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How Much Should You Spend on CRM?

Everyone is installing Customer Relationship Management (CRM) systems today. Millions of dollars are being spent on software, hardware and CRM personnel. Few companies have done any significant cost justification. If they were, their spending patterns might be quite different. In this article, I would like to provide a primer on CRM cost justification.

In the first place, what is CRM? It usually consists of building a massive data warehouse which is accessed by expensive CRM software such as E.piphany or Siebel. Many companies have spent more than $20 million on the warehouse and another million or more on the software. The software is supposed to use the database to select prospects and customers for promotions at strategically crucial moments in the customer’s life cycle.

What is CRM supposed to do? There are two tasks: customer acquisition and increased sales to existing customers. CRM is often justified by the phrase, “Make the right offer at the right time to the right customer.”  How can CRM do that? By collecting demographic and behavioral information about each prospect and customer, and using that to create actionable customer segments leading to communications that make relevant offers that will strike responsive chords in the recipient’s mind, resulting in sales.

To illustrate the value of CRM, let’s take an example of what happens when you don’t use CRM. Readers of my books will remember my experience with the Chevy Chase Bank. They called me at dinnertime a few years ago to tell me that as a very good customer of the bank that I was being offered free life insurance for two months, after which the cost would be only $14 per month. I asked the value of the life insurance. The sales woman replied, “$2,000.”  This was a ridiculous offer because I already had $300,000 worth of life insurance. Why would I want $302,000? It was a CRM failure because Chevy Chase knew that I had $300,000 worth of life insurance. They knew this because I had to tell them that on the home equity loan application that I had filled out in connection with getting a loan from them. I signed a statement saying they could use the information provided. They did not use the information they already had to make a relevant offer. Instead, they took a list of bank customers and gave it to a telemarketing firm. With a properly used CRM data warehouse, and CRM software, Chevy Chase could have made Arthur Hughes an offer that would have been worth listening to and possibly profitable for both of us. But they didn’t. They didn’t have a warehouse, and didn’t use what information they already had in their marketing activities.

If CRM success is in using customer information to create profitable customer communications, how can you measure CRM effectiveness or return on investment? To do the measurement, you have to recognize that almost all CRM’s effects are incremental. If successful, CRM results in higher response rates, higher conversions, and increased sales. But the original sales are seldom due to CRM itself. Almost all companies already are selling products and services before they add CRM. The CRM is financed out of the profits from their existing operations. The hope is that the CRM will make those operations more profitable.

So the expectation is that current sales of $100 million will become significantly higher by using customer and prospect information to make more relevant and timely communications. Could CRM increase sales by a measurable amount?  Perhaps, but only in certain unusual situations. Lets see how the increases come about.

Those using CRM effectively will have higher conversion rates than those who do not. How much can CRM increase conversion rates?  To determine this it is necessary to determine the current conversion rates. Let us assume that a corporation makes 50 million offers per year to the general public. These offers may be through TV, Radio, Print ads, retail stores, direct mail, email, etc. Assume that 3.5% of the offers result in a sale.

If CRM is to be successful, it must increase the conversion rate. How much of an increase can we expect? 2%, 3%, 4%? The rate will differ in each case. Let’s make some generous assumptions and say that CRM will increase conversion rates by 8%. Next, we have to determine how much CRM will cost us. If we build a database for $20 million, it certainly has a shelf life of five years or less, making the annual depreciation about $4 million. Annual maintenance and upkeep (adding data, cleaning data, appending data, merge purge, running reports) plus software and staff will cost approximately $2 million. The CRM warehouse is useless unless accompanied by customer communications, which will have a significant cost, let’s say $2 per customer per year.  The total cost of CRM will thus be $9.5 million per year:

Warehouse $20,000,000
Annual Depreciation $4,000,000
Maintenance $2,000,000
Communications $3,500,000
Annual CRM Cost $9,500,000

So what will happen to net sales as a result of the CRM initiative?

Before CRM With CRM
Offers 50,000,000 50,000,000
Conversion Rate 3.5% 3.5%
CRM Gain 0.0% 8 .0%
Conversion Rate 3.5% 3.8%
Sales 1,750,000 1,890,000
Average Sale $57.15 $57.15
Total Sales $100,012,500 $108,013,500
Cost of CRM $0 $9,500,00
Net Sale $100,012,500 $98,513,500

Sales will go up, but net sales after deducting the cost of CRM will go down.

How realistic are these numbers? Well, consider the views of the Gartner group. They estimate that 60% of the CRM projects now being launched will fail by 2003. Why will they fail? Because the companies installing CRM have not done the analysis, and are relying on unrealistic ideas of the effect of CRM on conversion rates.

Bear in mind that corporations installing CRM are in almost all cases already profitable. They are doing everything they can to make a profit. They give points or miles. They hire ad agencies to produce winning commercials. They have distributors and retail stores, plus sales people with laptops and telemarketers with modern computer screens and call directors. On top of this, they are installing CRM to further increase profits. To assume that CRM will increase conversion rates by even as much as 8% is quite a stretch.

There is also the problem of whether the product or service lends itself to CRM success. For CRM to be successful, it must be assumed that the supplier can somehow learn enough about the customer to make a relevant offer, and that the suggestion by the supplier is more important than the decisions being made independently by the consumer.

Will customers decide to rent a car because of a timely communication received from Hertz, or because they were planning a business or vacation trip and need a car? Will a law firm buy software because of a timely communication from a supplier or because they have decided to upgrade their existing system?  Certainly, the right offer to the right person at the right time is very important, but only incrementally important to the consumer. The decision to purchase anything is usually much more complex than opening your mail or email.


So what should you do?  There are some simple rules:

  • Before you install CRM, create the tables shown above and make some realistic assumptions about the increase you expect in the conversion rate.
  • Consider the possibility of building a data mart, instead of a warehouse. Data marts can be built for $1 to $2 million, and can be maintained for a half million per year. They don’t need million-dollar software, but they can produce the same results as CRM at a fraction of the cost.
  • Communicating with customers is always a good idea, and almost always profitable. You may not need a warehouse to do it. Think small. Think tests. Work with what you have to see how much impact you get from simple, inexpensive communications. Based on that experience, decide whether you need a warehouse or not.
  • Think about the Chevy Chase Bank. How much would it have cost them to enter all the data on their home equity customers into a simple data mart and use that information in creating their customer communications. I doubt that it would have cost them more than $100,000 to do this. Use the information you already have and see what you can do with it. Don’t go into CRM until you have experimented with something simpler and are sure that you need a warehouse.

Arthur Middleton Hughes, vice president of The Database Marketing Institute, has presented 28 seminars on database and email marketing.  Arthur has also authored several books includingStrategic Database Marketing 4th Edition (McGraw-Hill 2012). He and Andrew Kordek, chief strategist and co-founder of Trendline Interactive, are hosting a two-day Email Strategy Study Group in Fort Lauderdale  March 26-27, 2013, featuring group competition for email marketers responsible for subscriber acquisition, lifetime value, ratings and reviews, boosting their email budget, and doubling their ROI.  To learn how to attend the Study Group, click here

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About Arthur

Arthur Middleton Hughes has published over 200 articles on Database and E-mail Marketing. Click Here to read them.

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