Relationship U-Turn: Approaches to Increase the Value of an Unprofitable Customer

Helmes, Kerstin

Relationship U-Turn: Approaches to Increase the Value of an Unprofitable Customer

von Kerstin Helmes (Autor:in)

BWL - Offline-Marketing und Online-Marketing

Wirtschaftswissenschaften

Zusammenfassung

Customer relationship management concentrates to a great extent on the profitable customers and how to enhance their profitability. Little insight has been given on how to treat the "wrong" customer. This literature research paper shows that customer profitability and overall firm profitability can be improved when dealing with unprofitable customers. The managerial approaches discussed focus on maintaining the customer relationship. For this reason, this paper differs from the general widespread strategy of termination or "firing" an invaluable customer.

First, relationship marketing and "Relationship U-turn" are introduced in this paper. Second, customer value and methods of measuring customer value are discussed. The body of this paper concentrates on different approaches that try to turn unprofitable customer relationships into profitable ones. Some of the approaches focus on letting the customer take over more of the value chain activities such as self-service. Other approaches look more at the non-monetary value a customer can provide such as positive word-of-mouth. Examples from business-to-business (B2B) and business-to-consumer (B2C) markets are given for each approach and discussed in detail. The paper concludes with ideas for future research and a discussion. It emphasizes that companies need to realize that every customer is an asset that contributes to the value of a firm. However, customers differ in their needs and a company has to tailor its offering to meet these needs. Only when a company takes a more customer-centric view can it be successful, especially in mature markets.

Leseprobe

Inhaltsverzeichnis

Introduction

Angel or devil? These are the types of customers the computer electronic retailer

Best Buy deals with. Best Buy's angels are the ideal customers who boost profits by

purchasing premium items like high-definition televisions without waiting for

markdowns or rebates. The devils are the store's worst customer and the company's

nightmare. They wreck economic havoc by purchasing loss-leading products and

returning merchandise. Best Buy estimates that one-fifth of its 500 million yearly

customer visits are undesirable (McWilliams, 2004). The question is what to do with

the unprofitable customer, the so called "bad egg". Most of the current literature

discusses the option of exit management, i.e. simply dissolving the relationship with

an unprofitable customer (Alajoutsijärvi, Möller, & Tähtinen, 2000; Haenlein &

Kaplan, 2009). This phenomenon of simply "firing" the unwanted customers can

also be seen in the real world. The telephone company Sprint Nextel did exactly that.

It sent letters to 1000 high-maintenance customers telling them they would no longer

be receiving service because they complained too much (Mittal, Sarkees, &

Murshed, 2008). However, what about the other option of keeping the customer on

board? From an economic standpoint it wouldn't be worthwhile to maintain the

relationship, if there wasn't a positive trade-off between the costs and benefits.

Yet, there is the possibility of reversing the relationship, "Relationship U-

Turn", and making it profitable. After all, it is cheaper to retain an existing customer

than to acquire a new one (Ryals & McDonald, 2008, p.115). The value of an

unprofitable customer can be increased, so he becomes more profitable for a firm, if

a successful marketing approach is chosen. The main focus shall be on customer

retention and less on acquisition and recovery. The paper is structured as follows:

First, relationship marketing and "Relationship U-Turn" are introduced. Second,

customer value and methods of measuring customer value are discussed. The body

of this paper concentrates on different approaches that try to turn unprofitable

customer relationships into profitable ones. Examples from business-to-business

(B2B) and business-to-consumer (B2C) markets are given for each approach and

discussed.

The paper concludes with ideas for future research and a discussion.

Relationship Marketing

In the past 10 to 15 years, the focus of marketing thinking has shifted away

from transaction marketing, which emphasized products and one-time exchanges

with customers, to relationship marketing, in order to increase a firm's profits.

Relationship marketing is a marketing approach that focuses on customer retention

and managing customer relationships over a lifetime (Godson, 2009, pp.4). The term

"relationship marketing" was first introduced by Berry (1983, p. 25) as "attracting,

maintaining and ... enhancing customer relationships" with "individual customers"

(Jackson, 1985, p.2). Building on this, the definition has been augmented by

Grönroos (1994, p. 9):

"Relationship Marketing is to identify and establish, maintain and enhance

and when necessary also to terminate relationship with customers and other

stakeholders, at a profit, so the objectives of all parties are met and that this is done

by mutual exchange and fulfillment of promises."

