Business Opportunities: On-Line Articles - When It Comes to Business Value, Not All Customers Are Created Equal

When It Comes to Business Value, Not All Customers Are Created Equal
By Michael J. McDermott

In the highly competitive atmosphere of today's global marketplace, most discussions of customer value focus on what businesses provide to their customers. However, providing value to customers comes at a price, and businesses need to recover their investment.

That being the case, the most effective customer-based strategies are those that factor into the equation not just the value the enterprise provides to its customers, but the value individual customers represent to the enterprise as well.

In Managing Customers as Investments: The Strategic Value of Customers in the Long Run, authors Sunil Gupta and Donald Lehmann, professors at Harvard Business School and Columbia School of Business, respectively, suggest that estimating the lifetime value of customers can help companies make smart decisions that balance the "customer is king" perspective against the hard-nosed financial view that "cash is king."

Typically, a substantial percentage of a company's customers and potential customers represent only marginal return on investment, most often through the economies of scale they enable in areas such as production costs and marketing efficiencies.

Some customers actually cost a business money. The book cites one study that found only 30% of a typical bank's customers were profitable over the long run. "In other words, 70% of customers destroyed value," Gupta says.

Some insurance companies found themselves in a similar situation a few years ago after several natural disasters in Florida. "Their zeal to grow and add more customers had led them to acquire a large number of customers in disaster-prone areas," he says. A more recent example is the collapse of the sub-prime mortgage market.

Providing customer value comes at a cost, which businesses need to recover.

For long-run profitability, it is imperative for these companies either to convert unprofitable customers to a profitable status or to "fire" them, Gupta and Lehmann argue in their book.

They acknowledge that this notion of dropping customers runs counter to the intuition of managers who have been trained to think that adding customers, increasing sales and gaining market share are inherently good things. However, they contend, "In many cases, market share and revenue growth may be the wrong metrics to gauge success."

Companies can also go too far in the other direction, they warn. They write about a group they dub "vulnerable customers," who provide high value to the business but do not get a lot of value from the company's services in return. This group can include newly acquired large customers and longstanding customers who remain loyal chiefly because of inertia.

The best customers provide the highest value to a company in the form of high profit margins, strong loyalty and longer retention time. In return, these "Star Customers," as Gupta and Lehmann call them, get high value from the products and services the business provides them, resulting in a balanced, mutually beneficial relationship

MAKES SENSE

That makes sense to Edward Miersch, chief operating officer and a principal in SUNRx Inc., a Cherry Hill, N.J.-based pharmacy benefits manager (PBM) firm that was No. 5 on the 2006 Inc. 500 list of fastest-growing companies.

"Our point of difference in the marketplace is advocacy for our clients and full transparency. Unlike most firms in this industry, we are paid strictly on a per-claim basis," he explains. "We do not keep spreads. All rebates, market share allowances and other manufacturer incentives are passed on to the client."

Given SUNRx's business model, plan utilization rates and volume are the most important variables affecting revenue and profits, and the company uses them to help it determine lifetime customer value.

Certain occupations, such as health care workers and teachers, demonstrate high utilization rates of prescription benefits relative to the norm. Others, such as meatpackers, show the opposite tendency. For obvious reasons, high-utilization groups are more attractive to SUNRx.

Even more important is the number of participants in a client's plan, Miersch says, so the company goes after larger employers. There are important profitability breaks at levels of about 500 participants, 10,000, 30,000 and 40,000.

"We are very much a technology-driven company, and it costs about the same to set up a 500-employee company on our system as a 40,000-employee company," he says. "The larger employer offers greater lifetime customer value."

The best customers provide high profit margins, loyalty and long retention time.

For many types of businesses, defining and measuring customer value is not so cut-and-dried. Hospitals, for example, must cater to the needs of several different constituency groups-patients, independent physicians, professional staff-all of whom might be considered in the context of "customers," says B.G. Porter, president of Studer Group.

Studer Group has an international practice, with a significant portion of its operations in the New England and Mid-Atlantic states. The focus of the consulting firm's practice is helping healthcare organizations create and sustain outcomes in service and operational excellence, and it focuses on the customer service side of the equation in doing so.

"Our vision is to be the intellectual resource for healthcare organizations to maximize their human potential. To do that, we have to focus on our own," Porter says. "Consistency is important, and you capture that through measurement."

Studer Group clients rely heavily on customer satisfaction surveys as a critical feedback mechanism, and the consulting firm takes a similar approach in its own efforts to improve organizational performance. Compensation for the firm's coaches (the company's term for consultants who work directly with its clients, or "partners") is keyed to performance metrics.

ALIGNED FOCUS

"Fifty percent of the coaches' evaluation is based on them achieving our partners' goals, and 30% is based on client surveys of them and of the firm as a whole," Porter says. "So we really get an aligned focus on customer outcomes with a system like that. We are teaching organizations exactly what we practice."

At Rochester, N.Y.-based EMA Design Automation, consistent customer focus is the most critical key to success, says Manny Marcano, president and chief executive officer. "This is fundamentally how we have grown over the last several years, and how we will continue to grow our business."

EMA is a full-service provider of electronic design automation (EDA) solutions, a business in which there are few "new" market opportunities. "Most new business comes from replacing someone else who is not providing good customer support," he says. In that environment, it is critical for EMA to invest in its highest-return customers, and it does so in a number of ways. "All relevant decisions revolve around what is in the best interest of the customer. We may forego some short-term revenue by giving something away or not selling more than they need, but this type of behavior builds customer loyalty and is an investment in our future," he says.

EMA's efforts to measure and track the lifetime value of its customers are mostly informal, but they help the company focus its efforts on those customers that account for the lion's share of its profitability.

New business comes from replacing someone not providing good customer support.

"We track the annual run rate over the previous three years and make sure we are paying attention to the 20% of our customers where we earn 80% of our revenue," Marcano says, adding that he recognizes a need for "better quantification of this dynamic."

This article looks at how three companies in different industries have benefitted from focusing on customer value. In fact, the principles behind the success they have achieved in this area apply to virtually all types of businesses. It is important to meet the needs of your customers, but keep in mind that all customers are not created equal.