Is it more effective for a company to organize itself by customer type rather than by say, product, business unit or territory? And if so, how should the company structure itself? Should Proctor & Gamble’s philosophy of brand management be jettisoned?
Title: Managing Customers as Investments
Author: Sunil Gupta and Donald Lehmann
Pages: 224 pages
Publisher: Wharton School Publishing
For this final installment, we confront the usual management quandary of ‘how to slice the pie’; how should a company organize its house in order to capture best performance? More specifically, professors Sunil Gupta and Donald Lehmann (of Harvard and Columbia business schools respectively; for bios click here) delve into the cultural revolution of the customer-based organization.
Indeed, changing a company from a brand management structure, or from a territory-based structure, to a customer-based configuration requires serious work. Just as apostasy, such a step should not be taken lightly.
Add matrix chart here
As the chart above illustrates, the customer-based philosophy enables managers to follow the behavior of customers (usually groups or cohorts of customers; not individual clients). Brand management follows revenues by product line, and therefore loses the customer focus.
Time to change faith?
So when does it make sense for a company to espouse the customer-based faith? According to the co-authors, always. For two reasons.
Firstly, only a customer-based approach enables the company to have a full picture of its customers, and therefore of the share of wallet that the company captures. Without knowledge on share of wallet, one cannot estimate what incremental revenue each customer may deliver.
Secondly, the religion of product management can generate conflicts between company divisions. The co-authors mention examples such as Toyota clients not being properly upsold to Lexus, since the two brands do not necessarily share customer information. A company that adopts the customer-based religion will avoid such pitfalls.
All together now
New organizational priorities also mean new incentives, to ensure that staff is rowing in unison. For the co-authors, there are two principal objectives. On the one hand, the incentive system must help avert conflicts within the company, for example between co-existing brands or services (e.g. Toyota and Lexus; checking vs. savings accounts divisions). On the other hand, the groundstone of the incentive system must be overall customer profitability.
This brings the authors to the sometimes prickly issue of evaluating a product’s exact profitability, or what they term customer-based costing. The issue at hand here is that most companies have precise accounting on a product-by-product basis, but not necessarily on a customer-by-customer basis. In this framework, costs need to be accurately attributed to each customer (or customer cohort). The authors point to a McKinsey study of commodity manufacturers (e.g. glass, steel), and how the impact of customer discounts and freight or shipping charges impacted the ‘pocket price’ (i.e. the net invoiced amount).
Therefore, before setting up the exact incentive system, and customer development strategy (acquire? retain? exploit?), managers are well advised to lay sound foundations and know the exact cost per customer (and therefore revenue-per-customer).
New roles for new priests
For companies that choose the customer-based culture, the co-authors suggest some roles and responsibilities. After all, for any new dogma to catch hold, there need to be high priests and commandments, no? The co-authors put it this way: “Effective implementation of customer-based strategy requires a cultural change within the organization…” (page 150).
The table below summarizes some of the tasks and priorities that different managers in the organization will have to adapt.
Add table (cultural shift) here
Beware the customer ides
What are some of the common pitfalls that companies fall into when converting to the customer-based culture? The co-authors list seven of them, of which a few are worth citing here:
- One-sidedness: although assiduous at analyzing benefits to the company, the benefits to the customer are neglected, and defections strike;
- Lack of foresight: how will your customers change over time? Errors in appreciation here can lead to missing out on potential future major customers;
- Rose-colored glasses: this is when managers overestimate growth potential (both new customers and margins per customer for existing ones), thus forgetting that customer acquisition is costlier than retention and ‘juicing’.
Excellence or mediocrity?
As we conclude this overview of “Managing Customers as Investments”, the co-authors remind us that adopting customer-based management “…may be a ‘life or death’ issue. It may also mean the difference between excellence and mediocrity for many other companies…” (page 165).
Regardless of the urgency of implementing any new customer-based cultural shift in your company, it is always useful to be reminded that customers are the keystone to any company, and any help in better understanding, analyzing and gauging customers is surely beneficial.
Published in August 2010.
Next issue: September 8, 2010
Box on Harrah’s case study
Happily losing their shirts
How casino-operator Harrah’s found its customer religion and thus boosted its financial performance and share of wallet
As an example of a company that found the customer-based management religion, the co-authors turn to casino operator Harrah’s. The company had been relying on a property-based system, wherein each casino was considered a profit center. It was when Gary Loveman, a Harvard business school professor, joined Harrah’s in 1998 that the company developed its customer religion.
Based on extensive analysis demonstrating that its customers patronized various properties, the company realized that it only captured 36% of customer wallet in the early 1990s. A one percent increase in that share would translate into a $1.10 share price increase. Thus stimulated, under Loveman’s progressive influence, Harrah’s shifted to a customer-based management philosophy.
Further use of database customer analysis enabled Harrah’s to break down its customers into three clusters: new business, loyalty and retention. Specific marketing programs were developed for each. A loyalty program was introduced, featuring gold, platinum and diamond levels – to hell with modesty; this is for high-rolling customers after all!
The end result? An increase in share of wallet to 42%, and the highest profitability levels among casino operators in 2002.
The co-authors do not speculate how the company might have fared had it adopted a “game-based” management system, with a blackjack division competing against a roulette division against a poker business unit, and so forth…
Further details on Harrah’s can be found on pages 156-160 of the book.
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.
Michael and Chris Fodor