How To Manage Customer Value - Chartered Global
CGMA TOOLSHow to managecustomer value
contentsTwo of the world’s most prestigious accounting bodies, AICPAand CIMA, have formed a joint venture to establish the CharteredGlobal Management Accountant (CGMA) designation to elevate theprofession of management accounting. The designation recognisesthe most talented and committed management accountants with thediscipline and skill to drive strong business performance.Introduction and overview2Manage customer segmentation3Measure customer margins4Measure customer lifetime value5Measure customer impact6Manage customer profitability7Customer profitability: A comprehensive example81
Introduction and overviewThe focus on customer relationship management has become centralto all organisations. Companies have increasingly recognised thesignificant costs related to the loss of customers and are trying to betterunderstand, measure, manage and improve customer retention. Further,these organisations are examining how to measure and improvelong-term customer lifetime value.This tool provides a systematic approach for addressing customer valueissues that include: customer segmentation, measuring profitability,estimating customer lifetime value, identifying additional sources ofcustomer value and managing to enhance customer profitability. Thistool also demonstrates how organisations can create more value forand derive increased value from customers.Figure 1: The customer value management cycle1: M anage customersegmentation5: M anage customerprofitability4: M easure customerimpact2CGMA TOOLS – How to manage customer value2: M easure customermargins3: M easure customerlifetime value
Manage Customer SegmentationCustomer segmentation refers to the process of dividing customers intogroups for decision-making purposes. Segmentation allows the companyto provide differential advertising or value propositions to differentcustomer groups. The appropriate level of segmentation varies accordingto (a) the purposes for which segmentation structures will be used and(b) cost and profitability variations between customers within segments.Segments are often determined on the basis of customersimilarities, such as personal characteristics, preferences orbehaviours: Demographic segmentation segments customersbased on their observable characteristics, for example,customer demographics like age, geographic area orincome level. However, for many products and services,demographic characteristics are not fully representativeof buying behaviour and have not been useful inpredicting customer behaviour. Psychographic segmentation builds upon demographicsegmentation by including criteria that further categorisea particular group of customers. Segmentation basedon psychographic and lifestyle characteristics includescriteria such as attitudes and interests, values and socialroles. The psychographics approach assumes that acustomer’s choices and behaviour are related to thecustomer’s habits and routines. Behavioural segmentation based on buying behaviourrepresents the most effective of the current segmentationapproaches used today. Customer relationshipmanagement software available today enablescompanies to harness this valuable data. A nalytic segmentation integrates criteria such as costinto the value calculation of a company’s customersegments. Analytic segmentation provides the firm withan even more accurate picture of customer profitabilityand buying behaviour. This, along with psychographicand demographic characteristics, allows companies tomore effectively target their most profitable customers.Box 1: Analytic segmentationexamplesBOC, a UK-based supplier of industrial andmedical gases, now part of Linde Group,utilises an analytic approach to segmentation.The company’s strategy includes identifyingthe distinct requirements of its customers, suchas value placed on service and/or the desireto obtain the lowest price. After identifying itscustomers’ requirements, BOC is able to adaptits business model to maximise the operatingperformance from serving the requirements,reducing cost and increasing customer valuefrom the customer’s perspective.1This is also true for the planning strategiesof the American industrial gas market. AirProducts & Chemicals seeks out customers whoneed high levels of technical assistance fortheir applications (eg, liquid nitrogen freezingof hamburgers or oxygen enhancement ofblast furnaces) for which they can chargea high premium price. They spend fewresources competing in the area of low-margincommodities such as argon and oxygen usedfor welding.3
Measure Customer MarginsAlthough almost all companies have carefully designed processesfor assessing the profitability of their products, most are far behindin assessing the profitability of their customers. Assigning non-productcosts allows measurement of customer profitability through systematicallymeasuring customer-related costs and assigning them to the responsiblecustomers.Many companies have used activity-based costing, orABC, to assign non-product costs. Activity-based customercosting recognises that costs required to serve customersextend beyond direct costs, and provides a method foridentifying and assigning indirect costs to the specificsegments or customers responsible for them. Activity-basedproduct costing can also be used to better estimate productcosts as well.Today much available software allows automaticassignment of product costs, and in most companies,information about the relative