Relationship Management Module 2: The Value of Relationships

Unit 3: Measuring CRM Outcomes

MAR 4860 – Customer Relationship Management MODULE 2 UNIT 3

Introduction

In this unit, we will focus on highlighting the numerical ways in which we can measure the various concepts we have spoken about so far. What good does it do a company to have CRM strategies in place if it isn’t monitoring the results?

How are customers reacting to these strategies? What true financial value are CRM initiatives having on the company’s profitability? A company needs to be able to measure the outcomes of its efforts.

In Module 1 we covered the Gartner eight building blocks of CRM. Remember the last block? It was metrics. CRM must have measurable objectives and monitor all levels of CRM to turn customers into assets. Gartner says that metrics is the most important of the blocks. Although we’ll cover metrics more in-depth towards the end of the semester, we will start now by identifying which customer metrics are critical in driving CRM benefits.

The primary goal of CRM is customer retention and loyalty, with the end being to increase sales revenues profitably.

©2021 Sarah Cherres 1

Customer Performance Measures

• Customer Satisfaction (ACSI)

• Service Quality (RRATE)

• Customer retention and churn rate

• Customer Lifetime Value (LTV or CVL)

• RFM (Recency, Frequency, Monetary)

• Net Promoter Score (NPS)

• Customer Experience Index (CX Index)

• Customer Effort Score (CES)

• Social media metrics

Modu1~ 2 I Unll 3cM~asurl 11fCRMOutco""'<

MAR 4860 – Customer Relationship Management MODULE 2 UNIT 3

Customer Performance Measures

This slide lists the basic metrics used today to measure CRM customer outcomes. The underlying measure of CRM effectiveness is customer satisfaction. We spoke about this in our last unit and identified the American Customer Satisfaction Index (ACSI) as a reliable, research-based metric that serves as a baseline for measuring the differences between customers and industries.

We also addressed service quality and its five components. The acronym RRATE specifies these components: reliability, responsiveness, assurance, tangibles, and empathy.

For the remainder of this unit, we’ll look at each of the other measures listed here:

• RFM as a way to gauge customer retention. The philosophy is that:

• High RFM customers have high future revenue potential

• Low RFM customers should not be abandoned, but different appeals should be directed at them

• Customer retention – Repeat customers generate more income than new customers. Marketing expenditures are less for repeat customers, who influence others. The opposite of retaining customers is losing them, which is measured by the churn rate.

• LTV or Customer Lifetime Value (CLV)

• Net Promoter Score (NPS) from Satmetrix

• Customer Experience Index (CX Index) from Forrester

• Customer Effort Score (CES) from CheckMarket

• We’ll also take a look at 10 social media metrics as gauges for predicting future CRM in marketing strategies.

©2021 Sarah Cherres 2

Measuring Customer Loyalty

Behavioral/Functional Loyalty Is the customer active?

How m uch t ime is spent?

What's the proport ion o f vis its/purchase frequency?

How does the customer coo perate?

Word of mouth (referrals)?

RFM-KEY MEASURE- Recency, Frequency, and Monetary Value

Attitudinal/Affect/Emotional Loyalty Trust

Beliefs and psychologica l comm itment- predisposition

Preferences and intent to buy (Called Propensity)

Emotional bonding

Switching cost is too high – too much has been invested

Behavioral outcomes – satisfact ion and service quality

Modu le 2 I Un it 3,: Mei,sur i neCRM Qutcomn

MAR 4860 – Customer Relationship Management MODULE 2 UNIT 3

Measuring Custom er Loyalty

Before we get into customer retention, let’s revisit loyalty. There are two ways of measuring loyalty: behavioral and attitudinal. Think of loyalty as the level of commitment. They tie back to the categories of loyalty we looked at in unit 2. Behavioral loyalty can be seen through actions, more specifically the purchases. Attitudinal loyalty cannot be measured through actions, but rather through emotions. Emotional or attitudinal loyalty (affect loyalty), however, LEADS to BEHAVIORAL loyalty.

