Determining Customer Value
How Valuable Is Each and Every Customer?
Are all customers one and the same? Not in the eyes of many companies. In search of the most loyal customers, they divide their customer base into different categories. What at first sounds like additional work makes perfect sense. Because companies that differentiate between which customers make an increased workload worthwhile, act more purposefully. With such information, they can use their marketing budget more profitably and build long-term customer relationships.
But which customers should companies pay special attention to? In order to answer this question, there are several factors to consider. Because if you only evaluate customer relationships based on potential sales, you sometimes think far too short-term. In this article, we show how brands recognize the true potential of their customers and what segmentation options there are.
Table of Contents
What Potential Does a Customer Have?
Is your customer a cash cow? Valuable information remains hidden from companies that only see their customers as buyers. Because in many customers far greater potential that companies can use for their growth lies dormant. The following customer value analyses can help companies identify the potential of their customers.
1. Sales Potential
How much revenue does a customer generate per year? The sales potential is the most widely used indicator for evaluating your own customers and it can be easily calculated using customer data. The value determines how much money a customer spends per year on the company’s products or services.
Nevertheless, the sales potential has little informative value with regard to the actual customer value. This value is often well above the annual turnover of a customer. In terms of customer lifespan, however, the sales potential is of great importance. It is not only a deciding factor how much a customer has already spent on a company’s products or services. The expected sales in the following years are just as important in order to be able to go through the individual levels of customer lifetime value in full.
2. Cross-selling Potential
Why not get loyal customers excited about new products and thereby increase their current customer value even further? With cross-selling, companies can generate additional sales with existing customers through additional offers. Existing customers should be encouraged to purchase additional products or services. The aim is to sell as many different products from a company as possible, which ideally complement each other in a meaningful way. This can be car insurance taken out when you buy a car, or shoe polish that protects your new winter shoes from snow and rainy weather. The aim of cross-selling is to exploit the customer potential to such an extent that the customer value also increases.
3. Margin Contribution Potential
The contribution margin potential of a customer is calculated from the sum of the current contribution margin and the contribution margin forecast for the future. The contribution margin potential also takes future values into account. That makes perfect sense if companies want to make long-term decisions.
The contribution margin usually goes hand in hand with a high level of customer satisfaction. Customers who currently have a high contribution margin but are dissatisfied and will migrate in the following year are less profitable for a company than loyal customers with a low contribution margin. By combining the contribution margin ratio with other key figures, companies can significantly increase the informative value.
4. Reference Potential
Is a customer a multiplier who inspires friends and acquaintances about the company and its products? Then it may have high reference potential for a company. The reference potential describes the number of all potential buyers that an existing customer can influence positively or negatively by recommending them. Two factors usually determine the size of the reference potential: The characteristics of the reference provider and that of the products or services concerned.
Does the customer have charisma and credibility? How competent, involved, and satisfied is the reference provider? These aspects play a decisive role in the intensity of the recommendation. References are crucial for success, especially for socially conspicuous products such as cars or clothing. Conversely, references can also create a negative spiral, such as when dissatisfied customers dissuade potential new customers from their decision. The dissatisfied customer, therefore, has a negative customer value for the company. In this way, it quickly becomes clear: For companies, customer references are often much more important than direct sales to these customers.
5. Customer Retention Potential
What is the potential for long-term customer retention? An important principle is that the greater the customer satisfaction, the longer the business relationship usually lasts. A long business relationship, in turn, reflects high customer value. In summary, this means there is a relationship between customer satisfaction and customer value. But the reference potential of a customer is also linked to the degree of his or her satisfaction. The more satisfied a customer is, the more likely they are to recommend a company or its products to friends and acquaintances.
Related:
6. Information Potential
Information is valuable and in times of information overload, quality customer feedback is worth its weight in gold. Companies can therefore benefit from their customers’ willingness to provide information. If a customer likes to give feedback, he offers the company a high level of information potential.
The information potential thus includes all relevant expressions of opinion that a company receives from customers and then uses accordingly. These can be innovation suggestions, positive comments, but also complaints. With a customer-oriented information system or complaint management, companies can record the feedback from their customers and then evaluate it.
7. Willingness to Pay Potential
How punctually does a customer pay their bills? When companies have to remind customers to pay with repeated reminders, they invest valuable time in doing so. And time is money. If several customers are lax about paying their bills on time, companies can quickly run into a liquidity bottleneck.
Customers who have a high credit rating and are willing to pay are therefore more valuable to a company than those who pay late, as they usually have good payment behavior. Companies can determine and evaluate their customers’ payment behavior based on credit scoring. With the help of this information, a company can minimize its liquidity risks.
What Models are There for Customer Segmentation?
Taking a closer look at your customer base is always worthwhile. A customer value analysis can identify particularly profitable but also less valuable customers for the company. Marketing concepts can then be developed precisely for the respective customer segment.
Each customer segmentation is based on an existing customer base. The aim here is to combine all known individual customers into subgroups that are as homogeneous as possible, which reflect the respective customer value. There are a number of models for differentiating customers into individual groups. As a rule, you use classic key figures such as sales, contribution margin, or profitability. Marketing departments generally use the models and parameters described below to segment their customers.
1. ABC Analysis
In practice, companies primarily use the ABC analysis. What at first sounds like a play on words for first graders is a business analysis method. It ranks buyers based on their importance to a company. For this purpose, the ABC analysis generally takes into account precisely calculable numerical values such as sales, costs, and contribution margin.
Customers are divided into categories A, B, and C. Category A is the one with the highest values, while category C defines those customers who have a lower value and are therefore comparatively less important for a company. With the help of customer value analysis, companies can quickly get a rough overview of the composition of their customer base with comparatively little effort. The customers with the most purchasing power or the most cost-intensive are just as clear as all small customers, who consequently generate only a low turnover.
