Who Moved My ROI? Building the Value of the Customer and the Company

Stichting Marketing Foundation-Gent December 3, 2005 Who Moved My ROI? Building the Value of the Customer and the Company Martha Rogers, Ph.D. rogers@1to1.com Return on Customersm and ROCsm are registered service marks of Peppers & Rogers Group

Customer talks with you Save me time FEEDBACK You tailor your product, service or interactions • The more effort a customer invests, the greater • his stake in making relationship work • Going to a competitor = reinventing the relationship The “learning relationship”

The antithesis to Learning Relationships: the “Goldfish Principle” • Some species of tropical fish have no capacity for territorial memory • Businesses operating on the Goldfish Principle have no customer memories • One U.S. hotel

Customer Needs Satisfied Share of customer Traditional Marketing Return on Customersm Market share Customers Reached A different dimension of business competition Maximize the financial return generated by each customer Maximize the financial return for each product or each marketing channel

Daimler’s prediction of automobile demand Gottlieb Daimler World’s first four-wheeled gasoline-powered automobile Limiting factor: A shortage of qualified chauffeurs

Finding customers for the products available Limiting factor: A shortage of paying customers 20th Century Marketing Today:more products, services, and channels

Where does all our revenue come from? • From products? • From salespeople? • From our brand? • No, it’s simple – • All our revenue comes from customers • Fact: Some customers are worth more than others • Actual and potential value • Value today and value tomorrow

Which is harder for a business to produce? • Products? Capital? Or customers? • OK, it’s obvious: • Customers are more scarce than products or capital • So why do we keep measuring only the profitability of products? Why is the return on investment of money emphasized? • Customers are the limiting factor • You have to maximize the value created by each customer, not just the value of the financial investment

Maximizing enterprise value is similar to farming • Consider good Farmer Wilson • Wilson cultivates his land carefully 9

With conservation his land remains productive • It takes money to fertilize, to leave some land fallow, to cultivate in contours, and to rotate crops • But Wilson’s land will remain productive virtually forever 10

Contrast with bad Farmer Miller • Miller doesn’t practice conservation • He simply plants the most profitable cash crop every year, on every available acre of land • He saves money by reducing his fertilizer expenditures, and by avoiding crop rotation • In the beginning, Miller easily harvests more profit than Wilson does • But over time his land burns out

Short-term vs. long-term perspective • Scary thought: • In any given year, Wilson can always earn more by imitating Miller, and stopping his conservation • But that would be stupid, right? • Well, remember the last 4th-quarter meeting?

Enterprise Creates Value Two Ways • Profits are harvested, and • Customer equity is created or destroyed • Needed: A metric to capture the effects of both types of value creation • Customers are the scarce resource • So what is the rate at which a company creates economic value from its customers? Return on Customer

What is “Return on Customer”? • Customers are the scarce resource for a business • ROC measures true economic return on this resource • Consider the ROI on a portfolio of securities • Tally up dividend and interest income during the period • Then add in any increases or decreases in the value of the underlying securities • But what if you only counted the income? • A company is like a portfolio of customers who • Buy things currently (current-period profit), and • Go up and down in value (changes in customer equity)

Excessive focus on the short term • Creates a culture of bad management • Not only leads to accounting scandals and fraud • But diverts managers from their primary responsibility: preserving and increasing the value of the enterprise • Duke University survey of more than 400 senior financial executives in 2004: • 78% said their firm would give up economic value if necessary to meet Wall Street expectations! • Short-term focus distorts how a company views the value that its customers create for it

Short-term gain, long-term loss • Highly profitable bank:Market cap in Sept 2004 of $240b • Japan’s private banking clients generated less than 0.5% of the firm’s net income – less than $100 million • But then: All the bank’s private banking in Japan was closed by regulatory authorities and in September Merrill Lynch downgraded the bank’s stock because: This company “might lack something that poses a threat to its future growth: a sense of right and wrong.” Bank’s stock price was doing well, and then… $15 billion of lost value

Sept: Rollout announced May: Pilot test begun ROC increases shareholder return Best Buy is raising its “returns on specific customer segments” Fortune July Programs like this result in Wall Street “rerating the P/E”

How Do Customers Create Value? • They buy things today, generating current sales and costs • They change their likelihood (today) of future buying and cost generation • Suppose a customer calls you with a complaint... • Or makes a claim after paying for twenty years… • It makes sense for a business to try to increase the value that any customer creates • This means changing the customer’s behavior • The company must commit its resources to some campaign or other marketing (or other) activity • But what “resources” are required? • We use money, of course, but also customers

Profit from investment + Change in value of investment Starting value of investment ROC = ROI = Profit from customer + Change in value of customer Starting value of customer ROC is Similar to ROI Both money and customers are used by a business when it creates more value ROI answers the question: How much value do you get for the money you have to use? ROC answers the question: How much value do you get for the customers you have to use?

Which Resource Will You Run Out of First? If cash is scarce If customers are scarce

ROI and ROC – Both measures together Maximum ROI Every possible treatment permutation Highest value creation ROI “hurdle rate” Increasing ROI  Maximum ROC Increasing ROC 

Warning: “Marketing” can destroy value! • Example: Start with a million customers • A marketing campaign generates a 1% response (10,000) • Cost is €1 per solicitation, or €1 million total • Each response generates €125 in LTV profit, or €1.25 million total • So each individual campaign is successful, with a €250,000 profit • But suppose non-responders become just 0.5% less likely to respond with each solicitation Then with each campaign customer equity decreases by more than the “profit” harvested!

