CUSTOMER VALUE IN RELATIONSHIP MARKETING Pop Nicolae Al. Bena Irina Academia de Studii Economice Bucureşti, Facultatea de Administrarea Afacerilor (cu predare în limbi străine), Calea GriviŃei 2-2A, Sector 1, 010731 Bucureşti, Tel. 021 2128607, E-mail: [email protected], [email protected]

The approach by which the client is regarded as an essential company asset represents an important conceptual evolution in relationship marketing. Being the convergence point of organizational activity, the client is perceived in a constantly growing measure, not only as the bearer of demand the company seeks to satisfy, but as an asset, a measurable value needing a correct determination. The present communication intends to build up a bridge between marketing and financial management. Starting from simple evaluation models it tries to focus the attention of decision makers onto procedures and instruments meant to measure the effort of gaining and retaining an important client over a specific period of time. The results of these efforts are compared with the effects by using organizational performance indicators. The proposed models are accompanied by numerical applications, thus obtaining an operational character. After presenting the concept of customer lifetime value, the communication seeks to establish its relevant phases. The goal is to identify influence factors for the importance attributed to a client by the company and the relationship between the customer lifetime value and the company’s market strategy. Finally, this communication aims to establish a connection between the customer lifetime value and the value of a company. The bibliographic support is insured by an up-to-date specialty literature. Key words: relationship marketing; customer value; customer lifetime value; customer equity; customer retention.

1. Introduction Nowadays customers are considered in the scientific literature as a company asset (Lawis, 2005, pg. 230-238; Ryalds, 2005, pg. 252-261; Gupta/Lehmann, 2006, pg. 15-16). According to this point of view customers should be regarded as economical values. Such an approach would lead to a differentiated treatment towards distinctive categories of customers according with their long term level of profitability for the company (Haenlein/Kaplan/Schoder, 2006, pg. 5-20). In consequence, the marketing activity should be differentiated by the performance brought by each customer. It is obvious that such an approach is not specific to mass marketing, but only to a personalized marketing, characteristic for the relationship marketing approach (Pop, 2006, pg. 33-44). The preoccupation for the individualized customer knowledge is given by the importance each customer has for the company. Such a preoccupation represents a domination in contemporary marketing and evolved together with the shift from market orientation to the customer orientation of organizational activities. The intensification and broadening of direct communication with customers, which evolved jointly with the evolution of the direct marketing methods and instruments, obtained in Romania too an institutionalized contour (Pop/Mihoc, 2007, pg. 59-60). The advantages given by this direct communication significantly modified the problem hierarchy economic agents are confronted with in their effort of collecting information about the market they are addressing and want to serve. Big scale companies invest millions of Dollars or Euros for customer research, especially for determining satisfaction levels and identifying loyalization possibilities. Still some question remain: “Which is the value of a customer?”; “Is it sufficient to analyze the value of customer purchases or should the frequency taken into consideration?”; “What does the switch of a customer to the competitor really mean? What effects does it have?”. Scientific literature estimates that the effort needed in order to gain a new customer implies marketing costs up to five or six times bigger than the effort needed to re-gain a customer back from the competition (Meffert, 2000, pg. 873). The value of each customer is conditioned by the loyalization over a long period of time. Thus, the management of the customer’s relationship with the company becomes essential for the success on the market (Moisand, 2002, pg. 18).

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2. Evaluation models for customer value The interest on the subject of customer value is directly linked with the evolution of relationship marketing. As gaining and retaining customers becomes a vital preoccupation for companies, evaluating the attractiveness and profitability of customers becomes a must. (Eggert, 2001, pg. 42). By building up lasting relationships with customers, companies can achieve their ultimate objective: profitability. In order to ensure overall profitability any resources invested in creating those bonds have to be linked to customer profitability (Kumar/Shah, 2004, pg. 322). The concept of customer profitability reflects the companies’ perspective on customer value. In the scientific literature customer value has a two sided meaning (Eggert, 2001, pg. 42, 46): On one hand, customer value reflects the contribution customers make to achieving the company’s monetary and non-monetary goals. On the other hand, authors search for the way customers perceive the offer of companies – customer perceived value. Customers evaluate the relationship with a company and decide upon its continuity based on the perceived net utility. The focus of the present paper is the company’s perspective. First an overview of the evaluation models is presented – monetary ones in particular. Further, the paper offers a specific numerical example for one of the most common models based on financial calculations. The scientific literature comprises presentations of a large variety of evaluation models for customer value. Basically these models can be divided into two main categories (Helm/Günter, 2001, pg. 14-21; Eggert, 2001, pg. 42-46; Cornelsen, 2000, pg. 91): one-dimensional and pluri-dimensional. For the first category the models are partially analytical and focus on the determination of customer value based on one dimension regarded as the most significant one. Pluri-dimensional models try to encompass the complex contribution of different factors.

Sales analyses Monetary

Customer profit and loss account Customer lifetime analyses

One-dimensional

Nonmonetary

Evaluation models for customer value

Customer satisfaction analyses Purchase frequency analyses Scoring models Customer portfolio analyses

Pluri-dimensional

Holistic customer evaluation models

Fig. 1: Evaluation models for customer value Source: Cornelsen, 2000, pg. 91.