However, the ABC analysis model only classifies customers according to their past interactions with the company and thus only reflects the current situation. Forward-looking companies should therefore also evaluate their customers on the basis of soft factors such as their reference potential.
2. Customer Portfolio
Companies that want to classify their customers in more detail and comprehensively use models that combine monetary and qualitative criteria. One example of this is customer portfolio analysis. It is based on a four-field matrix, the two axes of which each represents a key factor, for example, sales and potential. “Sales” describes the monetary value, “potential” the qualitative criterion.
The customers are then assigned to one of the four fields of the matrix. Each field reflects a certain type of customer:
- Development customer
- Premium customer/star customer
- Skimming customer/yield customer
- Waiver customer/problem customer
Companies can now base their actions on the individual matrix fields. It makes sense to bind premium customers to the company as long as possible and, ideally, not to invest any further in relationships with waiver customers.
3. Customer Lifetime Value
Customer Lifetime Value refers to the value of a customer over their life cycle. It is assumed that a business relationship can be divided into five phases:
- Initiation phase
- Getting used to it
- Growth phase
- Maturity phase
- Separation phase
In each of these five phases, customers have a different value. As a rule, the following applies: The more advanced in the cycle, i.e. the longer the business relationship, the higher the turnover that a customer generates and thus the customer value. The exact customer value is calculated by accumulating the expected sales over the estimated duration of the business relationship. This means that the value not only relates to the present but also takes future customer potential into account.
In order to make a meaningful division into the different phases of the life cycle, the purchasing behavior and the relationship of trust of the customer should be checked during this analysis. Since the result is not only based on quantitative factors, but also on subjective assessments, errors can creep in. This can reduce the informative value of the analysis.
4. Scoring Models
Scoring models are also based on qualitative and quantitative parameters and thus enable a multi-dimensional, detailed and balanced customer evaluation. They are usually created with the help of very time-consuming and complex statistical procedures.
For this purpose, a criteria catalog with a maximum of ten variables is first prepared. It contains all monetary and non-monetary criteria relevant to the company, for example, sales, costs, and recommendation potential, and stores a rating scale. Each criterion is then given a weighting factor. This factor can vary based on different company priorities and different industries. A total customer value for each customer is finally determined from all factors and a ranking is established. The customer in the first place is, therefore, the most valuable.
The scoring model works best with a small customer base. In contrast to the ABC method, the analysis is more complex because of the larger amount of data. As with the customer lifetime value model, the customer lifecycle can be of limited informative value, as the criteria catalog is compiled and the evaluation is based on individual criteria.
What Role Does Customer Value Play in Customer Relationship Management?
Companies that want to increase the value of their customers rely on maintaining relationships. If a company actively contacts its customers, customers feel seen. A long-term customer relationship can develop. Customer relationship management (CRM) can promote this. It summarizes all strategies and measures the systematic design of the relationships and interactions of an organization with existing and potential customers.
In the context of CRM, for example, all customers are evaluated. They are classified based on their potential that is of use to the company. The analysis of customer satisfaction is also an important task of customer relationship management. As already described, customer satisfaction is directly related to customer value: The more satisfied the customer is with the company or its products, the higher their value for the company.
The Role of the Net Promoter Score® in CRM
A popular key metric for getting a general picture of customer satisfaction is the Net Promoter Score (NPS®). It is determined from a single question:
What is the probability that you would recommend our company to a friend or acquaintance?
The customers give their rating on a scale from 0 = very unlikely to 10 = very likely. The participants are then asked to give reasons for their opinion in an open answer field. Based on their answers, the participants can then be segmented into three categories, with which the Net Promoter Score can be calculated:
- Promoters: They marked a 9 and 10 on the answer scale and are fans of a company.
- Indifferent or passive: You are neutral towards the company and have marked this with a 7 or 8 on the answer scale.
- Detractors: Detractors are the critics of a company. Your willingness to recommend is between 0 and 6 points on the answer scale.
The NPS method is a real asset for customer relationship management. It enables companies to conduct a survey with a large number of participants with relatively little effort and to segment the participants at the push of a button. In this way, companies can design customer relationships even more individually.
Derivation of Marketing Strategies with the Net Promoter System®
No matter how many critics, indifference and promoters the NPS survey reveals: The division opens up numerous opportunities for companies to increase the value of their customers:
- Promoters can be used as multipliers or influencers by reporting positively on their experiences with the company on social media such as Facebook, but also in the newsletter or on their website. Even if you do not generate a large turnover yourself, you can recommend the company and its products to more affluent friends and acquaintances. They, therefore, have a high reference potential.
- According to the NPS, critics do not automatically have low customer value. If detractors justify their negative evaluation in an open answer field, they are also giving the company important information. Such information can be used for innovations or improvements.
Whether critic, passive, or fan – by giving reasons for their evaluation, customers have a high information potential. With its open answer field alone, the Net Promoter System can increase the value of the customers taking part in the survey.
The division of the participants into detractors, indifferents, and promoters also enables companies to define tailor-made marketing activities for each target group in the next step. Because if you know the customer value and know how high the customer satisfaction is, you can address the customers accordingly and focus on the most important relationships. The division and prioritization using the example of a matrix could then look like this (see graphic).
Companies that know the potential of their customers know how to use their marketing budget most effectively, based on the individual value of each customer. When companies reach the right buyers with the right marketing and sales campaigns, this not only increases customer value but company sales and profitability also benefit. It is only with tailor-made marketing strategies and social media campaigns that focus on the customer which increases a company’s long-term value.
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