Customers Don't Grow on Trees

How do you strike a balance between customer needs and the bottom line? A new way to balance two potentially contradictory demands.

Repeat after us: The only value your company will ever create is the value that comes from customers -- the ones you have now and the ones you will have in the future. Businesses succeed by getting, keeping, and growing customers. Customers are the only reason you build factories, hire employees, schedule meetings, lay fiber-optic lines, or engage in any business activity. Without customers, you don't have a business.

But that's not how many companies behave, is it? The demand to satisfy Wall Street on a quarterly basis drives executives to pursue contradictory business goals. Most believe, intellectually, that customers represent the surest route to long-term growth and value -- yet in practice, they're quick to compromise that belief in the rush to generate current revenue.

We propose a new metric, Return on Customer, that reflects the cost of that compromise. It acknowledges that capital isn't necessarily a company's scarcest resource; that customers don't, after all, grow on trees.

Return on Customer is a twist on return on investment. The essential equation: a firm's current-period cash flow from its customers, plus any changes in the underlying customer equity, divided by the total customer equity at the beginning of the period. Customer equity is the net present value of all the cash flows a company expects its customers to generate over their lifetimes.

Return on Customer explicitly takes into account the two different ways customers create value for a business -- by increasing the company's current-period cash flows and by increasing its future cash flows. When a customer has a good (or bad) experience with a company and decides on the basis of that experience to give more future business to it (or less), the firm gains (or loses) value that instant. This change in value is analogous to the immediate change in stock price a company experiences when it announces a change in its expected earnings.

"Tesco produces 4 million versions of each mailing, tailored to customers' diverse interests."

The actions a company takes to achieve either of these outcomes -- increases in current cash flow or increases in customer lifetime value -- can have costs and trade-offs. If a long-distance phone company makes thousands of telemarketing calls to its customers to stimulate current sales, it may also erode people's willingness to buy in the future, or even to pay attention to future solicitations. The harm to customer lifetime values might actually exceed the boost in current sales. At the other extreme, a firm that concentrates solely on increasing lifetime values may find it isn't producing enough profit on a current basis. It's good to invest in customer satisfaction and loyalty, but how much is too much?

To maximize Return on Customer, a company needs to optimize the mix of short-term profit and long-term value created. But it's difficult for most firms to think like this because they're so focused on acquiring new customers -- any new customers -- and protecting quarterly revenues. (An example: A video store refused to accept the return of a damaged DVD from a friend of ours, a longtime customer, without a receipt -- even though its own electronic records confirmed her purchase. Result: It saved the cash it would have had to refund on that purchase but lost perhaps a hundred times that amount in customer lifetime value.)

The antidote, of course, is to treat different customers differently. Businesses of all sizes and shapes are now technologically capable of doing this, and some are brilliant at it. Tesco, the British supermarket chain, sends out a mailing each quarter to 11 million households -- but it produces some 4 million different versions of the pitch, tailored to the interests of its diverse customers. Similarly, electronics retailer Best Buy has trained its store employees to recognize and consider the needs of five distinct types of highly valuable customers -- and to change merchandising and store designs accordingly.

Why don't more companies act like this? The problem is that treating customers as a scarce resource is an incredibly subversive idea, undermining one of the most tried and true business premises -- that capital is the scarce resource. When capital is the scarce resource, then aggressive telemarketing makes a lot of economic sense: As long as the return on investment is positive you can just keep the marketing engine churning through more and more customers and prospects.

The fact is, however, that customers are not unlimited in number at all. Customers actually are scarcer than capital. After all, as long as you have a customer, you're pretty much assured of getting the capital you need to serve him. But having capital is no guarantee of getting a customer. Because customers are scarce, your positive telemarketing ROI will last only as long as it takes to chainsaw through the customer base. By then, your business's future value will have been sacrificed to maximize current earnings.

So, repeat again: The only value you can ever create must come from customers, your scarcest resource. It's time for companies and their managers to behave accordingly.

Don Peppers and Martha Rogers are founding partners of Peppers & Rogers Group, a Carlson Marketing Group company. Their new book is Return on Customer: Creating Maximum Value From Your Scarcest Resource (Currency Books). "Return on Customer" is a registered service mark of Peppers & Rogers Group.

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