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Customer Portfolio Management - Generating Profitable Organic Growth

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3rd Jul 2006
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By Jeremy Cox, CMC Editor

One of the greatest causes of failure in any CRM implementation is a lack of any overarching customer strategy. Hide-bound by the limitations of accounting systems and practices, it is not uncommon for management to look at their total customer base and set revenue targets along the lines of 'last year plus 10%', and probably for the same cost. But this way of thinking is inadequate. Investment decisions are often driven not by the customer but the product portfolio. In this article we take a look at how smarter companies are doing it and some of the emerging thinking in this area.

The portfolio view

Smarter organisations look upon their customer base as a portfolio of selected customers with whom they wish to develop long term enduring relationships based on trust and insight. In their book Return on Customer, Don Peppers and Martha Rogers advocate the use of the metric Return On Customer, as the gold standard for measuring and in the providing investors with a better view of the health of a firm. This is not just a summary of the return on investment of the ‘customer portfolio’, but is a measure that can be used at the individual customer level. To maximise the overall return on customers, it is necessary to ‘treat different customers differently’, the essence of a good CRM capability. Firms which don’t take the time and trouble to assess and decide on how they wish the portfolio to grow, end up creating a vanilla standard of service and customer experience that might be a slight improvement on former capabilities, but rarely delivers the strategic goal of profitable and organic growth.

I refer to these as the 'hole-fixers' (see also Evolution of CRM – a commercial perspective). Such firms are also more inclined to chase ‘bad profits’ at the expense of customer satisfaction. Fred Reichheld (The Ultimate Question – Harvard Business School Publishing Corp. 2006) alerts us to the concept of good and bad profits. Good profits are based on treating customers as we would like to be treated so that they become advocates or promoters to the firm. ‘Bad profits’ on the other hand are often short term in nature and symptomatic of a transactional view of the customer. An example would be a bumping up the fees for an end of year tax return, where a partner involves himself more than is required because he lacks trust in his more junior staff that is perfectly capable of doing such a routine job without him. The client may pay the fee but is very likely to shop around, as they are seeing little value for the price. As Professor Francis Buttle said, "value is the benefit over the sacrifice made to get it." This explains why we will put up with a limited service from low cost airlines, which would be unacceptable for BA, Virgin Atlantic of Cathay.

This portfolio view of customers has already to some extent been accepted by major airlines and many banks. It does however present several challenges for many firms, the first of which is to put a stake in the ground and assess the current customer portfolio.

Customer Portfolio Analysis – key challenges

If a firm is able to assess the current profitability and potential for profit at the individual level, it is then possible to make informed strategic decisions about which customers to attract, keep and develop, or even which to sack. The first challenge is that accounting systems only show a fraction of the picture. They might show what has been bought by each customer (B2B this is relatively easy to find – less so B2C), but what then tends to happen, is that the total costs of the sales, marketing and services departments are then averaged, divided between the number of customers and then allocated. On this basis a customer which rarely complains, has a good relationship with the firm and buys their latest and greatest offerings, is allocated the same ratio of costs to sales as the customer who rings up every day, complaining and rarely buying.

Activity based costing begins to address this shortfall, but a survey by Better Management in September 2005, showed that across 528 companies ABC approaches were a long way short of being universally applied. In any event this approach rarely provides sufficient traceability of costs to individual customers, and in no way makes any prediction about potential lifetime value of customers or how different strategies or treatments might impact buying intentions.

John A Murphy Alfred McAlpine Professor of Customer Management Manchester Business School, in his book Converting Customer Value 2006 and following extensive cross industry benchmarking defines customer profitability as:

He acknowledges that for many firms, the task of arriving at a true view of customer profitability is exceedingly difficult; however he feels that the exercise alone will often prove valuable as firms become more aware of the activities this drive costs up and which yield little customer value. What often surprises management is that the assumption that 80% of profits come from 20% of customers, is rarely the case. Studies by Jan Kitshoff and Robin Gleaves, who contribute to this book, show that this Pareto assumption is false and dangerous with results ranging from:

  • 33% of customers give 125% of profits and 67% of customers delivering – 25% i.e. profit destroyers
  • 18% of customers give 600% of profits;
  • 22% of customers give 250% of profits;
  • 50% of customers give 150% of profits;
  • 10% of customers give 320% of profits.

Making use of the analysis

Arjen Wenzel MD of Customer Marketing International in the Netherlands cited a similar case of an electronics distributor. The firm focused attention on moving a small number of customers up the pyramid, and reducing the number of unprofitable customers who barely bought anything but soaked up resources.

