Chapter 02 MMAAA

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com
© Noel Capon and Siddharth Shekhar Singh, 2014. All rights reserved. PRESENTATION 2 OF 24 / 1
Managing Markets Strategically

Professor Noel Capon
R.C. Kopf Professor of International Marketing
Columbia Business School
New York, NY, U.S.A.
&
Professor Siddharth Shekhar Singh
Director Fellow Programme in Management & Associate Professor of Marketing
Indian School of Business
Hyderabad & Mohali, India
www.axcesscapon.com www.wileyindia.com Managing Markets Strategically
Section I: Marketing and the Firm

Chapter 1: Introduction to Managing Marketing
Chapter 2: The Value of Customers
Section II: Fundamental Insights for Strategic Marketing
Transition to Strategic Marketing
Section III: Strategic Marketing
Section IV: Implementing the Market Strategy
Section V: Special Marketing Topics
www.axcesscapon.com www.wileyindia.com
CHAPTER 2
The Value of Customers

www.axcesscapon.com www.wileyindia.com The Fundamental Business Model
Shareholder Value
Organizational Survival and Growth
Current and Potential Profits

Competitors
Attract, Retain, and Grow Customers
Competitors
Customer Value
Company
www.axcesscapon.com www.wileyindia.com The Value of Customers
• Globalization is driving increased emphasis on creating shareholder value

• Customers are the critical source of cash inflows
• Customers are the firm’s core assets
www.axcesscapon.com www.wileyindia.com Two Faces of Value
Products and services create Customer value attracts,

customer value retains, and grows customers
By being attracted, grown,

and retained, customers in
turn create value for the
firm and its shareholders
www.axcesscapon.com www.wileyindia.com Starbucks Stock Price Performance
Starbucks
www.axcesscapon.com www.wileyindia.com Amazon Stock Price Performance
Amazon
www.axcesscapon.com www.wileyindia.com Apple Stock Price Performance
Apple
www.axcesscapon.com www.wileyindia.com Nokia Stock Price Performance
Nokia
www.axcesscapon.com www.wileyindia.com Kodak Stock Price Performance
Kodak
www.axcesscapon.com www.wileyindia.com Samsung Stock Price Performance
Samsung
www.axcesscapon.com www.wileyindia.com RBC Stock Price Performance
Royal Bank of Canada

Core Topics
• Why are customers so important for the firm?
• How can the firm bind customers closer?

Why Are Customers
www.axcesscapon.com www.wileyindia.com So Important for the Firm?
Session Roadmap A
• Customer lifetime value (CLV)
• Profit margin
• Customer retention
• Addressing current customers and potential customers
• Customer revenue and profit rules
• Customer suitability
Why Are Customers
Session Roadmap A
• Profit margin
www.axcesscapon.com www.wileyindia.com Customer Lifetime Value (CLV)
Year 1 Year 2 Year 3

m1 x r1 m2 x r1 x r2 m3 x r1 x r2 x r3
CLV = + + + ………
(1 + d) (1 + d)2 (1 + d)3
m = profit margin
r = customer retention rate
d = discount rate (cost of capital)
Definition: CLV = Discounted profit margin earned from the customer, factored by
customer retention rate
rxm
CLV =
(1 + d – r)
m1 = m 2 = m 3 … = m
r1 = r2 = r3 … = r
Profit margin
rxm
CLV =
(1 + d – r)
r
Margin multiple =
(1 + d – r)
Increase profit margin, m
mxr
CLV = Increase customer retention rate, r
(1 + d – r)
Reduce discount rate, d

Review
• Customer lifetime value depends on just three factors:
• profit margin
• customer retention rate
• discount rate
• Margin multiple definition
• margin multiple = r / (1 + d – r)
Review
• Customer lifetime value depends on just three factors:
• Margin multiple definition
• CLV simplification
• CLV = m x r / (1 + d – r)
• Actions to increase CLV:
• increase profit margin
• increase customer retention rate
• reduce discount rate
Why Are Customers
Session Roadmap A
• Profit margin
www.axcesscapon.com www.wileyindia.com Profit Margin
Customer Life Cycle Effect

Customer Life Cycle Effect

Increasing Profit Margin Aid to the Firm

• Customer selection • Learning
• Customer satisfaction • Network externalities
• Customization • Positive word of mouth and
referrals
• Raise prices
• Signals
• Reduce operating costs
Why Are Customers
Session Roadmap A
• Profit margin
www.axcesscapon.com www.wileyindia.com Customer Retention
• CLV: Illustration — Increase customer retention by 5 percent

• Margin multiple values
• Impact on firm growth
• Margin multiple values adjusted for profit margin growth
• Impact of market share
• Duration effect
• Relationship to customer satisfaction
Impact on CLV: Illustration — Improve Customer Retention 5 Percent