margins of customersand segments is widely available. As might be expected,the costs driven by a customer or segment extend farbeyond the costs of the products they purchase. Serviceand support requirements can vary significantly amongcustomer groups. See box 2 for examples of cost categories.Box 2: Assigning non-product costsOne way to identify cost categories and thecosts they might include follows: Order-level costs are costs associatedwith order placement and processing. Thesecosts include order entry, picking inventory,delivery and billing costs. Customer-level costs are costs associatedwith individual customers or segments. Theyinclude costs such as acquisition costs,advertising and promotions, selling, salesreturns, responding to enquiries, relationshipmanagement and managing receivables. Channel-level costs are associated withdistribution channels. They include fixedlocations, delivery equipment, informationtechnology and marketing costs. Market-level costs benefit all channels.These costs include general research anddevelopment, branding and other generalmarketing, market research and othermarketing functions. Enterprise-level costs are high-levelorganisation costs. They includeadministrative costs such as administrativesalaries, facilities and financing costs.4CGMA TOOLS – How to manage customer value
Measure Customer LIFETIME VALUE“Customer lifetime value” (CLV) introduces a new dimension to understandingthe value a customer provides to the company. The lifetime value of thecustomer reflects the present value of all future flows associated with thecustomer. Although the specific formulations vary, CLV calculations all sharethree essential components: profits, retention rate and discount rate. Box 3details the specific components of the CLV formula.Customer retention and customer loyalty are importantconcepts for companies seeking to effectively measure andmanage lifetime value. The retention rate, as includedin the CLV calculation, refers to the probability that acustomer will continue doing business with the companyin future relevant periods. Customer loyalty refers toa customer’s level of satisfaction with the company orbrand, as well as that customer’s intention to make futurepurchases. Understanding the loyalty of customers in asegment is important for CLV calculations. The profitcomponent of CLV is based on estimates of how muchcustomers will purchase in the future, and how much itwill cost to serve and retain these customers.Companies begin incurring costs when they spend moneyto acquire customers. As the customer makes purchases,the acquisition costs are recovered, and the company earnsincreasing profits from customer sales margins as salesrecur over time. Additional costs to serve the customer overtime include ongoing promotional and service costs andretention costs, which include the costs of maintaining thecustomer relationship over time. In addition to recurringmargins from repeat sales, companies can gain additionalprofits through selling upgraded or new types of productsand services to existing customers.Together, all of the costs associated with serving thecustomer over time are netted against the total margins thecompany expects to gain through sales to that customer. Theresult is the CLV. It represents the present value to the firmof a customer’s lifetime stream of profits. The CLV modelthus views the customer as an asset that generates revenuesthroughout the life of the relationship, and also drawsresources as it is acquired, maintained and, possibly, retired.Box 3: Customer lifetimevalue formulaThe formula for calculating CLV is as follows:CLV (profit t1 x retention rate t1 x discountfactort1) (p t2 x rt2 x d t2) (p tn x rtn x d tn) CLV is the sum of profits earned in timeperiods 1 through to n, where n representsthe last period the company deems relevantfor profitability analysis. Expected customerprofits in each period are adjusted to reflectthe expected customer retention rate duringthe period and discounted to the present timeperiod, t0. Profit (p) is the profit earned during the timeperiod. Profits include gross profit, and takeinto account lifetime costs and revenues suchas acquisition costs and growth in marginsover time. Retention rate (r) is the rate at which customersin the segment maintain their relationship withthe company and continue future purchases.This could also include the net differencebetween new customer acquisitions andcustomer exits within the segment. Discount factor (d) is the multiplier used todiscount future profits to their present value.The discount factor is based on the company’shurdle rate (often the after-tax cost of capital).5
Measure Customer IMPACTThe final component of value provided by the customer is customerimpact. Of course, profits resulting from current or future sales tocustomers are the most significant source of value for most customersegments. But value can be created (or destroyed) by customers inmany other ways that fall outside the reach of CLV and other methodsof assessing customer value.The power of customers is greater than ever and continuesto increase due to a variety of factors. In addition to theirown value-generating behaviours, customers have thecapacity to affect corporate profitability by influencing theperceptions and behaviours of others.customers. Some customers influence others by servingas a role model. High-profile customers such as celebrity,sports or political figures can serve this function, as can“influentials” — opinion