7/24/2015

Computing the true value of a customer | Business Line

Computing the true value of a customer

Makrand Jadhav
Who is your valuable customer?

Getting it right There are a number of methods to determine the worth of your customer PathDoc/shutterstock.com

Most organisations will answer this question in revenue terms. A retailer will most likely say its the one who spends
the most money with him in a calendar year. A telecom service provider would say its one with the highest ARPU
(average revenue per user), a bank may say its one with the highest AQB (average quarterly balance) or two-three
active accounts, and an airline may say its one with the highest frequent flyer miles in its account. All very valid.
Lets examine some other techniques used to determine the most valuable customer. One of the largest banks in
Canada decided to approach this question rather differently: Can I determine how much profit each customer is
contributing? Needless to say, not a very straightforward or easy task. On the contrary, quite data-intensive and
laborious to begin with. After a lot of discussion and deliberation it adopted the following approach to measure
customer profitability:
Customer profit = Net Interest Revenue + Other Revenue (Direct costs + Indirect costs) (Risk provision)
Obviously it first had to start with unique customer identification and associating multiple accounts with a single
customer. It then applied the above to each piece of the customer-level information. What came out was a true
measure of a customers value to the bank. It then chose to run this across its over-four million customer base. So even
if you are a customer with a moderate AQB but transact less and mostly through electronic channels, you may be
more valuable compared to a high AQB customer but one who soaks a lot of RM time. This approach formed the basis
of its customer communication/promotion programme resulting in $7.5 million in incremental revenue and 15 per
cent increase in high value customer volume.
Life times worth
Another measure deployed is Customer Life Time Value (LTV). Here the organisation tries to estimate the potential
earnings that it may accrue from a customer based on the length of his stay with the organisation and his potential to
buy more of its products over time. In insurance parlance it will use a formula like:
Customer Life Time Value = Value from current policies (Premium value of current policies + Expected tenure of
current policies) + Value from future policies (Probability of repeat purchase + Expected value of future policies +
Expected tenure of future policies)
This requires statistical capability to determine the units for the Expected parameters, and relevant historical data
(payment history, product holdings, channel of acquisition, product category, etc.) to develop it. Such an approach is
also common with banks, and telecommunication companies.
Another common measure used, especially in retail and e-comm is RFM - Recency, Frequency, and Monetary value. In
this case, the recency of customer visits/transactions is measured/classified over a certain period of time
(week/month/quarter), i.e., when was the last transaction done one week prior, one month prior or two months
prior? Next, the Frequency is calculated. Heavy is anyone who does 10+ transactions in the period, Frequent (7-10
transactions), Moderate (3-6 transactions), Limited (1-3 transactions). As for monetary value, if the value per
transaction is Rs
.
1,000-1,500 the customer could be classified as Low, someone spending Rs
.
1,500-2,500 could be
Medium and Rs
.
2,500+ would be High. This will give 36 classifications where each customer can be plotted. As a final
measure each customer could be classified as VIP (High in monetary value, Heavy in frequency and with the most
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7/24/2015

Computing the true value of a customer | Business Line

recent transaction not more than the last week) or Dormant (Low in value, Limited in transactions, and a dated last
transaction), and treated accordingly.
A holistic measure
A more simplistic approach is the one similar to the one I described in my previous column on Distribution
composite score (see cat.a.lyst edition dated July 10). Identify the top characteristics you want your customer to
display revenue, complaints, payments, tenure, number of visits/transaction, value per transaction, profit, channel,
number of products ... the list can be endless. Then weight each of them as per your business objectives. Apply it to
your customer base. What you will get will be a composite measure/score for each customer ranked on the
parameters identified by you. You may change the parameters or weights on a periodic basis to reflect the business
priorities and the score will reflect the same.
As industries move from an acquisition phase to more mature and competitive phases (read telecom, developed
economies) organisations will have to decide which customers to focus on. The above measures can assist in
delivering custom treatments based on the customers overall value to the organisation, via the channel of his
preference. Engaging with the valuable customers is deeper, relevant, and timely. Needless to say, it leads to better
wallet and market share.
As industries move from an acquisition phase to more mature phases, organisations will have to
decide which customers to focus on.
(This article was published in the Business Line print edition dated July 24, 2015)

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