Chapter 16: Applications of CRM in B2B and B2C Scenarios (Part 2)

2 V. Kumar and W. Reinartz – Customer Relationship Management Topics Discussed  Optimal Resource Allocation across Marketing and Communication Strategies  Purchase Sequences Analysis  Link between Acquisition, Retention, and Profitability  Preventing Customer Churn  Customer Brand Value  Customer Referral Value

3 V. Kumar and W. Reinartz – Customer Relationship Management Optimal Resource Allocation  Customer Equity: Aggregation of expected lifetime values of a firm’s entire base of existing customers and the expected future value of newly acquired customers  The NPV objective function required to maximize the Customer Equity of a firm is related to  The cash flow from each customer  The expected Inter-purchase time  The cost and frequency of marketing/communication strategies employed

4 V. Kumar and W. Reinartz – Customer Relationship Management Optimal Resource Allocation (2)  The NPV objective function required to maximize Customer Equity of a firm is based on 3 elements:  A probability based model that predicts the inter-purchase time of each customer  A panel data model that predicts the cash flows from each individual customer  An optimization algorithm that maximizes the profits from each individual customer

5 V. Kumar and W. Reinartz – Customer Relationship Management Real World Industry Application of Optimal Resource Allocation  By applying an optimization model, a manager can know:  The extent to which face-to-face meetings should be decreased and frequency of direct sales increased or vice-versa  How to maximize profits across various customer segments  Two-step approach:  Develop model and check predictive accuracy  Examine the improvements in profits

6 V. Kumar and W. Reinartz – Customer Relationship Management Effect of Firm and Market Variable on the Value of a Lost Customer Actually Bought in the next 12 months Actually did not buy in the next 12months Total Expected to buy in the next 12 months as per the model N = 225N = Not expected to buy in the next 12 months as per the model N = 12N = 6678 Total324 Hit Rate = /324 = 90% Example:

7 V. Kumar and W. Reinartz – Customer Relationship Management Duration of Association Approach  Comparison of average profits:  Cross analysis of Duration of Relationship and Customer Value obtained on the basis of the NPV maximization objective function indicates that:  Not all the short duration customers deliver lower profits, and not all the long duration customers deliver higher profits  Some of the profitable customers had escaped the firm’s attention  Firm was allocating disproportionately higher resources to some Long duration customers in the mistaken belief that the duration of their association with the firm was indicative of their profitability Average Profit per customer Duration of Customer-Firm Association ShortLong $29,235 (n = 170) $141,655 (n = 154)

8 V. Kumar and W. Reinartz – Customer Relationship Management Customer Value Based Approach  The observations in cell III indicate that more than 50 % of the customers that the firm was chasing in the long duration segment were actually low value customers  The observations in cell II indicate that the firm was ignoring a sizable set of customers by classifying them as short duration customers, when indeed they were contributing significantly to profits Shorter DurationLonger Duration Low Customer Value Cell I N = 78 Average Profit = $ 1,387 Cell III N = 82 Average Profit = $ 1,245 High Customer Value Cell II N = 92 Average Profit = $ 52,976 Cell IV N = 72 Average Profit = $ 302,542

9 V. Kumar and W. Reinartz – Customer Relationship Management Reallocation of Resources Based on Customer Value Customer Value Duration of Relationship High Low High Low Low/ Low Face to Face Meetings: -Currentlymeets once every 6months -Optimalmeeting frequency is once every 14 months Direct Mail/Telesales: Current Interval is 27 days Optimal Interval is 26 days Face to Face Meetings: -Currentlymeets once every 3months -Optimalmeeting frequency is once every 4months Direct Mail/Telesales: Current Interval is 10 days Optimal Interval is 19 days Face to Face Meetings: -Currentlymeets once every 4months -Optimalmeeting frequency is once every month Direct Mail/Telesales: Current Interval is 21 days Optimal Interval is 13 days Face to Face Meetings: -Currentlymeets once every 6months -Optimalmeeting frequency is 4 months Direct Mail/Telesales: Current Interval is 13 days Optimal Interval is 4 days High/ Low Low/ HighHigh/ High

10 V. Kumar and W. Reinartz – Customer Relationship Management Purchase Sequence Analysis  It is important to understand which product in the portfolio is likely to be needed next by a customer  Purchase Sequence Model addresses:  What is the sequence in which a customer is likely to buy multiple products or product categories?  When is the customer expected to buy each product?  What is the expected revenue from that customer?  Other attributes of the model include:  The model captures the differences in the durations between purchases for different product categories  The interdependence in purchase propensities across products is modeled by incorporating cross-product category variables  An individual customer level profit function is developed to predict Customer Value

