All value created by a business comes from customers. Without a customer or client, at some level, no business can create any shareholder value at all, and this simple fact is inherent in the very nature of a business. By definition, a business exists to create and serve customers and, in so doing, to generate economic value for its stakeholders. But some customers will create more value for a business than others will, and understanding the differences among customers, in terms of the value they each will or could create, is critical to managing individual customer relationships. In this chapter, we explore the most fundamental ideas about the value that customers represent for an enterprise, including both a customer’s “actual” value and “potential” value. We show how a firm can use insights about customer value to better allocate resources and prioritize sales, marketing, and service efforts. We consider whether and under what conditions a firm should consider “firing” very low-value or even negative-value customers.

The inability to see customers as being different does not mean the customers are the same in needs or value, only that the firm sees them that way.

Recognizing the Hidden Potential Value in Customers

Pelin Turunc

Consultant, Peppers & Rogers Group, Europe

Differentiating or grouping customers in terms of various characteristics such as value, needs, and behavioral trends has proven to be an effective and widely accepted marketing practice among a variety of industries across the world. The most widely used segmentation method, pursued by the vast majority of companies focused on a customer strategy, involves differentiating customers by value and then designing different strategies for different value segments—launching aggressive retention strategies for high-value customers, for instance. Even though it is a popular strategy, many companies still succumb to a costly pitfall, related to just how a customer’s value is assessed. Far too frequently, companies take into account only the narrow viewpoint of the customer’s current “actual value,” largely based on historical behavior patterns, (this phrase actually only applies to “actual value”) while overlooking the immense potential of many customers to generate even more value than they have in the past or to generate value not directly indicated by transactional records or the historical picture.

It is understandable, of course, that a firm’s marketing analysts may be reluctant to forecast future behaviors for a customer when they haven’t already observed and modeled those behaviors in the customer’s transactional history. In addition, analysts may hesitate to try to quantify the results of customer behaviors that are not directly associated with purchasing and service costs. However, leading companies know that success often comes from taking account of individual customers’ potential values, not just their actual values. (Remember that both current value and actual value are “future” oriented, but, while a customer’s current value is the estimated net present value of future financial contributions currently expected, based on what is known now, a customer’s potential represents the increased value that could be realized if the customer were to behave differently, presumably based on the firm’s behavior.)

Consider, for instance, the idea that today’s customer might actually increase his or her patronage with a firm considerably, based solely on the fact that, as time goes on, the customer matures into an older and more productive person. Royal Bank of Canada (RBC)a was one of the first banks to look carefully and analytically at the youth segment as a promising group of retail banking customers when most banks were overlooking this segment due to their low current (actual) value. RBC recognized the high potential value of young college students, many of whom would become highly paid professionals in the future. The bank gained a competitive advantage by reaching out to and building loyalty in this segment early on. In a similar way, certain groups of customers who are in a temporary financial slump, or even in bankruptcy, could have the potential to be promising and high-value customers in the future. A bank that identifies such customers (differentiating them from other customers who are bankrupt now and likely to remain in financial distress for the long term) and reaches out to them at this difficult stage in their lives is certain to win these customers’ loyalty and trust.

In telecommunications, some companies find hidden word-of-mouth power in the ranks of their currently low-value “public sector employees” segment. For example, when Sprint offered attractive rates and group discounts to this public sector group, the word-of-mouth impact resulted in increased new customer acquisitions, increasing each company’s profitability and market share.b A close look at the needs of the customers was of course an enabling step in this strategy, where the telecommunications company was able to find the rate, payment, or discount benefits that best suited the needs and payment behavior of this customer group. The benefits could easily have been missed, however, had this company looked solely at these customers’ historically based actual values.

Taking into account the “customer influence” factor in modeling lifetime value is even more critical in some industries where a small number of customers exert a disproportionate share of influence on others’ buying decisions, such as in the pharmaceuticals industry. The primary customers here, at least in most countries, are physicians, and some physicians almost always stand out for the amount of influence they have on the medical practices of other physicians. Identifying and trying to quantify the value of such “key opinion leaders” (KOLs) is a high priority for pharmaceutical companies, such as Abbott Labs, Bristol-Myers Squibb, and Biogen Idec.c KOLs usually are viewed by their peers as experts in specific therapeutic areas, and as such they exert immense influence over other doctors when it comes to the types of medications to be prescribed and the kinds of medical treatments to be administered in these therapeutic areas. Even though some KOLs may have low actual values themselves, in terms of the prescriptions they write in their own medical practice, their influence is disproportionately valuable. Some pharmaceutical companies (e.g., Roched) even try to identify rising KOL stars, who are for the most part relatively less well-known professionals who show signs of future success and influence. The companies then invite these rising stars to participate in medical education and other activities, hoping to build long-lasting relationships.

