How Are You Measuring Customers?

If you need to get your hands around the long-term viability of a company and its business model, you need to look at its financials. Hence, public companies have to file their financial statements to satisfy the U.S. Securities and Exchange Commission and Wall Street.

However, if you truly want to determine the company’s value, you need to know the value it places on its customers. So, shouldn’t it be easy to try to find out the company’s estimate of its customers’ lifetime value? Unfortunately, it’s not a number most people are focused on. Your car steers in the direction your eyes are focused on, and so will your business. This is why you need to understand the value of every customer.

Around the time of September 11, lots of folks decided they’d give airplanes a miss and turn to alternative forms of transportation. Enterprise Rent-A-Car didn’t have a logistics system to offer or track one-way rentals. But it did have a customer-centric corporate culture. So, the local managers took matters into their own hands and made one-way rentals available. One regional manager explained, “We knew we had to do the right thing and worry about the rest later.”

The cost to Enterprise was the displacement of thousands of its cars — operational chaos. What was the benefit? In a struggling economy, Enterprise now leads its category and is stronger this year than it was last year.

I asked Jim Novo, a customer behavior analyst, what his take on this event was:

I’m sure the financial statements at Enterprise groaned under the weight of these added operational costs — in the short term. But as a private company, Enterprise didn’t have to worry about making earnings for the next quarter; they simply understood the actions they took in this situation would create increased customer value and loyalty down the road. I doubt anybody convened a meeting where people got out their slide rules and tried to calculate the potential increase in lifetime value by taking this action. They simply already knew enough about their business and customers to eyeball it and say, “Yeah, this works. Let’s do it.”

What are the issues? This kind of situation pits customer accounting versus financial accounting, and it entails working with lifetime value calculations. I believe these issues are the root cause of “CRM Failure.” These misunderstandings are holding back progress.

A fundamental disconnect exists between the concept of customer-centricity and the periodic financial accounting system. A company ruled by the quarterly financials and Wall Street estimates has little incentive to engage in any customer-centric activity, because the costs frequently don’t synch up with the benefits on a monthly basis. Novo explains:

What is needed to solve this problem is a customer accounting system running in parallel with the financial accounting system, so that the cost of customer-centricity can be tracked and the value demonstrated to Wall Street. Public catalog companies, who not coincidently have been among the most successful companies on the Web, have always done this, reporting on metrics like “percentage of customers active in the past year.” Another clue — many of the most profitable catalog companies are private. If the stock market is truly a forward-looking mechanism, why does it have such a hard time dealing with lifetime value?

Perhaps the dissonance is because the lifetime value concept was horribly distorted during the boom years, when it was used to justify ever-higher stock prices. This is an example of customer accounting gone wrong. Just as the books were cooked on the financial side, they were cooked on the customer side, too. The problem was people skipped over the concept of the customer lifecycle. The customer lifecycle describes the activity of the customer while he is truly a customer and tells you when the customer is no longer a customer.

To calculate lifetime value, you need to know when the customer is no longer a customer. If you don’t know the lifecycle, or refuse to look for it, you can’t calculate lifetime value. It’s impossible. Think about it. This failure to “call an end” to the customer lifecycle is what created the “infinite” projections of lifetime value used by dot-coms to justify acquiring a customer for $300 or even $1,000.

David Galland from Everbank explains:

Regardless of your corporate resources, or lack thereof, you can — with just a little effort — build a simple model that projects a conservative lifetime value. Carve that number into the wall of your office and then use it to drive important metrics such as allowable cost per sale and, more to the point, the decisions you make that can affect those metrics.

At Everbank, we built an automated system that tracks every penny we spend and every dollar we make from each client relationship, so our data is very complete. However, using an Excel spreadsheet and some common sense, anyone can come up with a lifetime value number that, when you discount it to no better than a moderate case, will let you make marketing and CRM decisions and not get in trouble.

Having used this simplistic approach in building marketing and CRM programs for over 20 years, I can say without qualification that I have never exceeded my marketing budget or missed on the overall cost per sale.

Lifetime value is not difficult to measure; it’s just math. All you need is the courage to examine the customer lifecycle and call the end to a customer life. It really gets very simple after that. To get started right away, just forget about getting it down to the penny. Concentrate on “relative value.” For example, one group of customers is going to be more valuable than another. That is really all you need to get going.

The intangible value of the customer relationship is measured all the time — in “sales” and in “costs.” Forget trying to chase the pot of gold at the end of the rainbow called intangible value. Like they say about that spaghetti sauce — “It’s in there.”

What would customer experiences be like and how accountable would marketing be if all businesses focused on lifetime value instead of next quarter’s earnings announcement? I’m sure we’d all like to know. Tell me where your business is focused.