11 V. Kumar and W. Reinartz – Customer Relationship Management Purchase Sequence Analysis (contd.)  Model developed for hardware products of a firm  Test group of sales people adopted strategies based on the model for a year  Comparison made between previous year and current year for test group and with control group for current year alone  Change between current year and previous year Example: Test GroupControl GroupDifference Revenue ($)1,050 (18,130)1,033 (17,610)537 Cost of Communication ($) -750 (3,625)75 (4,580)-1,780 # of Attempts Before Purchase -4 (15)1 (18)-8 Profits ($)3,000 (9080)637 (6,275)5,168 Return on Investment (%)5,4 (3,7)2,2 (2)4,9 Customer value approach improves the quality of marketing decisions Test group performs better

12 V. Kumar and W. Reinartz – Customer Relationship Management Prospects Non-acquired Customers Relationship Duration Customer Profitability Acquisition Process Retention Process - Firm actions - Customer actions - Competitor actions - Customer characteristics Acquired Customers Linking Customer Acquisition, Relationship Duration, and Customer Profitability

13 V. Kumar and W. Reinartz – Customer Relationship Management Balancing Acquisition and Retention Resources  The amount of investment in a customer and how it is invested has an impact on acquisition, retention and customer profitability  Investments in customer acquisition and retention have diminishing marginal returns  The relative effectiveness of highly personalized communication channels is much greater than the less personalized communication channels  Under spending in acquisition and retention is more detrimental and results in smaller ROIs than overspending  A suboptimal allocation of retention expenditures will have a larger detrimental impact on long-term customer profitability than suboptimal acquisition expenditures  The customer communication strategy that maximizes long-term customer profitability maximizes neither the acquisition rate nor the relationship duration

14 V. Kumar and W. Reinartz – Customer Relationship Management Preventing Customer Churn  Impacts of Customer Churn on a firm  Incurs a loss of revenue from the customers who have defected  Loses the opportunity to recover the acquisition cost incurred on the defected customers  Loses the opportunity to up-sell/cross-sell to the defected customers  Loses social effects  Influencing other customers on product/service adoption  Potential negative word-of-mouth  Invests additional resources to replace the lost customers with new customers Customer churn drains the firm’s performance level and resources

15 V. Kumar and W. Reinartz – Customer Relationship Management Preventing Customer Churn (2)  Analytical models (ex: dynamic churn models)  Analytical tools to prevent customer churns  Used to predict future customer behavior  Help firms decide which customer/distributor is likely to quit at what time  Key questions managers consider to prevent customer churn  Should we intervene?  Which customer should we intervene?  When do we intervene?  Through which channel do we intervene?  What do we offer them? Build Propensity-to-Quit models and integrate them with the CLV based models

16 V. Kumar and W. Reinartz – Customer Relationship Management Predicting Propensity to Quit 1.Identify the need to intervene 2.Decide which customer to intervene 3.Pick the appropriate time to intervene Time Propensity to Quit B C A Does not intend to quit Increase in propensity to quit from Jan 2010 Strong tendency to quit from early on Customer B and C should be targeted with intervention offers

17 V. Kumar and W. Reinartz – Customer Relationship Management Proactive Intervention Strategy Time Propensity to Quit B C A  Decision on the channel of intervention and type of intervention offer is based on individual customer characteristics  The amount of resources to be spent on each customer is directly linked to the Customer Lifetime Value I2I2 I1I1 Intervention Points

18 V. Kumar and W. Reinartz – Customer Relationship Management Preventing Customer Churn (2)  Churn models help firms to identify the customers who are likely to quit  The Intervention strategy based on CLV helps to effectively intervene to retain valuable customers  Accurate customer profiling analysis helps firms to target profitable prospects and implement a solid marketing strategy  Firms should apply the knowledge gained about the new customer across the entire organization by:  Cultivating customers  Synchronizing departments  Approaching customers on the one-to-one basis  Providing solutions to customers’ needs and wants

19 V. Kumar and W. Reinartz – Customer Relationship Management Customer Brand Value (CBV)  Important roles of Brands  Draw new customers to the firm  Remind existing customers about the products/services it offers  Forge an emotional attachment with its consumers  Customer Brand Value (CBV)  Brand Knowledge – Brand Awareness and Brand Image  Brand Attitude – Brand Trust and Brand Affect  Brand Behavior Attention – Purchase Intention  Brand Behavior – Brand Loyalty, Brand Advocacy, and Brand Premium Behavior  Customers with greater CBV are more likely to engage in activities that increase in CLV

20 V. Kumar and W. Reinartz – Customer Relationship Management Customer Brand Value (2)  Linking CBV to CLV  Established using customer-level data and advanced modeling techniques  Compute CLV from customer transaction database  Compute CBV from CBV survey results  Managerial Benefits of Linking CBV to CLV  Monitor the overall performance of CBV  Identify the weak components in the individual brand values and develop different strategies  Manage brand at the segment level  Manage brand at the individual level  Personalized marketing actions can be performed to send the right message at the right time to simultaneously maximize the the individual CLV and CBV Poor PatronsTrue Loyalties StrangersAcquaintance High Low CLV High Low CBV