One-dimensional models can be in turn divided into monetary and non-monetary models. The best known monetary model and the one widely used in praxis is the ABC Card based on the so called “80:20 Rule”: 80% of the sales are generated by only 20% of the customers (Bartl, 1992, pg. 42). Still, some of the sales producing Acustomers can be on a closer look also loss creators due to their high negotiation power and the special offers they receive. Rust et al. propose (Rust/Zeithaml/Lemon, 2001, pg. 191) propose the Customer pyramid with the following four levels: − − − −

platinum customers: heavy users, less price sensitive, ready to try new products out; gold customers which demand sales discounts for their loyalty; iron customers which build up the mass of the demand but do not manifest stability and have a low profitability; lead customers: the costs exceed the incomes. 1114

Customer profit and loss accounts imply a rigorous financial data management for each customer or group of customers. The company has to be able to identify and attribute costs and revenues to customers in order to compute the contribution surplus (cash) generated during a specific period of time (Bayon/Gutsche/Bauer, 2002, pg. 217). Customer lifetime value (CLV) represents a more sophisticated monetary approach to compute not only past but also future customer profitability. It may be defined as the “measure of expected value of profit to a business derived from customer relationships from the current time to some future point of time” (Kumar/Shah, 2004, pg. 322). It is thus a forward looking metric that incorporates into one, all the elements of revenue, expense and customer behavior that drive profitability. The CLV analysis views customer relationships as investment decisions and customers as generators of future costs and revenue streams (Stahl/Matzler/Hinterhuber, 2003, pg. 268). Accordingly, CLV follows the formula of the financial metric “Net Present Value (NPV)” and represents the sum of all future, discounted net cash flows attributed to customers.

3. Customer lifetime value. Computing example Starting from the NPV approach authors have proposed different formulas for computing CLV (Bayon/Gutsche/Bauer, 2002, pg. 216; Stahl/Matzler/Hinterhuber, 2003, pg. 276; Günter/Helm, 2006, pg. 373; Pfaff/Simon, 2002, pg. 8). The differentiation comes from the effort to include in the calculations several aspects of a long term relationship: word of mouth, derived demand, retention rate or learning potential. In the approach of Pfaff and Simon (Pfaff/Simon, 2002, pg. 8) the weight falls on the customer retention rate. This rate is used as a measure for customer loyalty and helps to defining the upper margins of a company’s investment in the relationship. −1

  

t

d

t

∈0

t r

T

×∑

i

(1 + )

M

t

t

∈0

  −  

d

i

×∑

t r

T

C G

Vi L C

(1)

 = 

(1 + )

GCi is the amount of coverage per customer i, while Mi represents the relevant acquisition and marketing costs per customer i. T stands for the planning horizon usually set between three and five years. The customer retention rate is noted with r, d is the discount rate and t the time index. The starting point is given by the 20.000 new customers in year 1 (Fig. 2). This example follows the evolution of this customer group over a period of two years (year 2 and year 3). The retention rate in each year shows the percentage of customers who remain loyal to the company also for the next year. For instance: 60% of the 20.000 customers from year 1 still buy in year 2, meaning that the number of customers in year 2 is 12.000. Using two different averages, orders per year and value per order, the total annual revenue may be computed. The second part of the example addresses the costs. The direct cost for dealing with the specific number of customers is calculated as a percentage from the total revenue. An important aspect in this example is represented by the acquisition cost. The amount of money for acquiring the 20.000 initial customers must reflect all the company’s efforts in this sense and is spent only in the first year of the relationship. The premise for each CLV calculation is a clear delimitation and determination of costs and revenues for each customer or at least a specific group of customers. While this requirement may be easily fulfilled in case of a correct and detailed accounting basis, acquisition costs are rarely directly measurable. Because accuracy is imperative for each CLV analysis, the thoroughness of using the acquisition costs in the calculations may come on the second place. Thus, if not exactly determinable, the computation should be done by excluding the acquisition costs.

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Fig. 2: Computing example for customer lifetime value Source: Pfaff/Simon, 2002, pg. 10. As a difference between the total revenue and the total costs results the gross profit. In order to establish a comparison bases all profit values must be brought to the level of the first year. For this purpose a discount rate is used, which reflects an average between the annual inflation rate and interest rate for money deposits. t

=

P t G d

Vt P N

(2)

By using the formula (2) the NPV corresponding to each year is computed for the entire group of customers. The cumulative NPV reflects the level to which the profit amounts with each year that passes. CLV per customer is calculated by dividing the cumulative NPV to the number of customers. The rising CLV per customer for year 1 to 3 shows a growing profitability of the relationship with the group of customers in question. Consequently, the company should focus on maintaining a high retention rate, but the investment for this goal should not exceed the level of the CLV for each customer. 1116

4. Conclusion The presented models for customer value determination are tools for companies to use in order to ensure profitability. From them all, CLV includes the most representative aspects of the customer-company relationship and also offers a time dynamic. We propose CLV as a decision making tool to locate the maximum marketing investment on a loyal customer without running the risk of spending more than the revenues. Regardless of the approach, monetary or non-monetary, the relatively new concept of CV should be repositioned among the management preoccupations of companies. Such a repositioning imposes as a premise certain changes. First, the mentality of decision makers has to adapt to the new perspective. Second, distinctive and concrete attributions and responsibilities related to the entire mechanism of the relationship with customers have to be established.

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