Behavioral/Functional Commitment is objective & measurable. This can consist of the time spent in a store or online on a website or with a service provider; the proportion of visits in relation to the purchase frequency; the level of cooperation received from the customer to participate in surveys or other activities; or the word of mouth referrals provided by the customer to others. RFM is the most popular way to measure behavioral loyalty. The RFM variables are:

• Recency = time elapsed since last purchase. • Frequency = number of purchases in a given time period. • Monetary = monetary value of purchases in a given time period.

Behavioral loyalty relies on the actual conduct of the customer, regardless of the attitudes, feelings or preferences. Theoretically, it is possible that a customer can be loyal to a brand, even if they don’t like it, provided there are other reasons for repeat purchase. Customer loyalty is not the cause of brand preference but rather the result of it, and brand preference is not the only thing that might lead to behavioral loyalty.

Attitudinal/Emotional Commitment is more subjective & difficult to measure. Assessing attitudinal loyalty requires more expensive and subjective polling and surveying techniques. Attitudinal loyalty can consist of the degree of trust, the psychological commitment, or the emotional bonding the customer feels with the provider. Commitment can also be mandatory meaning that the customer feels like they have no other choice or that the switching cost is too high. The customer remains loyal because he or she has too much invested. Behavioral outcomes such as satisfaction and service quality are also measures of attitudinal commitment.

According to Peppers & Rogers (2011), positive attitudes, however, do tend to drive positive behaviors. Even if the firm observes loyal behavior, if the customer has no genuine attitude of loyalty, then the relationship is vulnerable to competition. Attitudinal loyalty without behavioral loyalty has no financial benefit for the company, but behavioral loyalty without attitudinal loyalty is weak, even though the company may be getting some financial benefit. With this in mind, we will now explore customer retention and LTV.

©2021 Sarah Cherres 3

Why are Companies Interested?

Customer Value: The economic value of the customer relationship to the firm – expressed on the basis of contribution margin or net profit.

CRM: The practice of determining corporate practices and methods that will maximize the lifetime value (LTV) of each individual customer to the firm.

Modu le2 IUn it3 : Measur inaCRMOutcomes

MAR 4860 – Customer Relationship Management MODULE 2 UNIT 3

Why are companies interested?

A customer can’t be viewed as a set of independent transactions, but rather as a lifetime stream of income to the company. This is what customer value is – it’s the economic value of the customer relationship to the company. This can be expressed in terms of contribution margin or profit margin. CRM is all about figuring out HOW you are going to grow and maximize the lifetime value of each individual customer. Once you identify what the value of each customer is, then you can categorize them into groups or cohorts.

Let’s define what customer lifetime value is and how it is calculated. LTV or Lifetime Value is the determination of current profitability and the estimation of future or potential profitability from each customer group, segment or cohort. LTV is the total present day value of a customer, segment or cohort. It is the sum of all past net margins compounded to today’s value, and all future net margins discounted to today’s value. Said in a different way, it’s the sum of all purchases (margins) over time minus the costs of reaching that customer, segment or cohort, compounded to today’s value.

LTV can also be used to PREDICT where additional (future) profits can be obtained from customers. The potential value of a customer is all future net margins discounted to today’s value. The slide shows how CRM is the practice of determining corporate practices and methods that will maximize the lifetime value (LTV) of each individual customer to the firm. Solid CRM practices will result in increasing levels of profit growth! That’s the goal. This is how you know whether or not your marketing strategies are working or not.

Sounds complicated doesn’t it? Let’s look at a real simple example on the next two slides.

©2021 Sarah Cherres 4

Customer Retention

Company A 15"' chum ,-111 Company B ,,.,..-,,_,

Year EJtlltlng Now …. ,

Eltlldng Now …. ,

customer customer customers customers …. customers customers ….