The diagram above shows a 2% net upward migration led to over 13% revenue growth and more than 60% improvement in profitability.

Customer Portfolio Strategy takes effort which will be rewarded

Developing a customer portfolio strategy without the rationale provided by customer profitability analysis and the projection of potential lifetime value is a missed opportunity. Judgements made purely on revenue performance are historic and backward looking. It might be difficult and the data imperfect, but it beats flying blind. I’m surprised that there is no sign of accountants moving in to this territory as part of their strategic advisory services. Customer Portfolio Analysis would seam to be a great area in which to develop a competency.

Once the results of the analysis are known, major questions can be asked to determine why some customers are more profitable than others. Is it the nature of the customer or the firm’s ability to serve them that makes them unprofitable? Care needs to be taken before passing any rash judgements, however once the reasons are known, then decisions can be made on how the portfolio of customers should ideally develop over time.

This brings us to our second major challenge – converting desires into reality.

Adding foresight to hindsight

Segmenting customers by value or potential value to a firm is one way of looking at the customer portfolio. However to bring about the desired changes, real insight into customers, wants, needs, buying behaviours and preferences needs to be extracted. Firms which merely rely on feedback from campaigns are missing the point. As Don Peppers says, different customers need to be treated differently. In a perfect world we would know everything there is to know about our customers and then use that to trigger changes to value propositions and the complete customer experience. The best many of us will be able to come up with are proxies based on clustering customers or identifying segments where there are sufficient similarities in behaviours and needs.

This has been good marketing practice for many years, but it is getting harder to elicit information from market research or customer surveys, as we are all over-surveyed and can spot a sneaky promotion a mile off.

As our offerings in most markets become commoditised, increasingly it is the experience of customers with our companies that makes the difference. Perhaps the most encouraging sign of all is that to succeed as a ‘portfolio manager’ you have to gain and develop trust with the customer. The portfolio manager becomes the steward and guardian of this trust. Short term self interest has to make way for the longer term. Return on Customer is one measure that reflects this longer term mutually beneficial view. Another measure is the Net Promoter Score developed by Fred Reichheld and Satmetrix. (see Insights into customer loyalty - How are leading companies doing it? for a brief outline) What Reichheld and Peppers & Rogers are saying is essentially the same. If you want to develop a profitable and growing business, then you have to treat customers as you would like to be treated yourself. The metrics provide the indication that you are succeeding.

By Jeremy Cox CMC Editor Business & Strategy
If you would like to contact me and share your own experience or opinion please contact me at [email protected]

Recommended reading

  • The Ultimate Question – Fred Reichheld 2006 - Harvard Business School Press
  • Converting Customer Value – Prof. John A Murphy 2006 – Wiley & Sons Ltd
  • Return On Customer – Don Peppers & Martha Rogers 2005 – Marshall Cavendish

     

Replies (4)

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By Jeremy Cox
04th Jul 2006 08:48

thanks Graham, trust you to point out something I've missed! However in principle I agree the risk element should be considered. Prof Adrian Payne gave me an example of this yesterday. In practice, though I suspect it is a bridge to far. Most firms struggle with assessing the value of an individual customer.Accountants can't do it, so it's tough, and then there is a confidence issue with the results.

As for the customer in all this, I tend to agree with Vladimir, CEM is merely a convenient label for a very important aspect of CRM - generating superior value.

To my mind the point of portfolio analysis is to identify the customers you want to add superior value to so that you can make more money.
What's wrong with that? It's business!

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Dr. Graham Hill
By Dr. Graham Hill
04th Jul 2006 07:51

Vlad

Your experience roughly mirrors my own at a UK mobile operator a couple of years ago.

One of their biggest problems was in generating a Customer P&L from the Product P&L that the accounting system automatically generated as part of management reporting. The Customer P&L was an enabler of their wish to move towards more of a customer-based organisation structure (no customer-orientation though).

Paradoxically, your discussion of Customer Plans and Value Maps (and this larger discussion of customer portfolios in general) shows just how unimportant the customer is in the eyes of most companies. They are treated as just another resource, like the original economist's land, labour and capital, to be milked for whatever they are worth whilst the companies provide as little value for the customer as practical.

But times are a changing. Customers are no longer willing to just sit down and to be milked. They are starting to demand benefits of their own in return for their customer. And to walk if it is not provided. It is precisely because of these changing customer attitudes that CEM has recently appeared, to bring a little more balance into the picture.