21 V. Kumar and W. Reinartz – Customer Relationship Management Customer Referral Value (CRV) Customer Referral Value  Customer’s expected future referral value with the firm  Enables managers to measure and manage each customer based on his/her ability to generate indirect profit to the firm WhereT = the number of periods that will be predicted into the future (e.g. quarters, years) A ty = the gross margin contributed by customer ‘y’ who otherwise would not have bought the product a ty = the cost of the referral for customer ‘y’ 1 to n1 = the number of customers who would not join without the referral n2 – n1 = the number of customers who would have joined anyway M ty = the marketing costs needed to retain the referred customers ACQ1 ty = the savings in acquisition cost from customers who would not join without the referral ACQ2 ty = the savings in acquisition cost from customers who would have joined anyway

22 V. Kumar and W. Reinartz – Customer Relationship Management Customer Referral Value – Example (1/2) Tom is a customer from a financial services company. Calculate the Tom’s customer referral value (CRV) Number of referrals per period (n 2 )4 Marketing cost per period (M ty )$18 Average gross margin (A ty )$98 Cost of referral (a ty )$40 Acquisition cost savings (ACQ1 ty and ACQ2 ty )$5 Number of referrals that would have joined anyway (n 2 – n 1 )2 Yearly discount rate (r)15%

23 V. Kumar and W. Reinartz – Customer Relationship Management Customer Referral Value – Example (2/2) 1.Determine the number of customers who would have made purchases anyway (n 2 – n 1 ) = 4-2 = 2 2.Predict future value of each referred customers (A ty – M ty – a ty + ACQ1 ty )/ (1+r) t = ( ) / (1.15) t 3.Predict number of referrals generated (4 referrals per period) * (2 periods in a year) = 8 referrals per year 4.Predict the timing of customer referrals Since Tom has 8 referrals per year, assume 4 referrals each in first and second half of the year Tom is a customer from a financial services company. Calculate the Tom’s customer referral value (CRV)

24 V. Kumar and W. Reinartz – Customer Relationship Management Customer Referral Value – Example  Impact of CRV grows as time progresses, because of the growth of the new customer base due to referrals in each period  In period 2, there were 6 new customer base because of 2 customers from period 1 who bought only because of the referral. Tom is a customer from a financial services company. Calculate the Tom’s customer referral value (CRV) Period 1: Period 2:

25 V. Kumar and W. Reinartz – Customer Relationship Management Customer Referral Value (2)  Linking CRV to CLV  Measure CLV: Value provided by the actual purchases made by the customer  Measure CRV: Influence the customer has on other people (CRV)  Managers need to market to customers based on the various combinations of whether the customer is low or high CLV  Marketing studies found that customers with high CRV are not the most valuable customers (high CLV) Deciles (ranked by CLV) CLV ($) (1 year) CRV ($) (1 year) 11, , , Top 30% CLV customers have no overlap with the top 30% CRV customers Managers need to consider both the concepts of CRV and CLV to avoid decrease in customer growth and negative WOM

26 V. Kumar and W. Reinartz – Customer Relationship Management Customer Referral Value (3)  Managerial Benefits of Linking CRV and CLV  High CLV and high CRV customers are distinct sets of customers  Customers in each cell should be evaluated differently with respect to their total value to the company and then be approach with different types of marketing offers to get the greatest overall value Affluents 29% of customers CLV (1yr) = $1,219 CRV (1yr) = $49 Champions 21% of customers CLV (1yr) = $370 CRV (1yr) = $590 Misers 21% of customers CLV (1yr) = $130 CRV (1yr) = $64 Advocates 29% of customers CLV (1yr) = $180 CRV (1yr) = $670 High Low CRV High Low CLV

27 V. Kumar and W. Reinartz – Customer Relationship Management Customer Referral Value (4)  Customer Referral Value (CRV) or Customer Lifetime Value (CLV)?  Firms should measure both CLV and CRV to implement marketing campaigns that focus on customers based on both dimensions  Marketing campaign focusing on both metrics will allow firms to increase both the customer profitability and the positive WOM  However focus on either one depending on the campaign goal:  CLV campaign: Encourage users to buy more within/across category Usually occurs in a competitive market, when difficult to acquire new customers  CRV campaign: Acquire more customers/prospects through current customers Necessarily if the current customer is already spending majority of their spending budget on the company

28 V. Kumar and W. Reinartz – Customer Relationship Management Summary  The NPV objective function required to maximize customer equity of a firm, is related to cash flow from each customer, expected inter-purchase time and cost and frequency of the marketing/communication strategies employed  Cross analysis of duration of relationship and customer value indicates that not all short duration customers deliver lower profits and not all long duration customers deliver higher profits  By linking acquisition and retention process, it is possible to see a complete and unbiased picture of the drivers behind customer selection/acquisition, relationship duration, and customer profitability  When firms understand the link between CBV and CLV, they can efficiently allocate resources to maximize value  Customers should be evaluated and approached with different types of marketing offers catering to maximizing CLV and/or CRV