One industry in which potential value can be an important differentiator is the airline business. Because of their widely used frequent-flyer programs, airlines usually have a fairly good handle on the transactional histories of their most frequent travelers who are, for the most part, business flyers. But even if a business traveler flies 50,000 miles a year on an airline, the airline has no way of knowing, from its own transactional records, whether that traveler is flying another 50,000 miles on a competitive carrier. So, in trying to estimate the potential value of an airline customer, it is critical to look at external data sources (and, in some cases, simply to ask a customer in order to get share-of-customer information) when such sources are available and perhaps to tap into the data available from distributor partners, such as travel agencies or credit card firms. Lifestyle changes can also create shifts in the potential value of a customer and should be taken into account. Southwest Airlines, for example, identified and sent relevant offers to some currently low-value customers who moved to another country as expatriates, and these customers proved to have high potential value as evidenced by their future travels on holidays to their home country.

In addition to overlooking customers with high potential value, some companies make wrong and unprofitable investments in customers who seem to be high in value now but in fact have a low or sometimes negative potential value. In the retailer category, Best Buye successfully differentiated its customers to deliver exceptional treatment to identified high-potential customers while paring some of their less valuable customers from their mailing lists and tightening up their return policies to prevent abuse. In this way, Best Buy avoided unnecessary time and monetary investment on customers with low potential values. Filene’s Basement Discount Storesf represents a more extreme example. When Filene’s Basement realized that some of its customers who appeared to be high-value customers with high sales volumes were actually serial returners (often returning clothing after using it once), it banned some of them from its stores altogether, preventing losses from this group who proved to be Below Zero over the long term.

Another company that avoided unnecessary investment in low-potential-value customers is Capital One Bank, which recognized its low potential value customers and adjusted its reactive retention strategy to deemphasize them. (After all, why should the company go out of its way to retain a low-value customer?) One variable that can reduce the potential value of a financial services customer is financial risk. Understanding the likelihood that a customer will need to be charged off in the future is an important function for any credit-granting institution. Capital One, while giving incentives and positive offers to its high-value customers who want to close their accounts in order to save them, encouraged the high-risk customers (i.e., low-potential-value customers) to close their accounts with the bank. This policy helps to minimize future financial losses to the bank, improving overall profitability.

Assessing customer value as a combination of current and potential value is no longer a choice if a firm wants to remain truly competitive. Estimating a customer’s potential value is certainly more complex than simply trying to forecast actual value, or LTV, and requires a deeper look into factors such as needs, lifestyle phases, and behavioral trends. But making a genuine attempt to do so will likely prove quite beneficial.

aV.G. Narayanan and Lisa Brem, “Case Study: Customer Profitability and Customer Relationship Management at RBC Financial Group (abridged),” Journal of Interactive Marketing 16, no. 3 (Summer 2002): 76.

bAdvisory Opinion No. 05-1, “Conditions under which a State Employee May Accept a Discount on Goods or Services”; Sprint PCS (“Sprint”) provides wireless telephone services for OTDA and other state agencies through a contract approved by the State Office of General Services (2004), available at: www.nyintegrity.org/advisory/ethc/05-01.htm, accessed September 1, 2010. Sprint PCS company Web site and Nextel company Web site indicate 15 percent for government employees, available at: www.nextel.com/en/solutions/federal_govt.shtml.

cRachel Farrow, “Forging Key Opinion Leader Relationships: Developing the Next Generation,” TVF Communications ( July 2008); available at: www.tvfcommunications.com/publications.aspx, accessed September 1, 2010.

dIbid.

eRajiv Lal, Carin-Isabel Knoop, and Irina Tarsis, “Best Buy Co., Inc.: Customer-Centricity,” Harvard Business School Cases, April 1, 2006, p. 1.

fScott Wilkerson, “Marketers Must Understand Customer Value to Make Segmentation Pay,” Hawkpartners Group, Alert! Magazine, September 10, 2009, available at: www. hawkpartners.com/perspectives/articles/alert-mag-October-2009.pdf, accessed September 1, 2010.

