Defining Customer Valuation by mThink, May 23, 2005 Most utilities view their interactions with customers mainly monthly billing and payment as highly routine, with neither party giving a second thought to the value at stake in the relationship. Deregulation and new service offerings increased the opportunities for utilities to enhance their performance by determining customer valuations and using them for strategy development and operations. Customer valuation is defined as the analytical process of increasing knowledge of customers, at a segment or even individual/household level, in order to determine and improve the value of customer relationships, interactions with customers or corporate programs. Customer valuation can utilize any attribute of current or potential customers necessary to meet strategic objectives. Consider a brief litmus test to determine if customer valuation may enhance performance: Has an initiative fallen short of its objectives because of a poor understanding of how customers would respond? Have executives held back from investing in a strategy or project because of uncertainty about what the take rate, marketing cost per customer or revenue per customer would be? Could the strategy have been more successful if it had first been piloted, with hypotheses on customer values and preferences then validated? Customer valuation can aid in strategy development and execution by helping utilities understand customer preferences in detail, and how their actions drive performance at an individual customer or household level. Customer preferences might include receptiveness to certain offers, bill payment and energy conservation habits, or power reliability demands. Opportunities for Using Customer Valuation In the utility industry of the next several years, there are three opportunities for utilities to apply knowledge of customer value: improving customer acquisition and retention; optimizing customer service quality while reducing costs; and enhancing the valuations of projects, such as infrastructure changes, that impact customers. Although retail competition has remained dormant for residential customers, acquisition and retention capabilities are still important for any utility that sells value-added services such as warranty services, or whose larger customers have choice. For warranty services, utilities can use customer valuation to determine: Which customers are likely to respond to an offer and be profitable? Which offers attributes (e.g., annual versus monthly pricing, rebates on new appliances), messages (safety, cost advantages) and touchpoints (e.g., direct mail, email, billing message, combination) will elicit the best response or conversion rates? What is most important to the target customer? Does warranty usage increase renewal rates? Which customers have excessive warranty usage (e.g., are not profitable)? Amid increasing regulatory pressure, and an expanding set of customer relationship management capabilities, customer valuation can be a tool to improve on the dual goals of increasing service quality and reducing costs while limiting the constraints they place on each other. Asking and answering the right questions about customer needs and preferences can provide direction for which capabilities different customers will use or are using (especially the most valuable customers), and how investments should be prioritized. For example, many customers follow seasonal patterns of high-bill complaints or nonpayment that significantly increase utilities cost to serve. Identifying and proactively approaching the right customers to offer level payment plans or access to energy assistance programs such as LIHEAP can increase customer valuations through cost avoidance. Advancing changes in meters, sensors, software and analytical capabilities for distribution networks allow utilities to create intelligent networks with sophisticated performance management capabilities down to the neighborhood or even customer premises level. But this intelligence requires knowledge of what the performance should be, and for which neighborhoods or premises. Accurate customer valuation and knowledge of customers specific needs and preferences is critical input into the planning process for intelligent networks, as well as other infrastructure projects requiring choices about customer-impacting performance. Utility Experience With Customer Valuation Utility companies use a variety of approaches to understand the value of customers. In the regulated environment, customers are commonly viewed through a meter-centric lens that connects them to the company through their meter. Any resulting segmentation is product-based as determined by which product an account uses and the quantity and patterns of use. These segments have been used to target programs or offers and to establish rates, making them very similar to the customers rate classification. In moving toward an environment with more choice, many utilities have developed profile-based segments to reach customers by examining other aspects of the relationship, including buying habits, demographic profiles, industry, service preferences and the like. This involves building a profile of an attractive customer for a given expansion strategy or program. One of the biggest challenges often is to segment current customers by profile, and using that designation to determine customer values and drive specific actions. These profile-based approaches employ a more complete understanding of the customer, but most utilities have limited their use to specific programs or expansion strategies, with segment maintenance or updates. In the broader view of customer valuation, it often is best to incorporate a mix of product-based segmentation, profile-based segmentation and other customer valuation concepts as required. One approach does not fit all situations and there are myriad ways to leverage data sources, data manipulation techniques and marketing and analytical tools. The types of decisions required and the variability of the product or service being offered (e.g., offer content, components, price, terms) influence choosing a segmentation approach. Project decisions that are largely financial (e.g., driven by project NPV or ROI) will depend more on product-based valuation and have more static customer data needs. Decisions on marketing campaigns or customer service initiatives, managed over time, will be driven more by profile-based valuation with more complex data needs (e.g., update frequency, data volumes). Reaching the most attractive prospects with the right offer, message or change in performance is the key. An Approach for Valuing Customers We posit that utilities can increase profitability by more carefully considering customer value during the planning process. Improved decision-making for spending scarce resources can have significant impacts on growth, risk and profitability. The right method for determining customer value depends on a utilitys business rationale and strategy for using customer value real-time updates on customer website usage would be inappropriate for customer valuation to aid infrastructure planning, for example. We found that the successful development and use of any customer valuation capability is based on a simple, four-step approach. Customer Valuation Approach Step 1: Set the Strategy This most critical step in the process requires that stakeholders are clear and agree about the strategic drivers for customer valuation, be it for marketing campaigns or prioritizing capital investment options. The challenge is to clearly articulate which of these drivers are most important at any given time. Setting the strategy is the responsibility of senior management and requires the involvement of operations, customer service, marketing and finance. A simple rule is to involve senior managers from every area touched by the driver(s) and