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

Chapter 16:

Applications of CRM in

B2B and B2C Scenarios (Part 2)

2V. 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


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


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


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


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 = 225 N = 21 246

Not expected to buy in the next 12 months as per the model

N = 12 N = 66 78

Total 324

Hit Rate = 225+66/324 = 90%

Example:


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

Short Long

$29,235 (n = 170)

$141,655 (n = 154)


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 Duration Longer Duration

Low Customer Value

Cell I

N = 78Average Profit = $ 1,387

Cell III


High Customer Value

Cell II


Cell IV

N = 72 Average Profit = $ 302,542


Reallocation of Resources Based on Customer Value

Cu

sto

mer

Val

ue

Duration of Relationship High

Low

High

Low

Low/ Low

Face to Face Meetings:-Currently meets once every 6 months-Optimal meeting frequency is once every 14 months

Direct Mail/Telesales:Current Interval is 27 daysOptimal Interval is 26 days

Face to Face Meetings:-Currently meets once every 3 months-Optimal meeting frequency is once every 4 months


Face to Face Meetings:-Currently meets once every 4 months-Optimal meeting frequency is once every month


Face to Face Meetings:-Currently meets once every 6 months-Optimal meeting frequency is 4 months


High/ Low

Low/ High High/ High


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


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 Group Control Group Difference

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


Prospects

Non-acquiredCustomers

Relationship Duration

CustomerCustomerProfitability

Acquisition Process Retention Process

- Firm actions - Customer actions - Competitor actions - Customer characteristics

AcquiredCustomers

Linking Customer Acquisition, Relationship Duration, and Customer Profitability


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


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


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


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


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

I2I1

Intervention Points


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


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


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 Patrons True Loyalties

Strangers Acquaintance

HighLow

CLV

High

Low

CBV


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

rateDiscount

anywayjoinwouldwhocustomersofValue

rateDiscount

referralofbecausejoinedwhocustomersofValueCRVi

T

t

n

nyt

tyT

t

n

yt

tytytytyi r

ACQ

r

ACQMaACRV

1

2

11

1

1 )1(

)2(

)1(

)1(

Where T = the number of periods that will be predicted into the future (e.g. quarters, years)

Aty = the gross margin contributed by customer ‘y’ who otherwise would not have bought the product

aty = the cost of the referral for customer ‘y’1 to n1 = the number of customers who would not join without the referraln2 – n1 = the number of customers who would have joined anyway

Mty = the marketing costs needed to retain the referred customers

ACQ1ty = the savings in acquisition cost from customers who would not join without the referral

ACQ2ty = the savings in acquisition cost from customers who would have joined anyway


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 (n2) 4

Marketing cost per period (Mty) $18

Average gross margin (Aty) $98

Cost of referral (aty) $40

Acquisition cost savings (ACQ1ty and ACQ2ty) $5

Number of referrals that would have joined anyway (n2 – n1) 2

Yearly discount rate (r) 15%


Customer Referral Value – Example (2/2)

1. Determine the number of customers who would have made purchases anyway (n2 – n1) = 4-2 = 2

2. Predict future value of each referred customers

(Aty – Mty – aty + ACQ1ty)/ (1+r)t = (98-18-40+5) / (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




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.



Period 1: Period 2:

2

111

11

11

11111 )1(

)2(

)1(

)1(CRV

n

ny

yn

y

yyyy

r

ACQ

r

ACQMaA

93$)075.01(

)5($

)075.01(

)5$18$40$98($CRV

4

31

2

111

yy

2

112

21

12

22221

12

222 )1(

)2(

)1(

)1(

)1(

)( CRV

n

ny

yn

y

yyyyn

y

yy

r

ACQ

r

ACQMaA

r

MA

225)075.01(

)5($

)075.01(

)5$18$40$98($

)075.01(

)18$98($CRV

4

32

2

12

2

122

yyy

318CRVCRV CRV Total 21


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)

1 1,933 402 1,067 523 633 904 360 7505 313 9306 230 1,0207 190 8708 160 969 137 65

10 120 46

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



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) = $1,219CRV (1yr) = $49

Champions

21% of customersCLV (1yr) = $370CRV (1yr) = $590

Misers


Advocates


HighLow

CRV

High

Low

CLV



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


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

Documents

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