Assessing a Customer’s Potential Value

In trying to assess a particular customer’s potential value, some of the questions you want to answer include:

• How much of the customer’s business currently goes to your competition, but might be pried away with the right approach or relationship?
• How much more of a customer’s business could you capture if you modify your treatment of him?
• How many more product lines might the customer buy from you? What other services or products could you sell the customer if you had the products available?
• What additional value would you capture if you could prevent the customer’s defection?
• The customer has needs you know about. How can you identify the needs you don’t yet know about?
• How much could you reduce the cost of serving this customer, while maintaining his satisfaction?
• How much could this customer be worth in terms of referrals and other non-monetary contributions?

Your opportunity for organic growth is directly related to the unrealized potential values of your current and future customers. But that is just your perspective. From the customer’s perspective, potential value has to do with [the customer’s] need. This is important:

The outside limit of any customer’s value is defined by the customer’s need, not by your current product or service offering.

Source: Excerpted from Don Peppers and Martha Rogers, Ph.D., Return on Customer (New York: Currency/Doubleday, 2005), p. 82.

Pareto Principle and Power-Law Distributions

When it comes to analyzing how customer values are distributed, the 80-20 Pareto principle does not result in a “normal” distribution, like a bell curve. (See Exhibit 5A.) The Pareto principle is a special case of what mathematicians call a power-law distribution, or a log-normal distribution. The key to understanding how a power law differs from a bell curve is to recognize that power laws go on and on with the same kind of distribution. (for this reason, we say that power-law distributions are “scale-free.”)

EXHIBIT 5A (a) Bell Curve or Normal Distribution and (b) Power-Law or Log- Normal Distribution

For instance, if customer lifetime values are distributed according to the 80-20 Pareto principle, so that the top 20 percent of customers account for 80 percent of the total value, then the 20 percent of that top 20 percent of customers will account for 80 percent of that 80 percent of value. In other words, just 4 percent of customers (20 percent of 20 percent) will account for 64 percent of a company’s total lifetime values (80 percent of 80 percent). Multiply it again and you’ll find that fewer than 1 percent of customers will account for more than 50 percent all customer lifetime value, and so forth.

It’s important to remember that all such distributions are still inherently random, and no random distribution of discrete quantities (e.g., individual customer lifetime values) will ever conform precisely to a particular mathematical formula. But it’s easy to be confused by the Pareto principle, because it represents a power law, while many of the natural phenomena we observe in everyday life are distributed according to the more intuitively understandable bell curve. Human height, for instance, is distributed according to a bell curve, while wealth is distributed according to a power law. If you walk down a crowded city street and catalog the different heights of the people you encounter, chances are you’ll see an occasional 6 foot 6 person or maybe even someone who is nearly 7 feet tall, but the odds of finding someone much taller than 7 feet 6 inches are vanishingly small. (You’ll also see one or two adults who are under 5 feet tall and maybe even an occasional person less than 4 feet 6 inches.)

Wealth, however, has no natural upper limit and is distributed according to a power law. Let’s suppose human height were distributed the same way personal wealth is distributed, with the average “height” of wealth being about 6 feet. If that were the case, then when you walked down the street you’d run into a few people in the 5- to 7-foot range, but many of the people you meet would actually be shorter than 3 feet tall, and the vast majority of them be only a few inches high! Every block or so, however, you’d encounter a couple of people 20 feet tall, and you’d likely see a 100-foot-tall person or even a 500-foot-tall person once in a great while. The longer you walk, the more likely you’ll see someone even taller than the last giant you encountered. If you happened to run into the two tallest people in the United States, Bill Gates and Warren Buffett, they would each tower over the city, their heads more than a mile in the sky. Now, that would be a power-law distribution.

Power-law distributions characterize many kinds of measurable quantities that are based on networks, including the increasing proliferation of Internet-enabled social networks. As technology improves and continues to connect customers more and more closely together, power-law distributions can be expected to characterize things like the number of comments accumulated by different blogs, or the number of viewers of different YouTube videos, or the number of Twitter followers acquired by various users. As we read in Chapter 8, this is an important and more or less universal characteristic of social networks.

The goal of value differentiation is not a historical understanding, but a predictive plan of action.

Customer Referral Value

Obviously, some customers will refer new customers to an enterprise more frequently than others will, and this represents real value “created” by the referring customers. In most situations, a customer who comes into the enterprise’s franchise because of another customer’s referral is likely to be more satisfied with the service he or she receives, more loyal, and often significantly more valuable to the business than a customer who comes in through normal marketing or sales channels. This is only logical, because a friend’s recommendation is a highly trustworthy vote of confidence.

