The marketing industry has significantly changed from what it was just 10 years ago. Social media and multi-channel service has given customers the chance to interact with companies like never before. These interactions often reshape existing products and heavily influence new ones. For this reason, companies have had to learn to focus less on brand profitability and more on individual customer profitability.
The 80/20 rule, of course, states 80 percent of a company’s income comes from 20 percent of its customers. The marketing team’s job, then, is to nurture the most profitable customer relationships. Instead of blitzing media outlets, marketers have to prioritize individual customer interactions. Both present-day marketers and future marketers studying in today’s universities (click here to learn about strategic communications graduate degrees) have to learn how to maximize profit by carefully segmenting customer communications. Also, managers have to learn to do business in a way that portions employee time and customer expense in the most profitable manner.
What Is Customer Profitability?
Every business knows some customers spend a great deal of money while demanding very little in terms of expenditures like discounting, individualized customer service and sales returns. At the other end of the spectrum, some customers demand a great deal expenditure-wise while spending very little. Conventional wisdom has dictated to treat every customer the same way, but businesses are figuring out that strategy doesn’t maximize profits.
Profit maximization starts with customer segmentation. Companies have to predict how different types of customers will respond to promotions or to the business cycle itself; for example, forecasting purchasing behavior in response to discounts or seasonality. Then, they have to look at what the company pays to nurture each customer. The difference between customer purchases and customer cost determines customer margin.
How Is Customer Profitability Measured?
Thanks to big data and analytics tools, segmentation has become easier than ever. Most companies start by grouping customers according to characteristics, behaviors or preferences. Over time, they learn which criteria yield the most profitability for the company, and segment accordingly.
After dividing customers into segments, companies should figure out the costs of customers in each segment. For example, customer segment demands certain marketing, customer service, sales and collections costs. The Journal of Accountancy recommends looking at the highest cost-line items and determining whether the company gains from the way it is currently allocating these costs across its customer segments. In other words, if one customer segment purchases little and requires heavy discounting, then the company may not profit from the cost of doing business with that segment.
Customer Lifetime Value (CLV) and Impact
In addition to examining customer profitability over a set time period, businesses have to think of customers as assets. To value those assets, companies have to figure out the present value of a customer’s potential lifetime profit margin. Most new customers start with lower profit margins. Then, margins rise as customer relationships mature because customers spend more while costing the company less. Companies may discover customers who start with small purchases but whose purchases increase over time may be more profitable than a customer that makes a single large purchase, but doesn’t continue making large purchases over the long term.
Additionally, customers can provide financial value to a company through more than their purchases. They can also deliver value via their influence and knowledge. Influence measures how much one customer segment affects the behavior of other segments. A big influencer may not be a big spender, but that influencer may be crucial for recruiting new customers who may become big spenders. Knowledge is how much actionable information the company gets from the customer segment, whether from customer input or data analysis.
The Ultimate Result
The best customer analysis unveils ways that company behavioral changes can influence profits. For example, low retention in one segment could be changed by increased customer service communication toward that segment. Also, profitability may be increased in another segment by changing sales staff compensation to reward profitability instead of revenue. Ultimately, selling the most “stuff” isn’t the true path to revenue growth. Producing profitable customer relationships builds a solid growth structure that can last for years.
Handshaking image by David Castillo Domenici from FreeDigitalPhotos.net
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