Managing customers is quite different from managing inventory. With
inventory, there are two systems: LIFO and FIFO meaning Last in, First Out, and First In,
First Out. With a marketing customer database, the system we recommend is FISH, which
stands for First In, Still Here!. The goal is to keep customers actively participating in
our products and services for a lifetime. That is the goal of effective customer
There are a series of steps that customers should go through as they enter our customer
management system. We begin with acquisition with acquisition being defined as
finding first time buyers, and converting them into second time buyers. Only then do we
have someone that we can profitably manage. Our next step is migration. We want to turn
our acquired customer base into a strategic corporate asset. We must find out their needs,
desires, and incomes. We learn their ages, family composition, occupations, lifestyle. In
the case of business customers, we learn their SIC code, annual sales, and number of
employees. We learn their buying cycle, and their key employees: specifiers, influencers,
decision makers, etc.
The idea of migration is to convert these acquired customers into loyal customers, and
even get them to become advocates: people who will sing our praises and refer other
customers to us. The management process brings up the question, who owns these customers?
Who will manage them? Who will work to gain the customers loyalty?
In most organizations, this is a very difficult question. Most companies are organized
on a product, or brand basis. A bank has home equity customers, auto loan customers,
mortgage customers, credit card customers. There is a vice president in charge of each of
these functions. No one is in charge of the customer! No one is working to build loyalty
to the bank, to widen their purchases to other products, to deepen their involvement with
the bank. Many of these vice presidents can actually weaken the customer relationship by
the marketing programs that they are conducting. Lets look at some examples:
A company sets customer acquisition as a goal. Experience shows that discounted
transactions bring in new customers. Over a period of four years, they aggressively
promote acquisitions through discounts. In Year 4 they realize that, while they have
succeeded in acquiring many new customers, their profits are seriously eroded by the
discounts. They decide to eliminate all discounts. In Year 5 they end up with fewer real
customers than they had in the first place. Discounting, in other words, is a serious
trap. You educate the customer to think only about price, and not about the quality and
services provided by the institution. The image of the bank, for example, is one of cheap
discounts, rather than personal attention to its customers. All products suffer.
In another example of similar problem, the restaurant manager of a large hotel notices
that few people are eating in the restaurant on Wednesday nights. He decides to pep things
up. On Wednesday nights, he brings in magicians, Mexican bands, belly dancers. He attracts
a large crowd of locals who come for the excitement. Meanwhile, the regular businessmen
who are the life blood of the hotels business find that they cannot conduct business
in the restaurant on Wednesday nights. They decide to move to a quieter hotel elsewhere in
town. The restaurant managers program has certainly increased traffic in the middle
of the week, but what has it done for the hotels profitability? What has happened to
the loyalty of its business customers? Who is managing the customers?
In another situation, a business to business customer manager sets a goal of customer
retention. He succeeds: he doesnt lose customers, and those that he retains do not
decrease their spending. This may seem like success, until one looks at what has happened
to these customers. The business of the customers may have been growing by 30% per year,
but the companys sales to these customers has not increased. By standing still, the
company has been falling behind. In other words, the proper measurement is share of
wallet, not spending level. To know what our share of wallet is, we must have some
information about the size of the wallet. We have to understand our customers
business to understand our own business.
A final example may illustrate the dangers of failure to manage the customers. Here is
a company that aggressively promotes its customers. Visualize a company like the
Readers Digest that has more than one hundred different products that it wants to
promote to its existing customer base. Experience has shown, let us say, that single
product promotions for this type of situation, are more successful than catalogs with
scores of different products. There are not enough weeks in the year to accommodate 100
products with single item promotion? The company surveys its customers to determine their
interests. They find out which customers are interested in childrens products, which
like romance reading, which like current affairs, etc. This is good. It is segmentation
along interest lines. But then they make a major mistake. Of course, some customers have
checked more than one category of interest. Some check as many as ten! Having created
these segments, they begin to promote them aggressively. The manager of each category
promotes like mad, trying to increase profits in the area of his responsibility. Some
customers get one letter a month. Frequent responders get four or five a week!
The result is what we call "file fatigue". Your best customers are worn down
under a deluge of mail. You have worn out your welcome. Each of the segment managers says,
"I didnt over-promote. I never sent more than one a month." But as far as
the customers were concerned, they were seeing several a week. They soon learned to chuck
them out unread. Perfectly good, responsive, profitable and loyal customers had been
ruined by over promotion. A failure of customer management.
What is the solution in all of these cases: We must put someone in charge of the
overall customer relationship. Someone must manage each segment, and be sure that they are
being handled properly. We must not overpromote. We must watch the customers
business to make sure that we grow with the customer. We must not offer discounts to our
loyal regular customers. We must not degrade our service by cheapening our offering in the
effort to build the body counts, while losing the high valued customers.
