RiskRevenue Analysis

Risk/Revenue Analysis

There is another way of cutting the costs of customer management besides using the 80 percent rule. That is applying risk/revenue analysis. For this to work, you have to have done two things:

1. Determined the lifetime value of your customers and divided the customers into high, medium, and low lifetime value segments.

2. Determined the likelihood that customers will leave you and divided the customers into high, medium, and low likelihood of defection segments. When you have done this, you can develop a simple table that looks like Table 10-5.

   Table 10-5 : Risk/Revenue Analysis

   			Likelihood of Defection
   Lifetime value	High	Medium	Low
   High	priority A	priority B	priority C
   Medium	priority B	priority B	priority C
   Low	priority C	priority C	priority C

Assuming that all your segments are of equal size, you will have 44 percent of your customers in priority A and priority B and 66 percent of them in priority C. Customer management is not free. It costs money for communications, benefits, recognition, and rewards. Why waste a lot of money on managing your priority C customers? They are in one of two categories:

1. Of very low lifetime value to you

2. Very loyal and unlikely to defect

In either case, spending a lot of resources trying to modify their behavior is likely to be a waste of money. This means that you can concentrate your energy on managing (modifying the behavior of) only 44 percent of your customers, instead of 100 percent. This concentration on the real customer management problem will pay dividends in many ways.

In the first place, if you try to manage everybody, the resources you can devote to any one customer will be limited. Let’s say that you have a customer management budget of $1 million and a customer base of 1 million customers. That is $1 per customer per year. You can’t do much to change a customer’s behavior with $1 per year. That’s two letters and an email at best. Suppose you concentrate on only priority A and B customers. You will have $1 million to spend on 44 percent of your customers, which comes to $2.27 per customer. Even better, if you devote $4 per customer to priority A customers, you will still have $1.67 left for each of the priority B customers. You can do a lot more with $1.67 than you could have done with only $1, and much more with $4.

This chapter presents several case studies of different methods of customer management. All of them look appealing, and they are, because they have worked well for some companies. How can you determine whether they would work for you?

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There is a relatively easy answer. Plug your own numbers into Table 10-6 to determine whether customer management will work for you. Begin by asking yourself what success you are having today with

• Conversion of leads to buyers

• Conversion of one-time buyers to two-time buyers

• Cross-selling products to existing customers

  Table 10-6 : Increased Return

  	Present	With customer management	Cost of customer management	Net increased return
  Leads	500,000	500,000
  Conversion rate	30%	36%
  One-time buyers	150,000	180,000
  Conversion rate	50%	60%
  Two-time buyers	75,000	108,000
  Annual revenue	$200	$240
  Total revenue	$15,000,000	$25,920,000	$4,000,000	$6,920,000

We are assuming here that you develop a customer management program that costs you $4 million a year to run. It consists of a database with communications to the customers and to the sales force that is managing the program. A successful customer management program should increase the lead conversion rate, the conversion rate of one-time buyers to two-time buyers, and, through cross selling, the annual revenue from two-time buyers.

What will these customer management communications be? This is up to you. At this point, you know that you want personal communications based on data in your customer database. You want to capture email names so that most of the communications are essentially free. In the rest of this chapter, there are several valuable case studies showing how some companies have been able to manage their customers to produce results like those shown in the previous tables.