What do you mean – “use customers”? • Destroy equity by making money now at the expense of money later • Reduce the likelihood of future business • Forfeit all chance of future business from one customer to make money from another • The DVD rental store fiasco that happens a million times a day • Scenario: Insurance agent as gatekeeper

The agent who cost money with every sale • Company Y sells auto, property, health and life insurance • Agents recruit customers, then are protected from poaching by other Company Y agents • Life and health are far more profitable lines • But this agent does a terrific job winning new customers for auto insurance... How much value does Company Y lose every time this agent recruits a new auto customer?

ROC in Practice • Verizon’s wireless division generated $13.7 billion in operating earnings from 2002 to 2004 (Owned by Verizon Communications and Vodaphone) • But during this period the firm also cut monthly customer churn in half, from 2.6% to 1.3% • Cutting churn required balancing immediate profit against long-term customer satisfaction • Verizon created an additional $10.4 billion of value, in the form of increased customer LTV! • Average ROC during the period: 64%

Thinking about future customer buying... • Customers have lifetime values • Lifetime value (LTV) is simply today’s value of all future profits you predict you’ll get from a customer • When a customer’s likely future profits change, his LTV changes, also • The amount of the LTV change represents value created (or destroyed), right now • Tracking LTV is important, but • Measuring ROC means tracking changes in LTV • If a firm uses ROI alone, it might: • Miss the biggest opportunities to create value, or • Unknowingly destroy more value than it is creating • To understand the total value created by customers, it’s necessary to measure changes in lifetime value • Tracking ROC is the best and most direct way to Create maximum value for each customer

What if salespeople, service reps, account managers, and CEOs were penalized for the customer equity they have to spend today to achieve this quarter’s revenues? • What if Wall Street analysts held companies accountable for customer equity (as the best measure of enterprise value) as well as current revenue?

We become more relevant So how do we do that? We figure out a customer’s needs and meet those needs better than a competitor who doesn’t know what we know Anticipate what customer needs Take the customer’s point of view: Tesco, Orica, Eneco, SPAR, ING Europe How do we build a customer’s value to us?

Why do so many customer initiatives fail? • The information problem • Understand the whole value and need of each customer • Across products, services, geographies, touchpoints, and time • The strategyproblem • Ready, fire, aim! • Do our customers belong to “marketing,” or are they the only source of revenue for our company? • How do we measure the rate at which customers create value for our company? How do we report it? • Who’s accountable for that? How do we manage it? • The adoptionproblem • Every employee decision and action creates or destroys value. How do we build the ROC philosophy into everyone’s DNA?

Managing a firm’s “Customer Equity” • ROC means making a lot of marketing decisions, as well as non-marketing decisions, about how we do our job Every management decision should be made with an eye toward its impact on customer equity

Treat Different Customers Differently Taking the customer’s point of view means: Relationships built on trust are the vehicle for customer-specific actions

ROC has two equally important aspects • An economic metric for calculating the rate at which customers create value • Calculating the real costs of abusive marketing • Financial justification for a better customer experience, higher satisfaction, loyalty, etc. • A philosophy of doing business based on earning customers’ trust • Maximizing the value customers create requires • Maximizing the value created for customers

“Our goal with our Fair Play program is to make ethics a natural part of our business” “No one tries harder for customers.” Creating a culture of customer trust “Treat the customer the way you would want to be treated if you were the customer.”

Stena empowers its employees… • Irish Sea routes – 3mm+ passengers annually, for years it had a fairly bad service reputation • Today virtually 100% of passengers are asked about their satisfaction within 30 minutes of destination • Different Stena staff inquire, try to resolve problems on the spot • Everyone on staff – all 600 people – anyone can elect to spend up to £1000 to satisfy a customer!

Creating a culture of customer trust These companies are not just selling something. They are building the value of the customer base.

Return on Customer: Six rules First rule of ROC: Return on Customer = Total Shareholder Return Customer equity equals enterprise value for an operating company

Return on Customer: Six rules Second rule of ROC: Both long-term and short-term must be balanced Don’t ignore the importance of short-term earnings!

Return on Customer: Six rules Third rule of ROC: LTV is important, but LTV changeis the number you actually want You need to identify the “leading indicators” of LTV change

Return on Customer: Six rules Fourth rule of ROC:Think and act in a customer-specific way Customer relationships are required to maximize Return on Customer

Return on Customer: Six rules Fifth rule of ROC: Earn the trustof your customers Customers don’t care about their value to you; they only care about what they need from you

Return on Customer: Six rules Sixth rule of ROC: Educate your employees and empower them to take action Everyone has a different role to play, but the ROC metric provides a unifying objective for the whole organization. It’s everyone’s job to increase ROC.

Peppers & Rogers Group www.1to1.com • Speaking, media, strategic consulting and thought leadership focused on building enterprise value through the customer issues • Now the strategic consulting arm of Carlson Companies, Minneapolis • Magazines, newsletters, white papers • www.1to1.com • www.returnoncustomer.com rogers@1to1.com

Toyama no Kusuri-Uri • House-to-house medical supplies • Consumers only charged for usage • Detailed records kept in a database, called the “Daifuku cho” • Circa 1750

Peppers and Rogers Group Carlson Marketing Group www.1to1.com

www.1to1.com www.returnoncustomer.com

Who Moved My ROI? Building the Value of the Customer and the Company