by Don Peppers
When you plan a new marketing or service initiative you probably have to justify it by doing a business case, showing the return on investment you expect it to generate for your company. And ROI is simple to understand: Suppose you’ve invested in a stock worth $100. During the year it pays a dividend of $5, and by the end of the year its value climbs to $110, so your return on that stock investment for the year is 15%. Easy peasy.
But ROI isn’t always the right metric for evaluating marketing, sales, and service initiatives, because for many such initiatives the primary constraint isn’t the availability of money, per se, but the availability of customers.
Like labor and capital, you should think of customers as a scarce productive resource. Customers are almost always scarcer than money, because money is “stretchable” – the higher your prospective ROI, the easier it will be to find the money to make it happen. If you don’t have the funds to launch the initiative, you can borrow what you need from a bank, or from your shareholders, or from your rich uncle.
But there’s no secondary market for customers. You can’t go to a bank, borrow some customers to create value for your business, then return them to the bank with interest. No, the number of customers and prospective customers you have is a finite number. You might have a lot of them, but you can still count them one at a time. Most entrepreneurs will tell you that a good idea can raise capital reasonably quickly. But the real test of a new business is whether it can attract – and keep – customers.
So rather than calculating the return on investment when you’re evaluating a sales, marketing or service initiative, it might make more sense to ask what return you’re getting on the customers that are involved in the initiative.
Return on investment (ROI) answers the question “How much value can I create per dollar?”
Return on Customer (ROC) answers the question “How much value can I create per customer?”
And how would you calculate your Return on Customer?
Very simple: If you have a customer who has a lifetime value (LTV) of $100, and during the year you make a $5 profit on that customer, while your analytics model shows that by the end of the year you’ve raised the customer’s LTV to $110, then your Return on Customer that year for that customer was 15%. Again, easy peasy.
As with ROI, the ROC you earn on a marketing initiative must always be greater than your company’s cost of capital. If it isn’t, then it makes no sense to invest funds in the initiative, since your shareholders won’t be any better off, right?
There is a caveat to all this, however, and it has to do with customer lifetime value. The most academically precise definition of a customer’s lifetime value is the net present value of future cash flows attributable to a customer. But no one can truly know what the future holds, of course, so the best we can do is to dissect the patterns shown in previous customer activities to infer what customers will do in the future, given the patterns they now show. It’s never going to be exact, but in data-rich environments with large statistical populations (such as telecom, retail, and financial services), companies can get pretty good at approximating this “ideal” customer lifetime value metric.
Or, a business can use a proxy variable – some other metric that has been found to mirror LTV or to approximate, at least, a realistic view of the likely future cash flows of customers.
The point is, if you aren’t at least taking a stab at trying to understand the actual economic value of your customers, individually, then you can never evaluate your company’s marketing, sales, and service initiatives based on their true value to your shareholders.
At a minimum, you should be trying to correlate survey-based customer experience metrics (such as CSAT or NPS) with subsequent customer behaviors, so that you can use the quality of your customer experience as a proxy variable for changes (up or down) in customer lifetime values.
And remember: Because you only have a finite number of customers and prospective customers, every time you fail to maximize the value any particular customer creates, this represents a permanent, irreplaceable loss to your business. Yes, you might be able to find another customer to replace a dissatisfied customer, but if you hadn’t flubbed the first customer’s experience, you’d now have two customers, wouldn’t you?