• Duration effect
Margin Multiple Values
Discount Rate (d)

Retention Rate (r) 8% 12% 16% 20%
60% 1.25 1.15 1.07 1.00
70% 1.84 1.67 1.52 1.40
80% 2.86 2.50 2.22 2.99
90% 5.00 4.09 3.46 3.00
95% 7.31 5.59 4.52 3.80
Margin Multiple Values: Reduce Discount Rate
Discount Rate (d)

60% 1.25 1.15 1.07 1.00
70% 1.84 1.67 1.52 1.40
80% 2.86 2.50 2.22 2.99
90% 5.00 4.09 3.46 3.00
95% 7.31 5.59 4.52 3.80
Margin Multiple Values: Increase Customer Retention Rate
Discount Rate (d)

60% 1.25 1.15 1.07 1.00
70% 1.84 1.67 1.52 1.40
80% 2.86 2.50 2.22 2.99
90% 5.00 4.09 3.46 3.00
95% 7.31 5.59 4.52 3.80

• Duration effect
Impact on Firm Growth

• Consider two companies:
Company 1 Company 2
Retention Rate ® 95% 90%
Acquisition Rate (a) 15% 15%
• How many years will it take each company to double the size of its customer
base?
7 years 14 years

• Duration effect
mxr
CLV =
(1 + d – r [1 + g])
r
Margin Multiple =
(1 + d – r [1 + g])
Margin Multiple Values Adjusted for Profit Margin Growth – Discount Rate = 12%
Margin Growth (g)

Retention Rate (r) 0% 2% 4% 6% 8%
60% 1.15 1.18 1.21 1.24 1.27
70% 1.67 1.72 1.79 1.85 1.92
80% 2.50 2.63 2.78 2.94 3.13
90% 4.09 4.46 4.89 5.42 6.08
95% 5.59 6.33 7.31 8.64 10.56

• Duration effect
Long-Run Market Share Scenarios
Scenario A Scenario B Scenario C
Shalini Rahul Shalini Rahul Shalini Rahul
Shalini 80% 20% Shalini 90% 10% Shalini 95% 5%

Rahul 20% 80% Rahul 20% 80% Rahul 20% 80%
Long-run market shares

Shalini – 50% Shalini – 67% Shalini – 80%
Rahul – 50% Rahul – 33% Rahul – 20%

• Duration effect
Duration Effect
Duration Effect

• Duration effect
Relationship to Customer Satisfaction: Illustration — Bank

Why Are Customers
Session Roadmap A
• Profit margin
Addressing Current Customers
www.axcesscapon.com www.wileyindia.com and Potential Customers
mxr
Current Customers CLV =
(1 + d – r )
mxr
Potential Customers CLV = – AC
(1 + d – r )
Decision Rule: Acquire potential customers when expected CLV is greater than
the acquisition cost.
Options
How to Acquire Customers

• Independent marketing activities
• Affiliations
• Channel strategies
• Firm and business-unit acquisitions
Why Are Customers
Session Roadmap A
• Profit margin
www.axcesscapon.com www.wileyindia.com Customer Revenue and Profit Rules
80:20 Rule
80 percent of revenues
20 percent of customers
20:80 Rule
80:20:120 Rule
120 percent of profits
20:80(20) Rule
Reduce profits by 20 percent
CLV Distribution by Customer
Source: V. Kumar and D. Shah, “Expanding the Role of Marketing: From Customer Equity to Market Capitalization,”
Journal of Marketing, 73 (November 2009), pp. 119-136.
Unprofitable/Low-Profit Customers: Options

Selling Non-Selling
• Part-time sales force • Traditional direct marketing
• Shift to telesales • Electronic contact – e-mail, web sites
• Assign to agents/distributors • Raise prices
• Outsource selling effort • Stop serving
• Alliances
Current Customers: Illustration – Financial Services Firm
Original New
Customer Customer
Classification Classification
Why Are Customers
Session Roadmap A
• Profit margin
www.axcesscapon.com www.wileyindia.com Customer Suitability
• Capacity constraints
• Competition
• Evolving strategy
• Foreclosing options
• Impact on the firm’s reputation
• Impact on the offer
• Instability
• Non-payer
• Potential costs
Why Are Customers
Session Roadmap A
• Profit margin
www.axcesscapon.com www.wileyindia.com How Can the Firm Bind Customers Closer?
Session Roadmap B
• Customer relationship management (CRM)
• Customer loyalty
Session Roadmap B
www.axcesscapon.com www.wileyindia.com Customer Relationship Management
• Definitions and features