An enterprise should try to track customer referrals by individual customer, of course. For one thing, the enterprise needs to consider the fact of a referral in a customer’s transactional records, because referred customers as well as referring customers may tend to have different patterns of behavior and trajectories. In addition, the enterprise probably should thank the referring customer or provide other positive feedback that encourages additional referrals (although explicit monetary rewards are tricky here, as we discuss soon).

Fred Reichheld’s Net Promoter Score (NPS) is a compact metric designed to quantify the strength of a company’s word-of-mouth reputation among existing customers. Leading Bain consultant Reichheld suggests a business survey of its customers to ask how willing they would be to recommend the business or product to a friend or colleague, on a scale of 1 to 10. The NPS is then calculated by subtracting the percentage of “detractors,” who rate the likelihood anywhere from 1 to 6, from the percentage of “promoters,” who rate it 9 or 10. With research from Bain and Satmetrix, Reichheld claims that the resulting metric is positively correlated not only with customer loyalty but with a company’s growth prospects and its general financial performance. Reichheld also argues strongly that if a customer is willing to refer another customer, then he must be relatively more satisfied (and therefore more likely to remain loyal and valuable) himself as well.a As a very simple number based on a single question, NPS doesn’t offer a lot of diagnostic benefit—that is, by itself, it isn’t likely to say much about why a customer is or is not willing to recommend, but it has to be admired for its simplicity and practicality as well as its intuitive logic.

Significantly, calculating NPS requires subtracting detractors from promoters, which is an excellent idea, because customer dissatisfaction has been found to be a much better predictor of defection than customer satisfaction is of loyalty. Despite this fact, most companies that do track their customer satisfaction scores don’t bother trying to track dissatisfaction scores. This is a big mistake, because when customers talk about a company with other customers, it isn’t always positive. And negative word of mouth can be an insidious, destructive force all by itself, with a real effect on the financial value of the firm. (More about this in Chapter 8, when we discuss social media.)

At least one study more recent than Reichheld’s original NPS argument suggests that a customer’s actual referral value—that is, the true financial value of a customer’s referrals to an enterprise—is not well correlated with the value created by the customer’s own spending. In other words, although a customer may refer others to a business, this doesn’t necessarily mean that the customer herself spends much more than other customers. In a 2007 Harvard Business Review article, “How Valuable Is Word of Mouth?” the authors developed a comprehensive model for calculating the value of referrals, taking into account the likelihood that a referred customer might have become a customer anyway, even without the referral. They then applied their model to a sample set of customers taken from two different actual firms—one telecom company and one financial services firm. What they found was that the value created by customer referrals (CRVs) is a very significant component of overall customer lifetime values.b

So, for instance, a decile analysis of customer spending values (CSV) and customer referral values (CRV) for the telecom company’s customers would look like Exhibit 5B.

EXHIBIT 5B Decile Analysis of Customer Spending Values (CSV) and Customer Referral Values (CRV)

Rewarding customers with monetary incentives for referring other customers can be helpful sometimes in encouraging more referrals. This is the basis for the classic direct marketing strategy colloquially known as member-get-a-member and is a common feature even today of many airline frequent-flyer programs. Then there was the classic “Friends and Family” program launched by MCI, which was a remarkable success in the long-distance business in the 1990s. Name 10 friends or family members you make long-distance calls to, and if they become MCI customers, then everyone in your “circle” of friends and family will get a 10 percent discount off their calls to one another. More recently Sprint PCS has made it a practice to give any customer who refers another customer a service credit of $20, while Scottrade, the online brokerage firm, provides a few free stock trades to both referring and referred customers.c But the very best and likely most valuable referrals will come without requiring any monetary incentive. If a customer is very happy with a company’s product or service, then she is much more likely to see referring her friend to the company as doing the friend a favor. If, however, a financial incentive is offered, then (the customer might think) how confident can the company be in the quality of its product?