leaders who influence the thoughtsand actions of others.The most widely recognised source of customer influencecomes in the form of product referrals. Customers who aresatisfied with a product might encourage other customersto try the product, or when dissatisfied, they may dissuadecustomers from buying it.Customers also contribute value by providing usefulinformation to the company and its stakeholders.Customers who post product reviews provide value topotential customers. Other customers may actively sharetheir technical knowledge and expertise, providing tipsfor effective use of the product and solving problems forother customers. Leading companies are “crowd-sourcing”information from their customers in order to improve theirproducts and services.Another important source of influence is wielded bycustomers who possess high levels of power or prestige.These customers may influence others by serving asexpert users, legitimising the product’s use for other6CGMA TOOLS – How to manage customer value
Manage Customer PROFITABILITYBy developing a more complete picture of the value of a customer orsegment, a company can improve overall profitability by improvingprofit margins, increasing the lifetime value of customers and enhancingcustomer impact. Box 4 outlines strategies for managing customerprofitability. In summary: Customer profit margins in each period during thecustomer relationship make up the largest share ofcustomer lifetime value for many segments. Thus,improving profit margins on individual transactions is alogical starting point for companies. I n addition to normal revenues and costs, companiescan increase the lifetime value of customers by(a) improving customer retention, (b) reducingthe costs of acquiring and maintaining customerrelationships and (c) improving customer profitabilitythrough expanded purchasing. Companies can also take measures to enhance customerimpact by (a) increasing customer referrals,(b) cultivating highly influential customers and(c) capturing and using customer knowledge.To translate these strategies into action, companies mustuse the information provided by profitability analysesto inform decisions and develop metrics that can beincorporated into incentive programmes.Box 4: Strategies for managing customer profitabilityManaging customer profit marginsManaging customer lifetime valueManaging customer impactRe-price products and servicesImprove retention and acquisitionratesIncrease referralsReduce customer costs (reduce cost perservice and reduce services available)Upgrade customer profits (share ofwallet, up-selling and cross-selling)Pursue influential customersManage cost drivers (policy changesand charge for services)Reduce lifecycle costs (acquisition,ongoing promotions)Enhance data capture (captureevery interaction)Measuring, improving andmanaging customer satisfactionIncrease customer participation(communities, direct requests,employees)Use data effectively(experimentation, innovationand customisation)7
Customer Profitability: A Comprehensive ExampleIn this section, we provide an illustration of how measuring customerprofitability can pay off. We apply the customer value managementcycle to a fictitious company that will be called “Sagu Systems.”A brief description of Sagu Systems is as follows:Sagu is a software company located inDublin. Its primary product, SaguNetwork, isperformance monitoring software for corporatenetworks. Sagu currently sells SaguNetworkand related consulting services to clients. Themarket for performance management softwareis expanding rapidly, and Sagu is pursuingan aggressive growth strategy. In an effort tomaintain profitability through the growth period,the board of directors has mandated that Saguanalyze the profitability of its customers.Sagu works through the customer value managementcycle in the step-by-step fashion shown in figure 1 onpage 2 of this tool.Step 1: Manage customer segmentationSagu begins with an analysis of current customers and theirpurchasing patterns. The analysis results in three customersegments:1. I n-house support: customers with in-house IT staffcapable of supporting the software2. N o in-house support: customers lacking in-house IT staffcapable of supporting the software3. New to software: customers that are first-time users ofperformance-monitoring software and lack in-house ITstaff capable of supporting the softwareBasic financial information for the three segments is shownin table 1.Table 1: Revenue and expenses by customer segment (in millions)In-house supportNo in-house supportNew to software 60.0 70.0 20.0 150.05.030.015.050.0Total revenue65.0100.035.0200.0Cost of goods sold24.040.013.077.0Gross margin41.060.022.0123.0Operating expenses32.550.017.5100.0Operating income 8.5 10.0 4.5 23.0Percent of revenue13%10%13%12%SoftwareConsulting8CGMA TOOLS – How to manage customer valueTotal