CRM with its origins in marketing, sales and service automation is still largely about creating value for companies by being more efficient at marketing, sales and service. It's all about the companies that implemented CRM.

In contrast, CEM with its origins in customer-focussed turnarounds (particularly the airlines SAS and British Airways) and more recently in "living the brand" programmes, should be about creating value for customers by being more effective at knitting together key touchpoints over the lifecycle of the customer. It should be all about the customer.

But it is not a simple trade-off, not a lump of labour zero-sum game. There are many examples of companies who have delivered both a superior customer experience and superior profitability.

The challenge is in developing CEM as a balancing counter-weight to CRM so that healthy profits can still be earned (business isn't a charity, or rather, it shouldn't be one) and so that value can be delivered to customers over the duration of their relationship with a company. Fortunately, many of the same basic capabilities developed for CRM can be applied equally well to CEM as well, so it is not as though CRM has to be thrown away to implement CEM.

We will have to see whether CEM lives up to its aspirations. I am not particularly worried about the lack of links between CEM and shareholder value. These are still early days in the development of CEM. And truth be told, most marketers' customer value models are so overoptimistically simplistic that you can drive a coach and horses through them with relative ease.

Graham Hill
Independent CRM Consultant

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Dr. Graham Hill
By Dr. Graham Hill
03rd Jul 2006 18:17

Jeremy

In your discussion of "portfolios" you seem to have missed out the main reason why finance houses developed them in the first place. That is to manage investment RISK.

The same thinking should apply equally explicitly to customer portfolios.

A portfolio of customers should be created so that the portfolio's total value is optimised over a target time-period. To achieve this notional optimum, a mixture of e.g. profitable low-risk - low-value, medium-risk - medium-value and high-risk - high value customers should be brought into the portfolio to balance risk and return. A low-risk - low-value customer might be worth every bit as much as a high-risk - high-value customer in many circumstances. And they will still be contributing to profits long after the high-risk customer has defected.

Customer value can be placed at risk through any number of things: Through poor marketing communications that irritates potential customers (credit cards), through out-of-touch products that new entrants can replace with newer alternatives (mainstream short-haul airlines), through overly expensive products that customers can replace with cheaper fakes (luxury goods), through poor customer service that irritates actual customers (mobile telephones), through difficult merger-acquisition that allows management's eye to wander away from customers (endless choice), etc, etc.

The job of the analytically-minded CRMer is to identify a measure of customer risk that suits their organisation (a customer beta in CAPM terms), to understand the normal range of values the risk has and to identify how to manage the risk inherent in the customer portfolio and the business.

This is no easy job but it is definately one of the next steps forward for companies with large numbers of customers in highly risky, highly dynamic or highly commoditised markets.

Would you calculate present value without factoring in the discount rate? I didn't think so. So what makes you think you can calculate the value of your customer portfolio without factoring in risk?

Graham Hill
Independent CRM Consultant

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By vdimitroff
03rd Jul 2006 18:34

- of the underlying economics of customer centricity. To some extent it is a good counterpoint to the current CEM hype (while it's a valid discipline and an inseparable component of good CRM, the proponents of CEM fail to emphasize the importance of differentiation or to suggest any metrics that link to shareholder value).

Good CRM practitioners at successful companies have been managing customer portfolios, whether they cal lthem so or not, as a kind of customer 'balance sheet'. They use highly numeric models and tools for the purpose, reminiscent of a FInance function rather than Marketing or Customer Service.

At Peppers & Rogers (in my time) we used to call one such tool the Value Map and later, at Round, its equivalent was the Customer Plan (aren't consultants great at branding their generic tools to claim intellectual rights?). My nearly shocking discovery (in a positive way) was the CFO of a mobile operator, also Chairman of their CRM Steering Committee (a rare combination in itself), who was using the concept of portfolios and a tool similar to Customer Plan / Value Map for their routine planning, budgeting and performance measurement.

Not surprisingly, the approach is not met with overwhelming enthusiasm at companies where CRM is Marketing-led. It brings, among other things, accountability. Marketers don't like accountability - they prefer (in the words of their godfather) not to know 'which half of the marketing budget is wrongly spent'. And a customer portfolio plan doesn't have the 'cool' factor of an impressive campaign and doesn't win you BTAA awards...

In the meantime the really customer-centric companies and their management continue to plough and sow value by allocating resources in differentiated ways according to customer insight, engaging employees (and all other stakeholders) in the process - and reaping value for their shareholders in the form of sustained profitable growth.

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