A highly successful online banking service in the United Kingdom, for instance, had a reputation for extremely good customer service. By its own analysis, this bank had customer satisfaction levels and “willingness to recommend” levels far above its nearest bricks-and-mortar banking competitors. Moreover, the bank had grown substantially in the past through customer recommendations. Citing Market & Opinion Research International, the firm’s own Web site claimed it was “the UK’s most recommended bank.”d

However, after a few years in business, it had apparently begun to wear out its welcome among many of its most loyal customers. One customer, for instance, reported that while he used to recommend the bank to his friends regularly, he had stopped doing so. Why? Because lately the bank had been sending him repeated, irrelevant solicitations by mail. A 12-year customer of the bank, he “never borrows,” but he and his wife now get about one solicitation a week for mortgages or loans. “I still bank there. It’s a good bank,” he says. “But I used to recommend [this bank] all the time to friends and others. I just thought I was doing a good turn for my friends by recommending it to them. But now they’re more like all the other banks out there—just trying to hustle me for more business. So I haven’t recommended them recently to anyone. Also, I know several other customers who feel the same way.”d And this may be one reason why this bank now pays its customers £25 for each new customer recommended to it. Put another way: The bank’s current lower customer experience levels required it to pay a fee for recommendations it formerly got for free.

aFred Reichheld, The Ultimate Question: Driving Good Profits and True Growth (Boston: Harvard Business Press, 2006).

bThe authors defined customer lifetime values in terms of spending only, but we will call this “customer spending value,” while in our definition of “lifetime value” customer referrals are already included.

cV. Kumar, “How Valuable Is Word of Mouth?” Harvard Business Review 85, no. 10 (October 2007): 139–146.

dCustomer interview, November 12, 2003.

Is It Fair to “Fire” Unprofitable Customers?

As a company gets better at predicting actual and strategic value, it will become clear that just as 20 percent or so of its customers will likely account for the lion’s share of the firm’s profitability, another relatively small group of customers is likely to account for the lion’s share of service costs and transaction losses. It is not uncommon for a retail bank, for instance, to do a customer valuation analysis and learn that 110 percent of its profit comes from just the top 30 percent or so of its customers while the vast bulk of customers are either break-even or unprofitable for it, when considered individually. Other businesses have similar problems, although retail banking is probably one of the most extreme examples.

Because of traditional marketing’s heavy emphasis on customer acquisition, for many companies, it would be anathema even to suggest it, but the plain truth is that in many cases, a company will simply be more profitable if it were to get rid of some customers—provided, of course, that the customers it rids itself of are the ones who create losses without profit and who will likely continue to do so in the future.

Before leaping to the conclusion that this is unfair to customers, consider that it is the profitable customers who are, in effect, subsidizing the unprofitable ones. So “firing” unprofitable customers is not at all a hostile activity but one designed to make the overall value proposition fairer for all. Nevertheless, there are some important ground rules to follow when reducing the number of BZ customers at a company:

• However a company defines the value of a customer, the analysis must apply the same way to everyone. The company engaging in careful customer value differentiation does not care about skin color or gender, religion or political views. It cares only about each customer’s actual and potential value, and it acts accordingly. This may disadvantage some customers who have long ago abandoned loyalty in favor of coupon clipping or other price shopping but will appropriately reward the customers who are keeping the business in business.
• Some companies, such as utilities or telecommunications firms (or banks, in some countries), have enjoyed monopoly or near-monopoly status in the past through regulatory directive. Even if they are no longer government-sanctioned monopolies, as the established incumbents these firms are likely to continue to have universal service mandates that require them to serve any and all customers. Such firms still may choose to define value or customer profitability in a more sophisticated way than simple revenue minus cost of service. The telephone company that provides basic service to Aunt Matilda in a rural area cannot hope to make a “profit” on her, in the strictest financial sense, but rather than classifying her as a BZ customer, it should consider her part of the company’s mission to serve the community. Moreover, accomplishing this mission probably will be related to the company’s regulatory situation, and foreswearing such a customer might violate a legal requirement. For such a company, the real BZ customers would be those who move every few months and leave the final bill unpaid, requiring extra collection efforts; or who often cause mishaps with neighborhood lines; or who frequently change carriers or otherwise create excessive paperwork. These customers can be omitted from promotional mailing lists and other spending efforts. It’s okay to stop spending money trying to get a customer to generate a greater loss for the firm.
• Most important: Nothing about customer differentiation means treating anybody badly, ever. The enterprise that treats different customers differently will be required to maintain a consistently high “floor” of service that is the result of a fundamental recognition that customers are a twenty-first-century firm’s most valuable asset, and—by definition—the firm’s only source of revenue.