This definition shows relationship marketing is a process between two parties,

most prominently a customer and a firm that moves from customer acquisition to

establishing and maintaining long term relationships. Relationship marketing is

customer focused and does not just emphasize customer acquisition but retention and

recovery as well (Schnettler & Wendt, 2009, p.33). The customer-centric approach of

relationship marketing is interacting with customers, valuing them as assets and

serving them to their satisfaction (Rust, Moorman, & Bhalla, 2010). The relationship

with the customer evolves over a lifetime, which has lead to the establishment of a

customer life cycle. The customer life cycle is understood as a series of transactions

between a firm and a customer over the entire time period the customer remains with

a firm. It varies from customer to customer and in duration length, depending on the

type of business (Jain & Singh, 2002).

Relationship marketing originated in industrial marketing (Jackson, 1985) and

service marketing (Berry, 1983) because here taking care of customers and

interacting with them is important for success. Due to a restriction in partner choice,

firms concentrated more on cooperation, in order to reduce risks and increase

satisfaction (Turnbull, Ford, & Cunningham, 1996).

In B2B markets relationships are close, last for a considerable amount of time

and have significant value to both parties involved. Industrial companies in business-

to-business markets have few and large customers. The importance of the

relationship for the buyer is due to high switching costs and lack of alternatives. The

relationship becomes intimate for the supplier because each customer can generate a

substantial amount of profit and needs careful attention. Customers need careful

handling because they can make demands that cut margins, knowing that the supplier

is under intense pressure to maintain a relationship with them (Gruen, 1995).

Therefore, customer profitability and maintaining a relationship is crucial for the

success of an industrial company.

In the 1990's business-to-consumer markets also adopted the idea of

building relationships (Gummesson, 2004). Business-to-consumer markets (B2C)

are marked by many customers that lead to the success of a firm, so firms are less

dependent on one single customer. The customer can more easily switch companies

then in B2B markets as alternative options are available. Business-to-consumer

relationships are less intimate and complex than business-to-business ones, but trust

and customer satisfaction are important to maintain a relationship (Gruen, 1995).

Even though the two market types differ, both now focus on sustaining relationships.

The importance of long-term relationships has been described by Reichheld

(1996, p. 39) who lists six different economic benefits for a company, namely:

saving acquisition costs, guaranteed base profits, increased growth in revenue per

customer, reduction in operating costs, price premiums from customers and free

customer referrals.

2.1

Customer Relationship Management (CRM)

Customer relationship management has its roots in relationship marketing. The

bases are relationship orientation, customer retention and achieving a high customer

value created through process management (Ryals & Knox, 2001). CRM is defined

as the "values and strategies of relationship marketing - with particular emphasis on

customer relationships - turned into practical application" (Gummesson, 2002, p.3).

Hereby IT is one key element. A data warehouse, where information about customers

is stored, enables retailers to collect data, learn about their customers and tailor future

marketing initiatives (Gummesson, 2004).

Thanks to technology, customer management has become an easier task. A

company can now assess a customer's profitability on an individual level (Ryals &

Knox, 2001). Many service companies such as airlines, telecommunication

companies and financial institutions use customer relationship management software

to increase the lifetime value of a customer "by matching products and levels of

service more closely to a customer's expectations" (Peppard, 2000, p.321).

Usually, the usage of CRM systems has lead to firms "cherry-picking only

profitable customers" (Niraj, Gupta, & Narasimhan, 2001, p.15) and concentrating

all their marketing efforts on the most valuable customers. The emphasis has been

on maintaining long-term relationships with these customers. Companies treat

valuable customers like royalty or the cream of the crop and go to great lengths to

retain them. Take for example the airline company Lufthansa. In 2004 travelers, who

collected 600,000 frequent flyer miles over the course of the last two years could join

the HON circle program. These clients enjoy perks such as limousine pick up,

guaranteed booking, and check-in at special first class terminals (Haenlein & Kaplan,

2009).

However, only a small minority of customers are truly profitable. A well

known fact, the Pareto Principle, states that 20 % of the customers are responsible

for 80% of the sales revenue (Schnettler & Wendt, 2009, p.34). Companies in both

B2B and B2C markets have a large base of so called "unprofitable customers". A

company's client is unprofitable if he possess a "negative contribution margin"

which is the generated revenue minus the direct costs and cost-to-serve (Haenlein &

Kaplan, 2009, p.90). This means that an unprofitable customer costs more than he is

worth. A survey conducted in the German mechanical engineering sector showed

that about one fifth of the companies possess a customer portfolio in which more

than half of their customer are unprofitable (Helm, Rolfes, & Günter, 2006). In a

business-to-consumer setting, a German retail bank identified 26.8% of its customers

to be unprofitable (Haenlein, Kaplan, & Beeser, 2007). Yet, management of

unprofitable customers has mainly been reduced to "demarketing" (Kotler & Levy,

1971, p.74) or termination of the relationship (Helm, Rolfes, & Günter, 2006).

