Managing Customers for Value by Chris Trayhorn, Publisher of mThink Blue Book, March 11, 2004 Customer relationships are the most important asset of an energy retailer and represent the value of an energy retail business. Yet how many retailers out there can truly say they understand the total value of their customer base, let alone the customer lifetime value (CLV) of every customer? In many ways, CLV is a holy grail for energy retailers striving to manage their portfolio of customer relationships. Martin Yuill, utilities analyst at Datamonitor, emphasizes: “Understanding customer lifetime value and its associated profitability and loyalty dynamics is an important trend amongst leading energy retail organizations. Those retailers who are able to develop a competitive edge through leveraging detailed customer profitability and loyalty information for strategic advantage will find themselves a step ahead of their competitors.” As Yuill highlights, CLV intrinsically links customer profitability and customer loyalty. Customer profitability evaluates revenue, margin, and cost-to-serve at the individual level to determine each customer’s profit contribution. Customer loyalty evaluates the expected length of each customer relationship and the underlying dynamics. CLV incorporates both individual customer profit contribution and the expected length of the customer relationship (loyalty) to determine the value of each customer relationship in today’s dollars. Once a retailer understands the value of each customer relationship and the drivers behind it, enormous opportunities are created for managing and increasing that value. What is important to understand is that CLV is forward looking. It is not an evaluation of past profitability or performance of a customer relationship. It does not matter if a customer was acquired six months ago, is still in the red due to their acquisition cost, and has added little value during that period. Nor does it matter if a customer has been with the retailer for 10 years and has added enormous value to the bottom line during that time. The respective past values have already been attributed, received, and consigned to the past. CLV references historical profitability and loyalty as indicators to future performance, and evaluates that future performance from a zero-value base. The platform for CLV analysis is the customer information system (CIS), a primary operational system in an energy retailer’s IT application portfolio. An advanced CIS is a rich mine of up-to-the-minute transaction and customer interaction data. When combined with analytical models for customer profitability, loyalty, and lifetime value, the CIS has the potential to transform operational data into strategic knowledge far beyond an energy retailer’s traditional horizons. An advanced CIS captures detailed customer loyalty and customer profitability information that enables energy retailers to determine who is a profitable customer and who is a loyal customer today, and what characteristics individual customers are expected to show going forward. The retailer can then work with its salespeople and customer service teams to develop strategies to retain its most profitable customers and seek to change the behavior of the unprofitable and less loyal customers. Profitability and Loyalty Recent Peace research has sought to ascertain whether customer profitability measures leveraged in other industries apply consistently to the energy retail sector. One such measure is the whale curve of profitability that is typically found in other business sectors such as printing and haulage. The whale curve depicts the profit contribution profile of a customer base and highlights that typically 20 percent of customers can actually contribute up to 300 percent of overall customer base profitability, and that another 20 percent of customers can erode 200 percent of the bottom line (see Figure 1). Peace’s analysis of utility cost-to-serve factors including calls to call centers, billing frequency, and collection activity, as well as revenue drivers such as energy usage and pricing is yielding energy retail results consistent with the whale curve used in other industries. The ultimate business value, however, is not simply to recognize that there are profitable, break-even, and loss-making customer relationships within a customer base, but to identify which customers are in which profitability segment in order to focus business resources to increase individual and overall profitability. It is by applying customer profitability and energy-industry-specific analytical technology to CIS data that enables energy retailers to identify which customers are actually profitable. Peace research is also looking more deeply into understanding energy customer loyalty drivers. Figure 2 displays a selection of customer traits that contribute to the evaluation of individual customer loyalty. If a retailer is able to accurately answer these questions and determine what makes a customer satisfied or dissatisfied and attribute ratings to each, it will be able to apply an analytical customer loyalty model to build a picture of individual customer loyalty and provide comparisons across the entire customer base. It can help identify which customers and groups of customers a retailer should be focusing retention initiatives on in order to build loyalty. Customer Value Quadrants Figure 3 shows how customer profit contribution and loyalty combine to determine CLV. Golden customers: These are a retailer’s best customers. They have significant potential to enhance value going forward. Retailers require retention strategies that will reinforce the retailer’s positive image and keep the customer loyal for the length of time they continue to be profitable. This might include online payment options for those who work in an office or add-on services (such as energy audits, various types of warranties, and lighting) that foster an image of the company as an essential energy solutions provider. Mercurial customers: These include a retailer’s “butterfly” customers who flit from retailer to retailer. They are highly profitable, but might easily switch supplier given the right opportunity. In this case, a retailer armed with CLV information might strive to enhance loyalty with targeted retention programs addressing specific factors influencing the customer’s propensity to switch. This might include a committed contract term at an attractive price, the introduction of convenient electronic bank transactions, and online bill payments that enhance customer stickiness and affinity programs such as frequent flier miles or charitable donations. The goal is to move these customers in the direction of, if not into, the golden quadrant over time. Marginal customers: These are customers on the borderline of profitability or unprofitable and are not expected to be with the retailer for very long. Nevertheless, one would expect at least some of these customers to have the potential to move toward the golden quadrant. A retailer should not view all customers in this segment through a negative lens. A retailer might examine segments within this quadrant for potential to build both loyalty and profitability. Faithful customers: These customers are what some in the industry have labeled the “barnacles”: loyal customers who have always been with the retailer and have no intention of switching. An example of such a customer might be one who uses little power on their single product offering, and the overhead of the billing, payment, and customer care transactions is, and will always be, more than the margin on revenue. Facing a small or negative CLV, a retailer can decide whether it can influence the profit contribution upward through a lower-cost relationship or by up-selling additional products to increase revenue and margin. Every Customer Is Different As the customer value quadrants highlight, CLV and its associated loyalty and profit dynamics raise some interesting questions. A retailer might ask: “Do we have a strategy for new customer acquisition and retention that provides optimal profit and value for the company? When a customer shouts, should we always jump, and how high?” Sometimes it makes sense to temper the knee-jerk reaction by considering just how valuable that customer will be over the lifetime of their relationship. A retailer treating all customers the same risks suffering a double blow. First, resources can get squandered on unprofitable customers and, second, profitable ones can get short shrift and become less satisfied. With accurate per-customer cost and revenue information, and a deeper understanding of a customer’s loyalty drivers, energy retailers will be able to target investments at loyalty and profitability improvement objectives that focus on the appropriate customers, products, and channels. The Future for CIS Understanding the dynamics of individual customer loyalty, profitability, and value has however proved difficult for many retailers in the past. Many previous CLV strategies have floundered, overcome by too much data, too much complexity, too many intangibles, and the lack of systems equipped to support a CLV focus. Today, CLV has become feasible with advanced CIS systems that drill down into deeper customer insights, and shed light on the lifetime value of each customer. CLV analysis need not incur the time and cost of collating and incorporating every last piece of data at the outset. Early results can be attained from informed selections of data that can highlight major value drivers in specific business and customer segments that can then be fed back into the system to enhance value going forward. The customer is the retailer’s most valuable asset, and understanding and managing this value is entirely feasible with the right technology and the right approach. Filed under: White Papers Tagged under: Utilities About the Author Chris Trayhorn, Publisher of mThink Blue Book Chris Trayhorn is the Chairman of the Performance Marketing Industry Blue Ribbon Panel and the CEO of mThink.com, a leading online and content marketing agency. He has founded four successful marketing companies in London and San Francisco in the last 15 years, and is currently the founder and publisher of Revenue+Performance magazine, the magazine of the performance marketing industry since 2002.