Dealing with Tough Customers

Sometimes, because of the structure of an enterprise’s own industry or its distribution network, or simply because of the type of market it has to deal with, it will have to cope with very powerful customers—customers who have a great deal of negotiating leverage in their relationship with the vendors they buy from. Customers like these, while they may represent super-growth customers when considered in one light, are large enough that they can also demand and get highly favorable terms, in the form of lower prices, better service, priority delivery, and so forth. Occasionally such customers are so powerful that they may all but require an enterprise to lose money just to serve them. But extremely large customers also have prestigious names and are difficult for any company to resist.

In retailing, the giant mega-stores and category killers, such as Wal-Mart and Toys “R” Us, are very tough customers. In the high-tech field, companies that manufacture components in mature markets, such as microchips, must sell to tough customers like Dell and Hewlett-Packard. In the automotive category, almost all of the manufacturers are large, difficult to deal with, and obsessively concerned with price.

It’s important for a company to keep its perspective when serving “oppressive but necessary customers.”a In the first place, a firm can make rational decisions with respect to such relationships only if it understands its customers’ actual and potential values across the entire enterprise. But in addition, management at the enterprise should keep in mind that it really is a power struggle, so their firm must somehow develop more power for itself in the relationship. (Ironically, given all our discussion about “trust,” a tough customer will very likely trust the enterprise, but the enterprise will need to step carefully when dealing with this customer.) The goal, however, is to serve the customer’s best interests, and the enterprise won’t be able to do this if it has to give up on the relationship entirely because it has become too one-sided.

One former senior executive at Company X, a Fortune 100 technology firm, says that “[Company X] was always looked upon as the must-win account for every supplier—and we knew that well. So we routinely adopted very tough positions and made stringent demands.” According to this executive, the company’s “typical behavior” with respect to suppliers was to “work closely with that company, study them, and try to extract as much of the process and knowledge as possible, then fire the supplier and do it ourselves. Overall, being self-sufficient was always a key objective. A few companies managed to avoid this ultimate fate by continually innovating faster than we [at Company X] could absorb; so they maintained the ability to deliver new value each year.”

This is not unethical behavior on the part of a customer—far from it. It’s the policy that many large and powerful buyers follow, especially in highly competitive environments or during periods of rapid and potentially disruptive innovation. The problem, when selling to such a customer, is that it will be very difficult to increase profitability or even to maintain it. It will be nearly impossible to establish any kind of loyalty or to protect margins—but that is in fact the purpose behind the customer’s behavior in the first place. When dealing with suppliers, this kind of customer wants to use its power to hammer its costs down; and powerful firms have powerful hammers.

Sometimes an enterprise can maintain loyalty and protect its margins with tough customers by perpetually innovating new products or services, staying ahead of the customers themselves. Magna International sells automobile parts to all the world’s giant auto companies. Automotive companies are renowned for their tight-fistedness, their tough price negotiations, and their buying power. This is a brutal environment for a seller, but Magna is an innovative firm. With 238 manufacturing operations and 79 product-development, engineering, and sales centers employing 72,525 people around the world,b Magna is a large company—but it is still at a disadvantage when it comes to selling to most of its gigantic customers.

Magna set up its Magna Steyr operation specifically to cater to the most important, unmet needs of these auto giants.c As the auto business has matured, it has seen increased fluctuations in demand for particular models. The car companies themselves are often unable to cope with these demands, and a “hot” model might be sold out for months at a time. Rather than selling auto parts at arm’s length, the Magna Steyr division brings together all the capabilities required to manufacture cars, from parts to engineering, design, and production. For example, when demand for the new Mercedes M-Class SUV exceeded the capabilities of Mercedes’ Tuscaloosa assembly line in late 1998, Magna Steyr was producing additional M-Class vehicles for Daimler-Chrysler on its own assembly line in Graz, Austria, within just nine months. This kind of service can help a firm protect its margins even with the toughest customers. And as a strategic asset, Magna Steyr’s capabilities provide the company with a sustainable competitive advantage over its own competitors.

Sometimes an enterprise can deal effectively with tough customers by devising some service or offering that is customized to each customer’s own needs, or that is available only because of the enterprise’s own, larger breadth of experience or knowledge of the marketplace. In the commercial explosives business, Orica is a global company serving a large number of mining companies and quarry operators.d Quarry operators want their blasts to break rocks up into pieces of optimal size. An ineffective blast might leave the rock in chunks too large to be processed in an economically viable way. But as many as 20 different variables have to be considered when calibrating an explosive blast, and each quarry’s ability to experiment with these parameters is limited. Because of its size, and the many different mines and quarries Orica deals with, the company can collect a great deal of information from around the world, cataloging input parameters and blast results for a wide variety of situations. As a result, Orica has developed a sound understanding of blasting techniques and now offers to take charge of the entire blasting process for a customer, selling a service contract for broken rocks of a specific size. This service has two advantages for Orica’s customers.