Many authors suggest termination as "the way" to deal with unprofitable

customers (Kotler & Levy, 1971; Zeithaml, Rust, & Lemon, 2001). Termination is

when a company severs ties to a customer. The seller no longer wants to engage in

business with a certain customer because he no longer sees a value in continuing the

relationship (Buttle, 2009, pp.28). It can make sense not to keep customers who don't

pay bills on time, or who constantly call the service hotline. The same would be

industrial firms who change their mind on quantity or quality of deliveries (Zeithaml,

Rust, & Lemon, 2001). Zeithaml and co-authors (2001) see firing customers as a

possibility to increase profitability because a company no longer has to use their

resources to serve these customers and instead can employ them more effectively.

2.1.1

Relationship U-Turn

A "U-Turn" is to reverse things said or done in order to achieve a different

outcome. Relationship U-Turn shall be defined as follows: Managing the relationship

with an unprofitable customer by finding approaches to extract value. The objective

is to bring the scale of profitability back into balance and have the customer

contribute to a firm's profit.

In times of globalization and fierce competition customers are scarce and

every customer becomes an intangible asset that should be valued and managed to

improve firm profitability (Gupta, Lehmann, & Stuart, 2004). Considering

customers as an asset entails that companies should not only focus on the profitable

customers but also try to manage the invaluable customer relationships as well.

These customers have the potential of becoming profitable in the future (Sherrell &

Collier, 2008).

Also maintaining a relationship with an unprofitable customer can create

profit for the firm. Research conducted by Reichheld and Sasser (1990) show a 25 to

85% increase in a company's profit due to a 5% decrease in customer defection.

Also Gupta & Lehmann (2004) come to the conclusion that improving the customer

retention rate by 1% improves the firm's value by 5%. Increasing profits can be

achieved by noticing that different customer segments have different responses to

marketing efforts. The key is not to treat all the customers in the same manner but to

customize offerings and find ways to match the costs to the revenues in order to meet

the needs of the customer (Zeithaml, Rust, & Lemon, 2001).

The problem is companies have not established a systematic approach on the

operational level for dealing with unprofitable customers. At best, managers use

intuition and guidelines to try and turn the relationship around and only 20% of the

managers have taken approaches to dealing with these customers (Helm, Rolfes, &

Günter, 2006). In order to implement managerial approaches effectively, the seller

needs to know which customer relationship creates the most profit. Valuing a

relationship involves collecting data of customer behavior and analyzing it (Ryals,

2002). In the next chapter customer value is defined and two

methods on how to

measure customer value are discussed.

2.2

Customer Valuation

Customers are seen as assets because a firm derives value from a customer

(Gupta, Lehmann, & Stuart, 2004). In the English literature a host of different terms

are used to describe the value of a customer or customer profitability as perceived by

a firm such as: "customer value" (Sherrell & Collier, 2008, p.40), "value of the

customer" (Gupta, Lehmann, & Stuart, 2004, p.7) or "customer lifetime value"

(Mulhern, 1999, p.26).

In general the value of a customer is seen as the as the monetary and non-

monetary value a customer supplies to the firm in order for the company to achieve

its goals (Cornelsen 2000, p.38). The monetary aspect or economic values, such as

the contribution margin or customer lifetime value, are factors that can be measured.

However, a customer can also provide non-monetary value or "relationship value" in

the form of referrals or be a source of information for the company. These factors are

more difficult to calculate (Ryals, 2002, p.248).

In this paper the terms customer value as well as customer lifetime value and

customer profitability shall be used to mean the value of a relationship from a firm's

perspective. Also, the term "customer equity" is used in this context which is the

"sum of the lifetime values of all customers" (Rust, Moorman, & Bhalla, 2010, p.7).

This metric represents the value of the entire customer base and not just the worth of

one individual customer. It is a good indicator of firm value and therefore underlines

the importance of customer-orientation and cultivating customers (Rust, Moorman,

& Bhalla, 2010).