potential uses of the customer valuation being developed. The senior management team establishes and communicates commitment across all relevant areas, steers the project and stays closely involved through key team members. Customer valuation goals should be simple, measurable, have clear linkages between business strategy and expected results, and they may build on each other over time. A project charter can answer the full range of questions, including: What are we doing? Why are we doing it? How will we use the information? How much time and funding do we have? How will we measure success? We needed people who were familiar with the financial systems of the company so we could get to the data we had. We were fortunate we had a good financial director who was deeply interested in the project. Because she was responsible for consolidation of our annual operating budgets, her operating insights were indispensable. Sandy Bean, Marketing Director, Alabama Gas Corp. The asset evaluation provides a realistic look at the available information and skills within the company to get the job done. Many utilities underestimate how much customer information they have, but overestimate the difficulty of bringing this information into a usable, scalable format. The most readily available data energy usage, payment history and usage patterns for large customers will support only product-based segmentation, which is not customer valuation, but is the extent of what most utility companies do for segmentation. A profile-based segmentation requires a combination of demographic, aggregate behavioral patterns and psychographic information. (Demographics consist of basic personal information like age, marital status, and gender and are the most basic type of profile data. Behavioral data focuses on buying habits, preferences for newspapers over TV, etc. Psychographics depict consumers beliefs and interests in areas like musical tastes and political opinions.) And interpreting this information often requires a skill set not readily available in the utility business. Step 2: Design the Approach In this step, a designated project team develops the valuation hypotheses and plan details. This team should represent all stakeholder areas identified in Step 1, and it should also include financial analysis and IT support. It is up to this team to convert the team charter into an executable plan and to provide the sponsors with detailed information about how they will proceed. In a customer valuation project, often the information is difficult to retrieve in a usable format. We suggest that teams start with clearly stated hypotheses that they hope the data will answer. Combining hypotheses and business knowledge with IT and process expertise can aid in designing the overall approach, clarifying data needs and maintaining a manageable flow of data for analysis. It also helps to provide continuity for the employees who will be implementing and using customer valuation tools. If information is needed from an external vendor, define as specifically as possible the information or service needed and what you plan to do with it once you get it (think about proving or disproving hypotheses, as you did with your own data). Specificity often allows vendors to suggest helpful and often less expensive alternatives. Then define what the valuation output will look like. Examples include: expected customer lifetime values of all customers in a segment, relative value of every current customer, or a listing of target customers. Each of these deliverables requires a very different level of preparation and analysis. Design the approach to fit the defined deliverable, while also supporting continuity and usefulness for subsequent projects. Make sure the executive sponsors understand this output beforehand, particularly if it was not fully defined in the team charter. Step 3: Perform the Valuation This step involves execution of the approach from Step 2. Success in this step depends on an ability to support or disprove the teams hypotheses with flawless, fact-based logic. Start with the initial hypotheses that drove the data requirements developed in Step 2. Conduct the analysis by rigorously applying the valuation approach. Then refine and test your valuation conclusions within the team and with other stakeholders as needed. Has the team thoroughly proved or disproved each hypothesis and developed other important insights? If an outcome is counterintuitive, is the team certain that it is correct and can be clearly explained? We thought that allocating costs to customer segments would be our most time-consuming task because it required sifting through so many cost-generating activities and deciding the basis on which to allocate it to customer groups. This allocation actually turned out to be one of the easiest portions of the project. What took the most time was managing our scope and agreeing on how far we wanted to go with this step, particularly as the work progressed. Sandy Bean, Marketing Director, Alabama Gas Corp. Once the team has finalized its conclusions, it should turn them into recommendations and action plans. The recommendations and actions should be synchronized with the strategic drivers and clearly articulated with the project sponsors. While some rework is customary, this is where a thorough analysis and approach begins to pay off in the form of vital customer insights, targeted recommendations and well-documented benefit statements. Step 4: Implement and Manage the Process This is where the analysis ends and the application begins. The customer valuations just completed are used to make decisions on customerimpacting projects, processes and systems. It is likely that some members of the valuation team will lead the implementation efforts. In fact, it may be essential to building understanding and buy-in. A customer valuation project is rarely a one-time exercise. A customer valuation for acquisition, retention or customer service capabilities is used frequently and requires maintenance, refreshes and new functionality. A utility that creates a customer valuation for a specific project has an opportunity to develop this customer knowledge into a corporate asset that can be enhanced over time, providing a common view of customers for any project. Such enhancements and further development are opportunities for the measure and refine loop and can enter the process at any step. How to Get Started Look at some of the following opportunities in your own company to determine where to start: Evaluate your current operating budget and categorize the investments you are making. Does this spending support the services most valued by your customers? Which services do your customers value most? Conduct an audit of your current capital projects. Can you identify the impact on customers and revenue benefits from these projects? Has that revenue potential eroded or could it be improved over initial estimates? Examine the profitability of the six largest marketing programs currently under way. What effect would a 5 percent increase in customer conversion rates have on the bottom line? What are the biggest barriers to this improvement? Go on marketing and sales calls or review customer service calls. Do marketing and sales representatives have the information they need to vary how they handle or sell to customers? Benchmark your customer satisfaction scores against a utility peer group of similar size, services and geography. Do you know what these other companies do or what drives their customer satisfaction? What specific actions could you take to match or surpass their satisfaction rates? If the answers to any of these questions are not what you hoped or the answer is I dont know, it is time to implement a strategy for customer valuation and define drivers that are most critical to the success of the business. Filed under: White Papers Tagged under: Utilities