Usually a small percentage of customers drive the majority of a company’s profits. Upon closer inspection, companies find that customers who generate a lot of cash flow cost more to service per transaction. Unfortunately, many companies aren't using customer value analytics to determine which customers are truly profitable and which are not.
Instead of relying on total revenue or total orders, data analytics software has empowered companies to accurately measure customer profitability. Companies that do not have this information are at a severe disadvantage when competing with data-driven businesses. Armed with the facts, companies increase the profitability of low-profit customers and retain their most profitable customers.
Create customer profiles
When companies focus on gaining high-value, long-term customer relationships, it results in a positive financial outcome. However, having a clear and comprehensive insight into customer behavior was difficult before data analytics. The massive amount of data generated by companies today offers an unprecedented amount of granular insight into customer behavior. Analytics software presents this insight in real-time, which enables companies to understand their customers better and respond rather than react to quickly shifting market demands.
Creating customer profiles will allow you to identify customers who fit your business priorities. Companies launching new products might want to quickly increase sales. Whereas a company who relies on access to cash flow might want to focus on customers who pay quickly. Customer profiles can include information such as the age and gender of individual consumers, or size of business and type of industry for corporate customers; their interests, how they think, what they value is important; and most importantly, their purchasing behavior such as which products they buy, where they buy them, when, and how they pay. Profiling your customers in this way helps you to group them into separate categories so you can refine your marketing campaigns, promotions and customer relationships.
Analyze your customers' value
Analyzing your customers can tell you which customers are responsible for your profits. Pareto’s principle or the “80-20 Rule” applies to customer profitability. This means that about 20% of your customers are likely providing 80% of your profits. However, companies with the ability to do a deep-dive into customer value analytics can quickly determine each customers’ actual value. Some metrics include:
Historical value: This measures the value earned from a customer relationship over a period of time. This might be the previous fiscal quarter or the duration of the relationship. It can be measured as a simple average of previous periods or can be time-weighted, placing greater emphasis on recent periods. Historical value allows you to compare customers with each other to rank them for reasons such as marketing efforts or pricing or budgeting decision-making.
Current value: This measurement involves a shorter time frame, such as a month. Since factors such as seasonable sales may not be reflected within a single month, the current value is just a snapshot of the relationship. When compared to previous current values, this measurement can highlight significant changes due to marketing campaigns, new offers, and pricing adjustments.
Lifetime value: This measurement determines what a customer is worth in the long term. Before we can measure customer lifetime value, we must determine customer value. This is the value of a customer’s average order multiplied by their purchase frequency. This will give you the value of a customer during a specific time period. Once you know a customer’s value, you can determine their lifetime value by multiplying the annual value by how long the customer has been active.
Cost-to-serve: As a rule of thumb, profitable customers are those who buy your high-margin products, pay full price and on time, place a small number of large orders rather than a large number of small orders, and don’t require extensive customer service. High cost-to-serve customers can quickly go from being profitable to costly. These customers are called service-drain customers because they tend to place frequent, small orders rather than large, infrequent ones and customers who frequently return or exchange items. This drives up sales administration and delivery expenses, draining all of your profits.
Retain your profitable customers
It has been well established that it is far more cost-effective to retain profitable customers than it is to acquire new customers. As markets continue to become increasingly more competitive, companies must focus on preserving their high-value customer base. A customer strategy that focuses on extending the customer life cycle, as well as increasing customer profitability can deliver this. Customer value analytics is essential to tracking the issues that have the greatest impact on your customers. For instance, using the DIFOT measurement will ensure your customers are getting their orders when they need them. Using customer service metrics such as Average Response Time and Resolution Rate will highlight the efficiency of your customer service team. Finally, adjust your margins or consider a bulk discount or other preferential terms to your best customers.
Customer value analytics provides a clear picture of your high-value customers and those who are high-maintenance. Your sales team can focus their efforts on retaining these customers while eliminating your service-drain customers. Investing in long-term relationships is the key to ensuring sustained profitability. It allows you to determine a few key things, such as how much you can spend on acquisition and what you can spend to retain each customer and drive the results outlined in your business strategy.
To learn more about how to track customer profitability by downloading this ebook, Cross-selling and upselling.