This episode brings you a four-step analytical endeavour into customer-based planning. Two steps of reciprocal analysis (company and customer), and then on to designing and measuring marketing activities on the basis of that groundwork.

Book data
Title: Managing Customers as Investments
Author: Sunil Gupta and Donald Lehmann
Pages: 224 pages
Publisher: Wharton School Publishing
Price:  $34.99

For professors Sunil Gupta and Donald Lehmann (of Harvard and Columbia business schools respectively; for bios click here) business planning – namely marketing budgets – needs to take close account of how the monies are split between acquisition, retention and ‘exploitation’ (i.e. getting existing customers to spend more). Even though all three are important for the health of your customer base, marketing directors need to set priorities, and make sometimes tough choices.

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To help marketing directors (and their big brothers in strategic planning), the co-authors suggest using the concept of the profit tree.

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Although the profit tree will be a differently shaped for each business, the basic rule remains the same. A first set of parameters (left side of the tree) relates to the volume of business that can be expected. In the example quoted by the co-authors, linked to a Canadian financial services company, the parameters include market size, sub-segment targeted, business mix, referral rate and conversion rate.

The second set of parameters (right side of the tree) relate to the profitability per customer. Here one finds indicators such as unit asset value (portfolio size), the fee rate per client, the variable cost per client, and the expected client lifetime.

By quantifying the branches of the profit tree, managers can then decide which branches are worth ‘pruning’ (i.e. limit investments into), and which branches are to be ‘grafted’ (so as to produce fatter fruit).

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If the first step of the customer-based planning is to determine the proper allocation of marketing resources, the second step is to understand the sources of value to customers. Why do your customers purchase your goods?

Here the co-authors distinguish between three possible reasons: economic value, functional value or psychological value. For customer-based planners, knowing which stimulus tickles the customer’s funny bone can then help design more effective marketing programs. For example, why rejig your price when customers are flocking to your product for psychological (‘brand image’) reasons? Or why invest in an expensive image campaign in glossy magazines when the shoppers want your bargain-basement prices?

Let us explain the three values briefly. For economic value, consider the energy-efficient yet expensive light bulbs introduced by Con Edison. At $8.00 per bulb, these were ten times more expensive than their energy-wasting rivals, yet over their lifetime the efficient bulbs could save $84 in energy costs. That is proven economic value.

For functional value, the qualitative appreciation of customers is paramount, since it is often difficult to quantify the value of a functional advantage such as faster acceleration, larger luggage room, or a greater number of entertainment channels.

Lastly, psychological value differs from its two siblings since it reflects intangible qualities. This is the area where brand equity jumps in, and where various measures developed by companies such as Y&R, Millward Brown or Research International are offered. These measures take factors such as awareness, associations, attitude, attachment and activity into account.

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For professors Lehmann and Gupta, the third step of customer-based planning concerns the marketing program itself, that core element that every marketing director spends hours defining, analyzing, modifying, testing and moaning over. Here the 4Ps (product, price, place, promotion) are brought back to table.

The co-authors dispatch product, place and promotion swiftly, and focus mostly on price – one sees their quantitative penchants poke through again. Certainly one valuable piece of their advice is for marketers to predict the impact of their marketing actions on four areas: customer acquisition, margin per customer, customer retention, and lastly fixed costs.

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Metrics are what enables the marketing director to ascertain whether or not her monies are being well spent. For the co-authors, good metrics need to be twin-faced. One side must concern itself with customer value (how valuable are you to the client?), whereas the other side is to preoccupy itself with company value (how valuable are the customers to the company?). These latter measures are often related to those used for Customer Lifetime Value (see part 1 of this series).

As for customer value metrics, the co-authors could write a complete book on this vast topic. In the meantime, they simply provide some leads: awareness, attitude, trial/usage/conversion, loyalty, and word-of-mouth activity.

Managers simply need to guard from data overload: too many metrics may hide the forest for all the trees.

Published in July 2010.
The next (and last) installment will appear on August 4 and will cover customer-based organization.

Professor bios
Just use the university ones.

Customer lifetime value in five sets

We examine “Managing Customers as Investments”, written by professors Sunil Gupta of Harvard Business School and Donald Lehmann of Columbia Business School.

Discover the algorithm that every company should use to assess the true value of its customers, and therefore how much it can afford to invest in marketing operations in order to capture new clients.

We cover this book in five parts:

Part 1 – June 9
Examination of the algorithm to evaluate customer lifetime value. How to calculate its value and what precautions to take. Click here to access part 1.

Part 2 – June 23
Focus on customer-based strategy. What are the key drivers of customer profitability and their impact on marketing strategy? Click here to access part 2.

Part 3 – July 7
Customer-based valuation: how the customer lifetime value can be used to value companies, namely in acquisition settings. Click here to access main story.

Part 4 – July 21
Customer-based planning: how planning with customer objectives in mind (retention, acquisition, etc.) varies from product-based planning. How effective can it be?

Part 5 – August 4
Customer-based organization: how a customer-based focus affects ideal corporate structure.

The editors
Michael and Chris Fodor