Four principle tactics can be used to improve and maintain the value of even the toughest customers, and each of these tactics involves increasing the enterprise’s relative power, uniqueness, or indispensability in the relationship:

Management should never forget, however, that selling to a tough customer is a deliberate decision, and it’s possible sometimes that this decision will be made for the wrong reason. There are almost always choices to be made when thinking about the types of customers to serve, but often companies focus on the very large, most visible and “strategic” customers (i.e., tough customers), in the erroneous belief that simply because of their size they will be the most profitable. But, according to the ex-technology executive from Company X:

Overall, I don’t think that we at [Company X] are all that different from most category-dominant companies. These guys know they’re good and can get away with demanding just about anything. What many suppliers discover sooner or later is that despite the outward allure of serving a company like ours, once you actually win the business, the long-term payoff can be too painful to harvest. It was not unusual for a supplier to “fire” us as a customer by politely declining to bid on the next program.

aThanks to Bob Langer, Tom Spitale, Vernon Tirey, Steve Skinner, and Lorenz Esguerra for their perspectives on the issues in this section on “tough customers.” The term oppressive-but-necessary customers is from Tom Spitale.

bAvailable at: www.magna.com/magna/en/media/facts/default.aspx; accessed March 2010.

cFor more about Magna, see Mark Vandenbosch and Niraj Dawar, “Beyond Better Products: Capturing Value in Customer Interactions,” MIT Sloan Management Review 43, no. 4 (Summer 2002): 35–42.

dSee www.oricaminingservices.com, accessed March 29, 2010.

Canada Post: Using Value to Differentiate Customer Relationships

Janet LeBlanc

Principal, Janet LeBlanc & Associates

Former Director, Customer Value Management, Canada Post

Canada Post is a major contributor to the Canadian economy, generating almost $5.5 billion in gross domestic product and $9 billion in labor income. With a 150-year history of serving Canadian consumers and businesses, Canada Post is the country’s leading delivery organization, serving 32 million consumers through 6,700 post offices across the country. Every day, it delivers 40 million messages to over 14 million addresses as of 2010—a number that increases by 240,000 annually. A key driver of the Canadian economy, Canada Post’s size and scale make it a formidable presence on the Canadian landscape, recognized as one of Canada’s top 10 brands—one that Canadians trust.

Canada Post is in the business of connecting Canadians. Its 72,000 employees work around the clock to process 11 billion pieces of mail, parcels, and messages each year to every corner of our vast country. Focusing on these daily operational requirements had led Canada Post to be inward looking—cultivating an “inside-out” culture where the needs of the company were put before the customer experience. Furthermore, Canada Post had traditionally and successfully operated in an environment with very little competition. However, with emerging communication technologies and multinational courier companies, the world has become much smaller and competition for business more fierce.

Canada Post faces intense competition in all its lines of business. The exclusive privilege of collecting and delivering the mail is becoming irrelevant as businesses, which generate 90 percent of Canada Post revenues, see in electronic communications a means to significantly reduce their costs of reaching customers. The erosion of transaction mail (bills, invoices, notices, statements) is a phenomenon that Canada Post and all postal administrations around the world are coping with.

To meet these challenges, Canada Post embarked on a major transformational change with the vision to become a more modern postal service. Over the last decade, these changes have included the implementation of an enterprise resource planning system, improved process performance, development of new technologies, and, most recently, the investment in new plants and equipment. These upgrades have and will continue to positively impact its ability to serve and create value for customers.

Company executives realized that if it was to be successful in the future, it needed to turn its focus outward, building customer relationships and making customer growth a priority by building flexibility into its business and responding more quickly to evolving needs.

Canada Post embarked on a journey to bring customers to the forefront of its business. In a little more than three years, Canada Post defined what customers value most, measured and tracked weekly performance in the marketplace, and identified customer-value metrics and competitive benchmarks to maximize customer value and drive cultural change across the organization. Today, its award-winning Customer Value Management program guides business strategy, helps focus redesign efforts, and shapes employee incentives and rewards.

