How B-to-B Marketers Calculate the Value of a Customer
Customer Valuation for Business-to-Business Marketers
Customer valuation, customer segmentation by value, and differentiated treatment of customers—these notions were invented in the world of direct marketing. Business-to-business direct marketers have used lifetime value, RFM and value-based segmentation as a decision tool for years. But when we move out of the nice, neat traditional world of mail order merchandise, measuring the value of a customer gets complicated.
Consider business-to-business services. Companies like agencies, printers, utilities, lawyers and accountants, who are selling services to other businesses, can certainly benefit from understanding the profitability of their various customers and clients. Insight into customer value assists decision-making at all levels of the company. Sales can decide which manager to assign to the account. Customer service can vary the perks and privileges. Finance can negotiate better pricing when the contract comes up for renewal.
But customer valuation in business-to-business presents a number of obstacles that are not necessarily faced by traditional mail order companies, for whom RFM is like mother’s milk. For one, the numbers are not immediately available—or obvious. Far from calculating a simple sum of the products purchased, less the cost of goods sold, services marketers must consider issues of fixed versus variable cost, and how to allocate overheads appropriately to each account. Then there’s the question of data collection: is it worth requiring employees to keep time sheets so that their labor can be applied to each customer accurately?
Another hurdle to customer valuation is the extra work involved. Management is likely to be focused on the financial reporting required by Wall Street or the IRS. They won’t be looking to add to the burden.
Perhaps the largest obstacle is the sensitive nature of information about customer profitability. No company wants this data to fall into the wrong hands. How would customers react were they to discover their relative contribution to their vendor’s bottom line? Worse yet, what competitor wouldn’t want to go poach your best customers, if they only know who they were?
Despite the obstacles, business services companies are making great strides in assessing the value of their customers. EU Services, an integrated printing and mailing services company in Rockville MD, has taken a very practical approach to the matter. Every year, the senior management team gets together and analyzes the entire customer base, to look at the contribution level of each account. Since every printing and mailing job is custom-bid, allocations and cost collection are not a problem.
But EU Services recognizes that a simple ranking of accounts by contribution margin does not tell the whole story. So, over the past several years, they have developed a 5-part assessment strategy based on the following criteria:
- Revenue dollars.
- Payment terms, whether the account pays in 30, 60, 90 days or requires some other consideration.
- Pricing terms, meaning the extent to which the client’s jobs tend to be complex—thus premium priced—or standard, commodity orders. A simple #10 direct mail package on standard paper stock, for example, versus an annual report using special inks and finishing, and requiring a press check.
- The “impact on the organization,” based on the input of 15 different department managers on how much work is required across the company to support the account.
- The “relationship,” meaning the opportunity for a long-term partnership, as assessed by the sales person on the business. Is the customer outsourcing jobs to EU Services piecemeal, or might the account be expected to give EU Services a sizable share of its printing and mailing business over time?
The first 3 criteria are generated by computer, through a program developed in house, and each account is assigned a score based on where it falls in a range. The final 2 are more subjective, and gathered manually. Once all the inputs are assembled, the account scores are cross-tabulated with yearend expenses, and a “contribution to overhead” number is established for each account.
According to Sylvia Konkel, VP of Marketing at EU Services, the combination of 5 criteria allow the company to compare accounts of all kinds on an equal footing. “We have some very large accounts, representing millions of dollars in revenue a year. And we also have many customers who only spend $25,000 with us annually. For peak efficiency, we need a mix of customers. This valuation strategy allows us to compare apples with apples.”
EU Services uses the contribution numbers to develop optimal account management strategies for the following year. “We sit with the sales reps and discuss each account,” says Konkel. “We are all looking for ways to add more value. Occasionally, we conclude that a certain account requires alternate solutions, so we weed out those customers whose expectations we cannot meet.”
Their main challenge in developing the process was deciding on the right criteria to include—and reject. The important thing was to create a complete profitability picture of the account that could not be skewed by anomalies like volume. Konkel notes that it took 7 years of experimentation to settle on a set of criteria that provided the right level of feasibility and flexibility.
The accounts are then classified into 2 groups: the top 10 and the top 100 accounts. Only the senior management team is privy to the final ranking order, due to its sensitivity from a customer and competitor point of view. But all employees are made aware of who the top 100 customers are, so that everyone in the company can be united in serving them well. Top accounts will be assigned dedicated support by an experienced account manager, plus a senior management contact from among the VP ranks. Other service offerings, like customized training, annual account review meetings and special perquisites are also made available for top accounts. “Our objective is to serve our customers as well as we know how,” says Konkel. “The valuation process gives us a tool to provide that service more effectively.”
Another example of customer valuation at work comes from Digital Impact, the Silicon Valley online marketing services company. DI is known as a full-service provider, best suited to companies that seek to build their customer relationships with highly targeted communications programs and need customized support. DI’s profitability thus rests on management’s ability to steer its way between revenue—set by pricing—and costs, which are primarily driven by staff time and technology usage.
Like most business-to-business companies, DI has good visibility into revenues and variable costs on each account. Some are direct expenses—the services staff, for example, keeps time sheets to assign their hours to a customer, so their fully loaded costs are applicable. Some of the technology, too, like dedicated servers or IP addresses, can be accurately associated with a particular customer. Other direct expenses, like bandwidth or computer hardware, are allocated by the volume of email the customer runs through the system.
According to David Oppenheimer, Digital Impact CFO, the major application of DI’s customer profitability analysis is in salvaging money-losing clients. “When we have an account that is unprofitable to us, but whose potential is high, what we want to do is bring that account into profitability. We will analyze the whys and wheres of the losses, and figure out how to price and structure the new contract to service the relationship profitably.”
A classically trained finance professional, with a long career in aerospace before moving into marketing services, Oppenheimer is well aware of the importance—and the difficulties—of customer valuation. When it comes to allocations, for example, the expense ratio will vary with the number of clients. “Eliminating an unprofitable customer is an important strategy for business management,” he notes. “But you have to get rid of the costs as well. Otherwise, they will just be allocated to the remaining customers, with a negative impact on the company’s overall profitability.”
On the pricing side, another vexing issue is applying the right cost to incremental volume. If you have excess capacity, it makes sense to price on the margin, that is, looking at only the variable direct costs incurred by the usage—whether it’s staff time or technology capacity. That way, you can bring in profitable new business and absorb otherwise unused overhead. But what happens when that capacity is used up? The length of the contract then becomes an important factor. Oppenheimer wrestles regularly with decisions about the best ways to view costs to support decisions about customer value optimization.
DI regularly ranks its customers by profitability, and develops strategies to optimize the value of each account. A highly profitable account, for example, would be targeted for additional cross-selling of service offerings. An account falling near the bottom of the list is examined for its opportunity. Is it a strong reference account? Is it running high volume through the system? Customer valuation thus allows a disciplined and rational approach to account management.
It may not be easy, but the principles of customer valuation and value-based segmentation still apply in business-to-business. Business marketers just need to get creative about identifying costs, and very disciplined about tracking and analysis.