2001 1000 100 1100 1000 100 1100

2002 11?,45 100 1145 990 100 1090

2003 / 088 100 1188 981 100 1081 2004 V 1129 100 1229 973 100 1073

20o y 1168 100 1268 966 100 1066 I 1,100 • 0 95 (5% chum rate) = 1,045 I

Module 2 I Unit 3, Mnsurin1C~M Outcome,

MAR 4860 – Customer Relationship Management MODULE 2 UNIT 3

Customer Retention

To achieve profit margin growth, marketing strategies must have the ability to retain customers. The opposite of customer retention is defection (churn). A credit card company or mobile phone carrier concerns themselves with reducing its customer churn rates. By reducing churn, a company has a chance of increasing loyalty.

Here on this slide, we see what happens when a customer leaves the company. In this simple example, we have two different companies: Company A and Company B. We track the number of customers that leave over a period of five years. In Company A, the churn rate is 5% and Company B the churn rate is 10%. Churn rate is the rate at which customers the defect or leave the relationships with the company. Improving the retention rate, which is really the opposite of the churn rate, will increase the size of the company's customer base. So let's take a look at how these numbers impact the bottom line and the customer base. In this example, in the year 2001, both companies start off with 1,000 existing customers and 100 new customers for a total of 1100 customers. The following year, several of those customers are lost.

In company A, 5% of those customers are lost therefore leaving the total existing customer base at 1,045 but since they do get 100 new customers each year, the total for that year will be 1,145. In company B, they lose 10% of the 1,100 customers. So basically, we would be looking at 990 customers plus the 100 for a total of 1,090. This example keeps the new customers steady, which we know is probably not realistic, but the idea is to illustrate the effect of churn/retention. It’s possible that the new customers each year are leaving, and that can cause a major drain on resources and consequently to the profit margin due to the high costs of acquiring new customers.

If we continue to do the math all the way through 2005, always using the customer base as the base number for the churn rate, then we end up at the end of 2005 with 1,268 customers in Company A and 1,066 customers in Company B. So we can see the significant impact that the churn rate will have on the total number of customers that a company has.

©2021 Sarah Cherres 5

Lifetime Value (LTV)

PER UNIT EXPECTATIONS

Price

Cost of goods

Contribution margin

Direct expenses

Allocated costs

Expected net profit

x number of units purchased per time frame (year)

x number or time frames Unadjusted lifetime profit expectations

t I S–:l.._,_, ……. (_.Jtc,,i,luoJ~

$100

:1Q $90 -10

:1Q $70

x12

~ $4,200

Value of money over has 11 ·, bttn 111kt 11 i11to co11sidera1ion

Modul~ 2 I Unit 3: Mn~uri n1 CRM O utcomH

MAR 4860 – Customer Relationship Management MODULE 2 UNIT 3

Lifetime Value (LTV)

Here’s another example. Let’s assume that this is a simple spreadsheet for a TV cable company for one customer. It costs the customer $100 each month for the cable service. This is the PRICE.

Before estimating the expected profit from each customer, the cable company must deduct its costs: ($10 for cost of goods sold or COGS, $10 for direct expenses, and another $10 for allocated costs). That leaves an expected net profit of $70 for this customer.

Now based on historical forecasts and research, the cable company knows that the average tenure of a customer is five years (number of time frames) and that the number of units purchased per year is 12 (payment for service is monthly).

By multiplying the expected profit per unit of $70 x the number of units of 12 x the number of time frames of 5, we get the UNADJUSTED LIFETIME PROFIT EXPECTED from this customer. Unadjusted means we have not taken into account the value of money over time. The company can expect $4,200 of profit (unadjusted) from each customer.

©2021 Sarah Cherres 6

Effect of Discounting on LTV

Undiscounted profit over 5 years

Year I O I · $SO 1 +S30

2 +$40

3 +S55

4 +S72

ill! Sill

Discounted profit over 5 years

(15" discount rate )

Ym lo I I 1 +S30/l.15 • +S26.09

2 +$40/1.151• +S30.25

3 +S55/l .151• +S36.16

4 +S72/l.15'• +$41.17

•S88/l .15'- illill Sill&

The net present value of 5 years of profit earned from this customer Is $127.43

Modul~ 2 I Unit 3: Mnsurini:CIIM OutcotMs

MAR 4860 – Customer Relationship Management MODULE 2 UNIT 3

Effect of Discounting on LT V

Let’s now look at the effect of discounting the value of money over time. Here we see two scenarios. The first one is similar to the last slide, where the profit expectation is unadjusted or undiscounted. The total undiscounted expected profit is $235 for five years.

