Managing Customer Profitability: Determine Which Customers Are Most Valuable to Your Organization

[ILLUSTRATION OMITTED] EXECUTIVE SUMMARY * The customer value management cycle presents a comprehensive model for measuring and managing customer value--it has five recurring steps. * Step 1: Manage Customer Segmentation. Customer segmentation refers to the process of dividing customers into groups for decision-making purposes. Segments should correlate to behaviors that drive customer profitability. * Step 2: Measure Customer Segment Margins. At a minimum, companies should measure revenue and gross profit by each customer segment. Allocating sales, marketing and customer service costs brings this analysis to the next level. * Step 3: Measure Customer Lifetime Value. The lifetime value of the customer reflects the present value of all expected future flows associated with the customer. * Step 4: Measure Customer Impact. Two critical sources of hidden customer value are customer influence and customer knowledge. Customer influence refers to the influence the customer has, either through intentional action or passive behavior, on other customers, on employees, or on other stakeholders of the firm. Customer knowledge refers to the actionable knowledge that can be gained by the company, either through analysis of customer behavior or through direct customer input. * Step 5: Manage Customer Profitability. All of the information derived from the measurement of customer value should be analyzed, and actionable tidbits should be derived. This goes far beyond simple reporting of which segments have been more or leas profitable. Innovative segmentation and interpretation of the results can uncover areas where small improvements can yield big improvements in value. All people may be created equal, but the same can t be said for customers. Everyone knows that some customers are more profitable than others. Conversely, some are downright unprofitable. Knowing which is which is the all-important question. Despite enormous variations in profitability, many companies continue unprofitable relationships with customers, often providing them with pricing and service levels identical to those received by the most profitable ones. Why? In most cases, companies simply do not know who the unprofitable customers are. As such, they cannot develop marketing strategies or manage costs accordingly. Companies don't necessarily need a state-of-the-art database or analytics technology to improve customer profitability. Rather, they can follow a comprehensive approach for measuring and managing customer value called the customer value management cycle (see Exhibit 1). Because of their unique qualifications and abilities, financial managers should take the lead in translating analysis to action and creating the culture of value. The customer value management cycle has five recurring steps. To demonstrate the concepts throughout this article, the customer value management cycle is applied to a fictitious company called Sagu Systems. A brief description of Sagu Systems is as follows: Sagu is a software company located in Chicago. Its primary product, SaguNetwork, is performance monitoring software for corporate networks. Sagu currently sells SaguNetwork and related consulting services to clients. The market for performance management software is expanding rapidly, and Sagu is pursuing an aggressive growth strategy. In an effort to maintain profitability through the growth period, the board of directors has mandated that Sagu analyze the profitability of its customers* STEP 1: MANAGE CUSTOMER SEGMENTATION Customer segmentation refers to the process of dividing customers into groups for decision-making purposes. Segmentation allows the company to provide differential advertising or value propositions to different customer groups. Segments are often determined on the basis of customer similarities, such as personal characteristics, preferences or behaviors. …