We soon learn that each customer segment needs to be treated differently based on their
contribution to overall profits. If we segment the customer base into five quintiles,
based on lifetime value, for example, we get a picture that looks like this:
The top quintile, our Gold customers, are where the bulk of our revenue and profits are
generated. We must treat these customers with respect. Dont, necessarily, market to
them. Provide them with super services service so good that you could not possibly
afford to provide it to every one of your customers. The marketing dollars should be aimed
at the second, third, and fourth quintiles. To the second quintile, you tell them how
close they are to qualifying for Gold. You tell them how wonderful it is to be Gold, and
how easy it would be for them to move up.
The bottom quintile may actually be losers with a negative lifetime value. Why
try to retain these people? Why reactivate them? Why spend expensive service dollars on
them? On the other hand, we need to manage them properly. Maybe some of these bottom
quintile people may be young college graduates just starting out in life. They may have
very low incomes and no children now, but they have a great life ahead of them with
hundreds of dollars of spending during the next forty years. Why alienate them too early?
Find out why they are in the bottom quintile. If they have a legitimate excuse and a
reasonable future potential, keep them in.
How can we measure what we are doing in our customer management activities. We
recommend determining the rate of return on customer investment. If we can determine the
lifetime value of each customer segment and divide that by the investment we are prepared
to make in that segment, we will come up with a ROI for that segment. The formula looks
ROI = (Lifetime Value of Customers in the Segment) / (Investment in the Customer
In doing this, it is useful to look at three activities: acquisition, retention and
reactivation of customers. Each may have different costs and success rates. Using this
information, we can determine where to put our marketing dollars. Lets start with
If we assume that our acquisition efforts cost us $1 each, the have a response rate
of 2.5%, then the average acquisition cost is $40 per customer. We can divide that into
our customer lifetime value to determine the ROI of our acquisition efforts. If customers
lifetime value is $100, then our ROI is:
ROI = $100 / $40 = 2.5 -- a good return on investment.
Let's now look at retention. Lets assume that we set up a regular series of
communications with our existing customers during year, designed to keep them interested
and loyal to our company. Each of these communications costs us $0.80 each. We mail each
customer four times per year. If our retention rate is 40% (which means that our annual
customer loss rate is 60%) then our cost of retaining customers is $8.00 per customer per
Again, assuming a customer lifetime value of $100, the ROI of retention activities
ROI = $100 / $8 = 12.5%
This is a much better return on investment than acquisition activities. What does this
mean? It is much more profitable to work to retain our existing customers than to beat
the bushes for new customers. We already knew that, intuitively, but here is the
proof, which you can compute for yourself if you do your homework and compute such things
as lifetime value, costs of acquisition and retention activities, and your success rates
in these ventures.
A final example shows the return on investment of reactivation efforts. We all have old
customers who no longer buy from us. Which would be more profitable: to spend money trying
to reactivate customers, or to spend the same money on trying to acquire new customers.
Let's take an example. Suppose that your cost of reactivation is $0.80 per customer, and
that you make two tries with each lapsed customer. Your success rate is 8%. What do the
numbers look like?
The ROI calculation looks like this:
ROI = $100 / $20 = 5.0
Conclusion: it is twice as profitable to spend money reactivating lapsed customers as
it is to work to acquire new customers. This is effective customer management.
But what do most companies do? Look at the advertising budgets of the typical company.
Advertising $10,000,000. Database Marketing $1,000,000. The spending on acquisition is ten
times the money spent on retention and reactivation combined! Look at your own company. We
wager that your percentages are similar to those we show here. How well are you managing
Peter Drucker said, "The only profit center is the customer". The most
profitable return on investment comes from customer management: learning to
- grow users
- grow usage
- grow satisfaction
- grow lifetime value
Investment in customer management has a long term payback.
In conclusion, lets look at two customer management strategies. We call them Hunting
and Farming. The Hunting strategy is that being pursued by the vast majority of all
corporations today: Concentrate on one product at a time, and sell the product to as many
customers as possible. It looks like this:
Using intelligent customer management, we move to a farming strategy. We focus on one
customer at a time. We try to sell that customer as many products as possible over the
customers total lifetime:
We can sum up our approach to customer management: Dont try to be all things to
all people. Learn about your customers, their desires, needs, and preferences. Segment
your customers by volume, lifestyle, or any other category that is meaningful to the
customer. Determine the lifetime value of each segment. Put someone in charge of each
segment, which responsibility to retain that customer for a lifetime, and to sell her the
entire company product line. Reward the executive for retention and sales volume.
Recognize, also, that some customers lifetime values are very low, or even negative.
Dont waste money promoting these losers. It is more important to reach the people
who count, than to count the people we reach.
Arthur Middleton Hughes is Vice President of The Database Marketing Institute. Ltd. (Arthur.firstname.lastname@example.org) which provides strategic advice on relationship marketing. Arthur is also Senior Strategist at e-Dialog.com (ahughes@e-Dialog.com) which provides precision e-mail marketing services for major corporations worldwide. Arthur is the author of Strategic Database Marketing 3rd ed. (McGraw Hill 2006). You may reach Arthur at (954) 767-4558 .
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