1. finance
2. bank

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CHAPTER 2
THE VALUE
OF CUSTOMERS
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Success is getting the right customers … and keeping them.
— Charles Cawley, founder of credit card giant MBNA
LEARNING OBJECTIVES
When you have completed this chapter, you will be able to:
• Identify the critical elements that define customer lifetime value.
• Calculate customer profitability and customer lifetime value.
• Recognize the importance of investing in, and retaining, the right customers.
• Relate delivering customer value to generating long-term customer loyalty.
• Explain the importance of measuring customer profitability.
• Make tough decisions on dealing with unprofitable current customers.
• Make tough decisions about accepting/rejecting potential customers.
• Establish a customer relationship management (CRM) program.
• Design customer loyalty programs.
OPENING CASE: ROYAL BANK OF CANADA
Toronto-based Royal Bank of Canada (RBC) serves over 14 million personal, business, and publicsector customers via offices in North America and 30 other countries. RBC is Canada’s leading bank,
with more than 1,700 offices and 5,000 banking machines. What sets RBC apart from competitors
is its focus on customer profitability. In RBC’s retail business, 17 percent of customers account for 93
percent of profits — an extreme version of the 80/20 rule at 93/17. RBC concentrates on this 17 percent and discourages, or even discards, its least profitable and loss-making customers.
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MARKETING AND THE FIRM
RBC calculates economic profit by customer.1 Identifying revenue, product profit margins (spreads),
and invested capital is easy. RBC tracks labor costs via activity-based costing. RBC monitors costs
for back office processing, call centers, serving customers through various channels, and other activities. RBC calculates labor costs per customer, based on product portfolios and monthly transactions.
Because RBC knows which customers earn it economic profit (loss), it can take actions other firms
cannot. RBC determines the shareholder value each individual customer or segment creates. RBC
also calculates an intrinsic price/earnings (P/E) multiple and compares this P/E ratio to the market
average. Golden customer segments — higher than average P/E ratios — are profitable investment
opportunities. RBC rationalizes, closes, or sells off customer segments with low P/E ratios.
RBC’s retail bank has nine customer segment managers and many product managers. Each segment/
product manager has individual and primary responsibility for strategy and profit and loss (P&L),
for their segment/product. They compete with functional managers — marketing, human resources,
facilities — for bank resources. This matrix organization encourages collaboration; it works because
RBC’s culture has always been customer-centric and consensus driven. Also, senior management has
clearly signaled that managing for team success is important for career advancement.
RBC’S NEW APPROACH. RBC traditionally ran mortgage promotions in the spring home-buying
season, emphasizing RBC’s rates. Competitor banks operated similarly. But Louise Mitchell, RBC’s
leader for the builders and borrowers segment, pursued a different approach — she targeted the life
event of a first home purchase. Mitchell created a value proposition to serve the total needs of firsttime home buyers, and add significant value to RBC’s shareholders:
• First-time home buyers have most of their financial lives ahead of them. Attracting these customers promises long-term banking relationships, with significant growth prospects.
• On average, first-time home buyers borrow larger amounts for longer terms than other buyers
and are less sensitive to rates. They promise larger investment opportunities, longer-term relationships, and higher returns on invested capital than other customers.
RBC distributed (direct mail and e-mail) a freestanding newspaper insert — First Time Home
Buyers’ Guide — full of information and expert advice. RBC’s offer included the mortgage and a
$500 savings deposit and free financial review (annually for the first five years). Customers also
received six months free online banking, one year free Internet service, and a no-fee Visa card.
RBC’s product-centric organization could not have executed this promotion; the promotion required
coordination among managers responsible for mortgages, savings accounts, financial advice, and marketing. As segment leader, Mitchell was a powerful catalyst. She stated: “Looking through the customer
lens,” the promotional ideas “jump right out at you.”
RBC’s customer-focused strategy delivered impressive results: First-time
mortgage share grew significantly, particularly in the longest, most
profitable (for RBC) terms. Although 2008 was difficult, from 1994 to
2010, RBC earned several increases: revenues — $7.39 billion to
$40+ billion; profits — $1.17 billion to $6+ billion; year-end market
value — $8.9 billion to $70+ billion; and P/E ratio — 8 to 15.
U E S T IO
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THE VALUE OF CUSTOMERS
KEY IDEA
‰ When the firm creates
value for customers, it
successfully attracts,
retains, and grows
customers.
‰ By being attracted,
retained, and grown,
customers create value
for the firm and its
shareholders.
KEY IDEA
‰ Customer lifetime value
(CLV) is the crucial link
between:
• Delivering value to
customers
• Creating value
for shareholders
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CHAPTER 2
Chapter 1 discusses the critical role customers play for the firm’s well-being. By attracting,
retaining, and growing customers, the firm makes profits today and promises profits tomorrow.
Profits allow the firm to survive and grow, and enhance shareholder value. Because of these
2
relationships, customers are the firm’s core assets. More precisely, customers are core assets
because of two sides of the concept of value. When the firm creates value for customers, it successfully attracts, retains, and grows those customers. By being attracted, retained, and grown,
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customers create value for the firm and its shareholders.
A retained customer returns to buy more products and services. If your local coffee shop provides good value, like a tasty cup of coffee and a fresh snack for a reasonable price, you will keep
going back, morning after morning. The value you bring to the coffee shop is more than just one
morning’s purchases. You make a stream of purchases because the coffee shop gives you value. By
delivering customer value, the firm generates customer loyalty. This relationship applies to all
customers regardless of product — automobiles, credit cards, haircuts, jet engines, or TVs.