Canada Post wanted its Customer Value Management program to be more than just research. It needed it to be a data-driven functional model used across all lines of business to help the organization prioritize its efforts and focus resources on those customers who yield the highest value. The company needed to shift its view from market development to customer development with the goal of revenue protection and growth.

But how do you focus on individual customer development when you are mandated to provide universal service to all Canadians? And what tools can you use to rank customers according to their true value to the organization and their potential value?

The Customer Value Management program became an important tool to understand a customer’s current strength and to influence a customer’s future behavior in order to impact unrealized potential.

Canada Post surveys more than 25,000 customers each year to measure the end-to-end customer experience, including its products’ features and benefits; how the product was delivered; and the service customers received from any one of its seven channels, including contact with a telephone service agent or its Web site, through face-to-face interaction with a sales representative, or interaction with a letter carrier or delivery person. Each customer is asked to evaluate the overall experience based on his perception of quality, the overall perceived value received, and the likelihood of recommending Canada Post to a friend or colleague. These three questions comprise its Customer Value Index. Those customers who rated Canada Post a top two box rating of 9 or 10 on a 10-point scale for all three questions were viewed as loyal to the organization and were calculated as part of its Customer Value Index.

This Customer Value Index is used as a proxy variable to assess the strength of the relationship customers have with Canada Post and the potential value they could bring to the organization. Using the Customer Value Index rating, Canada Post classifies customers into a loyalty classification (see Exhibit 5C). Those customers who rated Canada Post a 9 or 10 on all three Customer Value Index questions are ranked as loyal; conversely, customers who rated Canada Post a 6 or below are considered “at risk.” Customers with variable ratings are classified as either positive or hesitant.

EXHIBIT 5C Canada Post’s Customer Value Index and Loyalty Classification

Detailed linkage analysis revealed a strong link, making it clear that loyal and positive customers contributed more revenue to Canada Post than those who were classified as hesitant or at risk. This finding was an important discovery as it helped to direct the resources and activities of the organization’s sales, marketing, and operations teams toward areas of opportunity and growth or potential risk.

Canada Post used this value and loyalty classification plan to guide the account development strategies of its sales and marketing teams. Sales strategies for customers classified as loyal and positive were focused on cross-sell and up-sell opportunities. Customer retention plans were put in place to meet the needs of customers identified as hesitant or at risk.

A closed-loop process was also created to feed sales representatives with the Customer Value Index rating and overall evaluation of the experience for each of their customers who completed a survey. Sales representatives were alerted to a new Customer Value Index rating from their customers when received, indicating those areas of opportunity and potential risk. Sales managers and sale representatives were trained to review the findings and initiate a business review with their customers to understand the required action plans and initiatives. The business objective was to strengthen the relationship to grow and protect the business.

As difficult as relationships are to strengthen, they are remarkably easy to lose. Customers who identified themselves as “at risk” by rating Canada Post a 6 or below on its three Customer Value Index questions were highly likely to defect or erode their business. A detailed analysis revealed that customers who were identified as “at risk” defected within a year and took not only one line of business revenue with them but all of their Canada Post revenue. In fact, for one line of business, more than 50 percent of customers who identified themselves as “at risk” or “hesitant” defected.

All customers were grouped into one of four categories based on current Canada Post revenue: “growth,” “lost,” “eroding,” or “new.” By using the Customer Value Index as its proxy variable, Canada Post could validate whether customers who classified themselves as loyal or positive were in fact spending more with Canada Post and had growing revenue. The results showed that for one line of business, almost 75 percent of customers who were classified in the category of “growth” were rated as loyal or positive to Canada Post. This finding was important for Canada Post because it validated the measurement proxy within its Customer Value Management program as a significant indicator of the strength of the relationship that customers had with the company.

This structured approach to managing the customer relationship has been extremely valuable to Canada Post. Many companies use loyalty data to monitor relationship health, but few consistently act on the data in order to solve identified customer problems to ensure retention. By integrating the process of using customer data to pinpoint strengths and opportunities throughout the company, Canada Post instituted an ongoing customer management strategy focused on revenue growth and retention.

When Canada Post launched its Customer Value Management program in 2003, it wanted customer value to influence strategic planning and to incorporate customer data into the annual business planning process and the identification of process improvement initiatives. The Customer Value Management program identifies the critical elements essential to making progress from the customers’ perspective, directs scarce resources, and creates alignment across the organization for those areas that matter most to customers. Its successful implementation is a major achievement, moving Canada Post closer to its goal of becoming a world-class provider of physical and electronic delivery services.