listening to what they have to say.

What do these relationship building tactics consist of? They can be newsletters, personal communications, surveys, telephone calls, frequent buyer points, gold and platinum cards, or even just plain one-on-one friendships built up between the customer and a customer service rep.

Measuring the effect of relationship building is done by lifetime value analysis. A typical LTV chart looks like this:

In this chart, a company has kept track of a test group of about 20,000 customers over a three year period. They have determined the retention rate (40% to 50%) and the spending rate ($1,250 to $1,400 per year). The lifetime value of the typical newly acquired customer in second year after acquisition is about $332.50

Let us assume that this company has embarked on a relationship building program with their customers. The cost of the program is $15 per customer per year. As a result of this program, the company is able to increase the retention rate, and the spending rate, and is able to convert a sufficient number of customers into advocates to that their referral rate is 8% going in to the third year. The net effect of all of these activities is to boost LTV in the third year to $398 as shown on the next page.

As you can see, the retention rate increases from 40% to 50% rising to 60% in the third year for those enrolled in the relationship building program, while the spending rate rises from $1,250 per year to $1,700. The $15 per customer per year relationship building program not only pays for itself, it increases the LTV in each of the three years tracked.