In the next steps 2, 3, and 4, Sagu will calculate thecurrent and expected future value contributions for eachsegment. In step 5, Sagu will use the results of this analysisto make changes in the management of customer valuein each segment. Finally, Sagu will return to step 1 andbegin the cycle again — re-segmenting customers based onprofitability-related behaviours.Step 2: Measure customer marginsSagu has historically allocated operating expenses based ontotal revenue of the segment. However, Sagu realises thatoperating costs vary across segments as a result of differentcustomer behaviours within the segments. In particular,sales commission costs are associated with software andconsulting sales, and technical support costs are associatedwith the number of maintenance requests submitted by acustomer. Sagu separates these costs from other operatingexpenses and assigns them to segments based on the actualcommissions awarded and technical requests made by eachsegment. Results are shown in table 2.When segment profits are re-calculated using the newoperating expense numbers, the results are shown in table 3.With the reallocation of operating expenses, the company’s 23 million profit has shifted, increasing the profitabilityof the in-house support segment, and decreasing theprofitability of the other two segments.Table 2: Operating expenses allocated by customer behaviour (in millions)Operating expensesIn-house supportNo in-house supportNew to softwareTotalSales commissions 4.0 14.0 2.0 20.0Technical support8.021.011.040.0Other administrative16.018.75.340.0Total 28.0 53.7 18.3 100.0Table 3: Revised revenue and expenses by customer segment (in millions)In-house supportNo in-house supportNew to software 60.0 80.0 20.0 160.05.020.015.040.0Total revenue65.0100.035.0200.0Cost of goods sold24.040.013.077.0Gross margin41.060.022.0123.0Operating expenses28.553.718.3100.0Operating income 13 6.3 3.7 23.0Percent of revenue20%6%10%12%SoftwareConsultingTotal9
Step 3: Measure customer lifetimevalueArmed with information about current profitability, Sagucan begin to assess the long-term value of each customersegment. To do this, Sagu will estimate growth in profitsfor each segment and change in size of each segment asSagu loses old customers and adds new ones over time.Table 4 shows the CLV calculations for each customersegment during the coming six years. CLV shows thevalue of a segment’s customers to Sagu today, based on thediscounted value of anticipated future profits. To calculateCLV, Sagu estimates:1. O perating income for each segment based on anestimated growth rate applied to current periodoperating income2. A retention rate based on the expected differencebetween customers gained and lost each period3. A discount factor, which is the net present value(NPV) of 1 in a future time period at 10% interest10CGMA TOOLS – How to manage customer valueHere, to simplify the example, income growth and retentionrates are held constant for the coming six year period. Sagu’sCLV analysis provides a new perspective on the relativevalue of the three customer segments. The in-house supportsegment is expected to grow at a 10% rate, as a result ofadditions in software users to existing software packages. Inaddition, the number of clients in this category is expectedto grow each year, as the number of new clients enteringthe segment exceeds the number that exit. Discounting eachyear’s anticipated profits back to the present using a 10% rateresults in an expected lifetime value for the segment of 73.1million. The segment is currently the largest, in terms ofprofitability, and expected to remain that way for the comingsix years.The CLV analysis, however, tells a different story about therelative value of the no in-house support and new to softwaresegments. Using current period profits alone, these segmentsshowed incomes of 6.3 million and 3.7 million respectively.Analysing profitability over time, however, shows markeddifferences in the ability of the two segments to generatevalue for the fir
6 CGMA TOOLS – How to manage customer value Measure CustoMer iMPaCt The final component of value provided by the customer is customer impact. Of course, profits resulting from current or future sales to customers are the most significant source of value for most customer segments
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Customer satisfaction has identified as an important influencer on customer loyalty. Further, customer trust impacted by customer satisfaction which proved that customer satisfaction is an antecedent of customer trust. Moreover, an indirect relationship between customer satisfaction and loyalty through customer trust was observed.
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Value stream mapping is a combination of three word "Value", "Stream", "Map" Value: Creating or making something of value that a customer is willing to pay for. Based on value all task are divided two types: 1. Value added activities . 2. Non-value added activities Value added activities: According to garments perspective where any .
Can apply statistical analysis to understand customer behaviour and value at each stage in the customer value chain. Each stage has a cost Different types of analyses are appropriate at different stages Up-Sell media modelling DM response propensity analysis lead value models campaign response value optimisation propensity analysis value .
1. what is meant by the term ' customer retention ' 2. the economics of customer retention 3. how to select which customers to target for retention 4. the distinction between positive and negative customer retention 5. several strategies for improving customer retention performance 6. several strategies for growing customer value 7.
orientation, customer retention and superior customer value created through process management". Customer retention is an essential part of customer relationship management and organizations must take this into account (Watkins, 1999). The longer a customer stays with an organization the more utility the customer generates to the organization.
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