The customer-focused marketing approach concentrates on customer value or

customer profitability instead of product profitability. The three major drivers of

customer profitability are: customer acquisition, customer margin and customer

retention. Customer acquisition (acquisition rate and costs) deals with choosing

profitable customers for the firm and increasing the number of customers. Customer

margin (dollar margin and growth) centers on augmenting the profit from existing

customers and customer retention (retention rate and cost) is focused on keeping

customers (Gupta & Lehmann, 2005, pp. 48).

As research has shown that some customers are more profitable than others,

the importance of calculating the value of a customer has emerged (Reinartz &

Kumar, 2003). There are four main methods to measure in what way a customer

contributes to a firm's profits (Lind & Strömsten, 2006). In this paper, two methods

to assess customer profitability will be discussed: customer profitability analysis

(CPA) and customer lifetime value (CLV) calculation.

2.2.1

Customer Profitability Analysis

Customer profitability analysis (CPA) which focuses more on the customer

than the former product orientated ABC analysis is the method used to analyze

historic customer profitability (Boyce, 2000). It measures a customer's contributions

to a firm which is the "difference between the revenues earned and the costs

associated with the customer relationship during a specific period" (Conroy, Haskins,

& Pfeifer, 2005, p.7). Studies revealed that companies have many unprofitable

customers (Kaplan & Narayanan, 2001) because they fail to notice that customers

differ in the costs they cause (Raaij, Vernooij, & Triest, 2003). These costs, also

referred to as "cost-to-serve", are defined as "all costs of the administrative

commercial and logistic activities related to customer service-delivery" and are

linked to customer profitability (Guerreiro, Bio, & Merschmann, 2008, p.392).

Customers can be high-cost-to-serve or low-cost-to-serve. Profitable customers are

low-cost-to serve and unprofitable customers are the ones with high service costs

(Kaplan & Narayanan, 2001). The behavior each customer type exhibits can be seen

in Table 2.1.

Table 2.1

High and low cost-to-serve behavior. (Kaplan & Cooper, 1998, p.98)

High-Cost-to-Serve Customers

Low-Cost-to-Serve Customers

Order custom Products

Order standard products

Order small quantities

Order large quantities

Unpredictable order arrivals

Predictable order arrivals

Customized delivery

Standard delivery

Frequent changes in delivery requirements

No changes in delivery requirements

Manual processing

Electronic processing (i.e. Zero

defects)

Large amount of presales support

Little to no presales support

(i.e. Marketing, technical and sales

resources)

(i.e. Standard pricing and ordering)

Large amount of postsales support

No postsales support

(i.e. installations, training, warranty)

Require company to hold inventory

Replenish as produced

Pay slowly

Pay on time

To determine customer-specific costs a financial tool known as activity-based

costing (ABC) is used. Activity-based costing looks at the costs of an activity and

how much time is spent supporting a customer with this activity. Managers are then

able to understand which customers demand what activities and how much it costs to

serve them (Ryals, 2002). The outcome of the measurement can be represented is the

whale curve of customer profitability (Kaplan & Narayanan, 2001).

Figure 2.1

The Whale Curve of Cumulative Profitability.

(Hutt & Speh, 2006, p. 97)

The whale curve, depicted in Figure 2.1, is a graph of cumulative customer

profitability. The x-axis shows the cumulative percentage of customers and the y-

axis the percentage of total customer profit. The customers are sorted in decreasing

order of profitability. The whale curve shows that one-fifth of the customers generate

between 150 to 300 percent of the total profits. These 20 percent of all customers are

a company's most profitable. The middle 70 percent break even and the least

profitable, the bottom 10 percent, cause losses from 50 to 200% of total profits

(Kaplan & Narayanan, 2001).

Distributing costs to customers though activity based costing highlights the

point that not all customers contribute equally and that unprofitable customers have a

big impact on a customer's profits. A company studied, showed that a customer can

generate losses up to two and a-half times the sales revenue (Niraj, Gupta, &

Narasimhan, 2001). Interesting to note is also that large customers can be very

unprofitable because small customers do not make high volume purchases that would

lead to large losses (Kaplan & Narayanan, 2001). Single-period customer

profitability analysis is a good way to measure the current and historic revenues and

costs of different customers. However, it doesn't take into account the future

potential of a customer relationship. To be able to estimate future costs and revenue,

customer lifetime value, the retrospective CPA analysis is important and a first step

(Raaij, Vernooij, & Triest, 2003).