• The customer database
• Control and access
• Customer value and customer loyalty
• Event-driven marketing
Definition
Customer relationship management is the ongoing process of identifying and creating
new value with individual customers and sharing these benefits over a lifetime of
association with them.
Features
Definition
Features
• Synthesis of marketing, customer service, and quality management
• Goal is to form mutually beneficial relationships between the firm and its customers
• Technology plays an important role in CRM, but CRM is not about technology
• CRM techniques can be applied to other firm stakeholders – suppliers,
shareholders, and current and potential employees

The Customer Database
Customer
Customer Customer Customer Customer Customer Value
Reponses to
Identifier Characteristics Contact History Purchase History to the Firm
Firm Decisions
Jane Doe
John Smith
XYZ Inc.
DEF Inc.

Control and Access

19th-Century National Politics
Klemers Furst Von Metternich Foreign Affairs Minister, Austro-Hungarian Empire: “I
don’t care who the King is as long as I control the purse strings.”
21st-Century IBM Politics

Senior IBM Executive: “I don’t care who the CEO is, as long as I control the customer
databases.”

Customer Value and Customer Loyalty
Objective:
Objective:
Switch customers from competitors
Customer retention
– improve loyalty
High Action:
Action: Secure trial by sampling and
Targeted customer loyalty/
targeted sales promotions; then
reward programs
loyalty/reward programs
Customer Value
Objective: Objective:
No special objective Increase purchases
Low
Action: Action:
No special effort Cross-sell other products
Low High
Customer Loyalty

Event-Driven Marketing
• Triggers
• Scheduled events
• Significant events
Session Roadmap B
www.axcesscapon.com www.wileyindia.com Customer Loyalty Programs
Design Factors
• Rate of earning
• Aspirational value of the reward
• Cash value of the reward
• Deterministic or probabilistic rewards
• Ease of collecting the reward
• Length of time to earn the reward
• Rewards based on the firm’s products or services, or a broad variety
• Soft and hard rewards
• Type of reward
Value for the Firm
www.axcesscapon.com www.wileyindia.com Customer Loyalty Programs
Design Factors
Value for the Firm
• Creates competitor barriers
• Gains insight into customer behavior
• Lowers cost to serve loyal customers
• Makes loyal customers less price sensitive
• Encourages loyal customers to spend more
• Stimulates positive word of mouth from loyal customers
• Increases sales by purchase acceleration closer to the goal
Session Roadmap B
Core Topics
• Why are customers so important for the firm?
• How can the firm bind customers closer?

www.axcesscapon.com www.wileyindia.com
CHAPTER 2
The Value of Customers

Chapter 02 MMAAA

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www.axcesscapon.com www.wileyindia.

Managing Markets Strategically

Section I: Marketing and the Firm

The Value of Customers

Organizational Survival and Growth

Current and Potential Profits

• Globalization is driving increased emphasis on creating shareholder value

Products and services create Customer value attracts,

By being attracted, grown,

Royal Bank of Canada

• How can the firm bind customers closer?

Year 1 Year 2 Year 3

Increase profit margin, m

Reduce discount rate, d

Customer Life Cycle Effect

Customer Life Cycle Effect

Increasing Profit Margin Aid to the Firm

• CLV: Illustration — Increase customer retention by 5 percent

Impact on CLV: Illustration — Improve Customer Retention 5 Percent

• CLV: Illustration — Increase customer retention by 5 percent

Margin Multiple Values

Discount Rate (d)

Margin Multiple Values: Reduce Discount Rate

Discount Rate (d)

Margin Multiple Values: Increase Customer Retention Rate

Discount Rate (d)

• CLV: Illustration — Increase customer retention by 5 percent

Impact on Firm Growth

• CLV: Illustration — Increase customer retention by 5 percent

Margin Growth (g)

• CLV: Illustration — Increase customer retention by 5 percent

Long-Run Market Share Scenarios

Scenario A Scenario B Scenario C

Year 2 Year 2 Year 2

Shalini Rahul Shalini Rahul Shalini Rahul

Shalini 80% 20% Shalini 90% 10% Shalini 95% 5%

Long-run market shares

• CLV: Illustration — Increase customer retention by 5 percent

• CLV: Illustration — Increase customer retention by 5 percent

Relationship to Customer Satisfaction: Illustration — Bank

How to Acquire Customers

CLV Distribution by Customer

Unprofitable/Low-Profit Customers: Options

Current Customers: Illustration – Financial Services Firm

• Definitions and features

• Definitions and features

The Customer Database

• Definitions and features

Control and Access

21st-Century IBM Politics

• Definitions and features

Customer Value and Customer Loyalty

• Definitions and features

• How can the firm bind customers closer?

The Value of Customers

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