The first part of this chapter moves beyond the customers-as-assets concept to measuring the
value that customers bring to the firm. The critical concept is customer lifetime value (CLV)
— what the customer is worth. CLV is the discounted future stream of profits the customer generates over the life of its relationship with the firm. CLV is the crucial link between the value the
firm delivers to customers and the value customers deliver to the firm. Increasing CLV enhances
shareholder value. This chapter shows how to use CLV to increase the value customers bring to
the firm; both current customers and potential new customers. The chapter also identifies the
right customers and shows that some customers are undesirable.
Specifically, we address two questions:
• How can we put a monetary value on the firm’s current customers and on potential
customers it may acquire? This monetary value is CLV.
• How can we use the CLV concept to help the firm enhance shareholder value?
In the second part of this chapter, we examine practical ways in which firms use the CLV concept to bind customers closer to the firm. Specifically, we address customer relationship management (CRM systems and customer loyalty programs.
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THE VALUE OF CUSTOMERS
Mar ke t ing
Quest ion
What other messages did
you glean from this chapter?
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CHAPTER 2
KEY MESSAGES
•
•
•
•
•
•
•
•
•
•
Customer lifetime value (CLV) is the critical link between delivering value to customers and
creating value for the firm and its shareholders.
The firm improves CLV by increasing profit margin (m) and customer retention rate (r), and
decreasing discount rate (d).
Increasing customer retention rate (r) has greater leverage on CLV than decreasing discount
rate (d).
The firm has three broad options for addressing current customers — retain, grow, and
delete.
The firm has three broad options for addressing potential customers — retrieve, acquire,
and ignore.
The firm should strive to understand the reasons for customer retention and defection and
act accordingly.
Some of the firm’s current customers are probably unprofitable — but a fraction of these
may present future opportunities.
The firm may forgo a customer relationship for reasons other than poor profitability.
A well-designed customer relationship management (CRM) system deepen the firm’s
knowledge about its customers.
Understanding customer value to the firm and customer loyalty allows the firm to design
effective loyalty programs.
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VIDEOS AND AUDIOS
Loyalty Programs
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Ran Kivetz
Columbia Business School
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QUESTIONS FOR STUDY AND DISCUSSION
Can you answer the questions implied by this chapter’s learning objectives? Check!
1. A cable company spends on average $600 to acquire a customer. Annual maintenance costs
per customer — $45; record-keeping and billing costs — $30 per customer per annum. Price
of a basic service package — $30 per month. Typically, 40 percent of customers buy a premium
package — $50 per month; 10 percent buy the super-premium package — $80 per month.
Over time, 80 percent of customers remain with the company from one year to the next.
• What is the average CLV for all customers?
• What is the CLV of a super-premium customer?
2. Chapter 11 introduces brand equity. What is the relationship between CLV and brand equity?
3. Which firms do a good job of retaining and growing current customers, while simultaneously
acquiring new customers? What has made these firms successful?
4. Sonik CD (disguised name) was a wholesale buying club for classical, jazz, and blues enthusiasts — annual membership fee $40. Sonik scoured distributors and independent retailers for
hard-to-get and out-of-print releases. Sonik’s price of $10.95 per CD was lower than average
retail price; average Sonik cost — $10.50 per CD. Shipping and handling price — $4.00 per
package; average cost — $0.50. Subscribers purchased 19.9 CDs annually, mostly at Sonik’s
website; annual retention rate — 90 percent. Sonik fulfilled all orders — annual fixed cost,
$400,000; shipments averaged 3.7 CDs per package. Annual marketing expenses — $230,000;
90 percent for new subscribers, 5 percent for retention. Sonik’s cost of capital was 12 percent.
Three growth options were:
a. Continue niche strategy: Sonik anticipated acquiring 20,000–30,000 new customers
annually for several years without major new investment. Spending $0.5 million annually
would increase customer retention to 95 percent.
b. Mass-market strategy: Abandon the subscription model; add many music genres; build a
mass-market brand. An initial $1 million to $2 million investment would build brand awareness; distribution and warehousing would require $0.5 million annually. Sonik estimated
adding 40,000–50,000 new subscribers per quarter for $12.50 acquisition cost; annual profit
margin — $15; retention rate — 60 percent.
c. Distribution strategy: Sonik also distributed products for other online retailers. AmeriNet
Radio (ANR) operated 43 radio stations (southeast U.S., 25 million listeners); ANR sold CDs
through station websites. ANR asked Sonik for an exclusive arrangement: Sonik would
close retail operations; it would become sole distributor for all ANR CD sales, charging its
normal handling fee. Sonik’s CD price — $13.25; Sonik would pay ANR $1.50 per CD.
Research suggested: 5 percent ANR listeners bought CDs online; 10 percent would buy from
Sonik; a typical customer would buy twice a year, averaging two CDs per order. Sonik’s
additional fixed costs — $0.5 million annually.
Which option should Sonik choose?
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5. Develop a loyalty program for your favorite restaurant. Justify the variables — used/omitted.
6. Select a firm and one of its products. Alternatively, consider this book — Managing Marketing
in the 21st Century. Who are the customers? Use the Figure 2.6 framework to suggest how you
would address customers. Then, design a CRM program.