2.2.2

Customer Lifetime Value Analysis

The individual prospective approach is customer valuation analysis which

calculates customer lifetime value (CLV) (Lind & Strömsten, 2006). Customer

Lifetime Value (CLV) is defined as the "present value of the future cash flows

attributed to the customer relationship" (Conroy, Haskins, & Pfeifer, 2005, p.10).

The CLV framework is a tool for measuring profitability that looks at all the costs

and benefits over the life span of a customer, including his future potential (Reinartz

& Kumar, 2003). The future potential of a customer is a combination of forecasted

revenue, expected lifetime and favorable behavior regarding service costs (Niraj,

Gupta, & Narasimhan, 2001).

The CLV framework incorporates three basic factors. They are current as well

as future profits (contribution margin), the time value of money which means that

$100 of profits today are worth more than the same amount of profit tomorrow, the

possibility that the customer may leave the business and so terminate the

relationship. The latter is also called retention or defection rate and is how long the

customer will stay with the firm (Gupta & Lehmann, 2005, pp.15). Measuring CLV

is more align with the idea of relationship marketing as it emphasizes that a

customer's value must be measured over a lifetime. However for most applications it

is about three to five years. This time span is as far forward as a relationship can be

projected (Ryals & McDonald, 2008, p.127). Customer lifecycle as well as product

lifecycle and an 80% of profits can be accounted for in this time period (Kumar &

Rajan, 2009).

The CLV analysis differs from other measuring techniques like CPA because it

doesn't use accounting based profits, but projects costs and revenues into the future

and uses "discounted cash flow analysis to derive at a net present value" (Boyce,

2000, p.652). In other words this calculation is based on expected purchases of a

customer and adjusted back to the present day with the help of a discount rate. An

example of calculating CLV is shown in Table 2.2 (without considering the retention

rate).

Table 2.2

Calculating customer lifetime value. Source: (Ryals, 2002, p.245)

t + 1

t + 2

t + 3

t + 4

Customer Profit

$100

Discount Rate

(%)

Discount Factor

0.91

0.83

0.75

0.68

Present Value

$91

$83

$75

$68

CLTV

$317

As Table 2.2 shows the customer is worth $317 today, because it is expected

that he will contribute $100 each year over the next 4 years with a discount rate of

10%. It also demonstrates that the value of a relationship can be enlarged by

increasing profit (increase in revenue or decrease in cost-to-serve) or by extending

the length of the relationship with a customer (Ryals, 2002).

CLV analysis is a complex way of figuring out if a customer provides value

or is profitable to a company. It is seen as the "best metric used to measure customer

profitability" (Kumar & Rajan, 2009, p.2). The CLV framework is mostly used in

B2C markets (Cokins, 2004, p.15). Using the CLV calculation companies have a tool

to measure the future value of a customer and emphasizes the customer relationship

(Gupta, Lehmann, & Stuart, 2004). Kumar et. al (2009) suggest that the CLV of a

customer should be calculated before making other marketing decisions. After

segmenting customers according to their CLV - low, medium, high - appropriate

marketing approaches can be selected. Knowing the customer lifetime value lets

companies make informed marketing decisions. They can decide about product and

service developments and where and how to use their resources in the most efficient

and effective manner (Mulhern, 1999).

In B2B markets it is sometimes sufficient to simply use CPA analysis because

relationships are less volatile than in B2C markets, which means less customer

churn. Therefore past profitability is often, much the same as future profitability, so

CPA is sufficient for decision making (Cokins, 2004, p.15).

Details

Seiten
Erscheinungsform: Erstausgabe
Erscheinungsjahr: 2010
ISBN (PDF): 9783863415594
ISBN (Paperback): 9783863410599
Dateigröße: 674 KB
Sprache: Deutsch
Institution / Hochschule: Freie Universität Berlin
Erscheinungsdatum: 2011 (Juli)
Note: 1,7
Schlagworte: Customer Relationship Management Marketing Unprofitable Customer Value Approach
Produktsicherheit: BACHELOR + MASTER Publishing

Autor

Kerstin Helmes (Autor:in)

Kerstin Helmes was born in 1987 in Lexington, Kentucky. She grew up bilingually, speaking German and English, and later moved to Berlin, Germany. Here, she began her business studies at the Freie Universität. After a year abroad she recieved her Bachelor’s of Science in Business Administration. During her studies Kerstin obtained practical work experience through various internships at Manpower Engineering, an NH Hotel and a hospital. She also worked for the Kentucky Education Television Network. All of these experiences taught her about companies and their customers which motivated her to write this paper. Presently, she is doing her Masters in Munich.