The following blog item is an edited excerpt from my book, The Loyalty Leap.
It is a business practice so long-standing it is practically a cliché. Companies fall all over themselves to woo new customers, but once they get them, they have no idea how to make them profitable.
Sure, a customer can be acquired, but how do companies ensure that investment yields a return? All that work should guarantee some form of long-term dividends, and not only when there is a quarterly blowout sale.
Many marketers aspire to creating relationships between their company and customers that are like those of good neighbors, but the bottom line has to factor in somewhere. Every profitable company keeps an eye on business results, and that should include customer management and lifetime value, as that really connects with the mission of chief financial officer.
Yet customer equity is rarely considered in corporate financial analyses, and there are no established accounting standards for customer management. This may change as loyalty and data-driven marketing become increasingly prevalent, but marketers have a long way to go in this area of measurement. There are some reference points, however.
Customer experience experts Don Peppers and Martha Rogers, for example, established a measure called the Return on Customer, which comes down to a simple equation: “The sum of lifetime values of customers at the end of a period, plus profits delivered during the period, divided by the sum of lifetime values of customers at the beginning of the period.”
There is also Fred Reichheld’s Net Promoter Score (NPS) on the likelihood of customer recommendations. However, while NPS is a great tool, there is the one drawback that it does not focus on risk. And the risk of loss is great. In his book The Loyalty Effect, Reichheld reports half of the customers of most companies change over in five years. Half! That is a staggering loss on an asset that was expensive to acquire in the first place.
So ask: How happy would shareholders be if the cost of customer acquisition was not paying a dividend? Companies routinely fund capital investments in technologies that are amortized over a number of years. It makes sense that investments in the customer asset should be measured as well. The efforts a company makes to meaningfully connect with customers and create enduring, value-based relationships has a direct bearing on the bottom line.
The notion of customer lifetime value and relationship building is neither too lofty nor imprecise for shareholders to rally behind. The short-term profitability of the greatest companies is dependent upon the long-term value of their most valuable assets: their customers. These companies measure a customer’s worth not by a few transactions but over her lifetime, by multiplying the annual sales she is expected to generate by the number of years she is projected to shop with the company.
Once the value equation is fine-tuned so future profits can be correlated with a customer’s predicted lifetime spending, then customer relationships can be proven to contribute to company growth.