If you have taken a finance class, you may remember net present value or NPV. In the second example, we use a 15% discount rate to bring the future margins to the present time. What are those future profits worth today? After applying the discount rate, we see that the net present value (NPV) of the 5 year profit is $127.43. This is how much this customer will be worth over five years, at today’s dollars.

Companies normally use the weighted average cost of capital (WACC) as the discount rate. This is a figure that is published regularly in the financial world.

So how does all of this help a company? If you have this information for each of your important customers or customer groups, you can compare them and realign them into clusters based on how they are behaving and the value that these customers create for the company. We will learn much more about this when we discuss differentiating customers and study the “D” in the IDIC model.

©2021 Sarah Cherres 7

Impact of Customer Retention Rate

Year I Profit per NPV at 15% I Cuatonwr I • of I Total Annual Profit Cuttomer Discount Retention Cuatomera ($)

($) ($) Rate(%)

0 -100 100,000 -10,000,000

1 50 43.48 60 60,000 2,608,800

2 70 52 93 70 42,000 2 223,062

3 100 65 75 75 31 ,500 2,071 ,125

4 140 8000 80 25,200 2.016,000

5 190 94 53 85 21 ,420 2.024,778

8 250 10823 90 19,278 2,086,364

7 320 120 30 92 17,736 2 133,654

8 400 13072 94 16,672 2 179,346

9 450 127 84 95 15,838 2.024,744

10 500 12315 96 15,204 1,872.372

CI S…rahCherr … S..-:8-tklllljJ.

Module 2 I Unit 3, Mnsurin1CRM Outc<><Mli

MAR 4860 – Customer Relationship Management MODULE 2 UNIT 3

Impact of Customer Retention Rate Let’s look at another simple example, putting all of the previous slides together. Here we see several things happening:

• It takes an initial investment on the part of the company to acquire new customers. In this case, $10,000,000 to acquire 100,000. This means that the company generated an average $100 in profit per customer. For purposes of this example, we will track the lifetime of the first 100,000 customers without assuming additional new customers coming in each year.

• Included in this profit per customer are the revenues (price to customer) minus the costs associated with acquiring that customer. This is called the acquisition cost. Year 1 has no profit. The acquisition costs could be the marketing campaigns, F2F salespeople, advertising and other resources used to bring new customers in.

• We see that not all customers stay with a company after that initial investment. In this example, the company lost 40% of the initial customers (100%-retention of 60%). It’s essentially losing $40,000 in profits.

• If a company, however, works hard at keeping its initial 100,000 customers, we can actually see an increase in retention over time. Notice that customer retention rates are going up each year, from 60% to 70%, 75%, etc.

• Notice that it takes three (3) years to recover the -$100 profits lost in Year 0. In Year 3, we see a +$100. • As time goes by, the profits generated from each customer go up (first column), from -$100 to +$500 at the

end of Year 10. • What would have happened if the customer retention had not gone up each year? Do you think this company

would have survived, even if it brought in new customers each year? Remember that acquisition costs are significant!

There are several management strategies that a company can take to make these numbers more profitable:

1. Have strategies in place to make the first year retention higher. Losing 40% is too high. Keep as many new customers as you can!

2. Increase the profits earned from each customer by either making it less costly to serve each customer and/or offering additional products and services through up-selling and cross-selling.

3. Watch your marketing and sales costs. Do a better job at the marketing/acquisition /sales stage in increasing the number of customers at a lower cost. This means doing a better job of qualifying prospects and managing the sales process better. This means working smarter at marketing/advertising.

4. Giving special attention to customers with a high LTV. 5. Recruiting/targeting new customers with profiles that match those of customers with a high LTV.

©2021 Sarah Cherres 8

RFM Method 1

RECENCY (RI

ABC 1 months

DEF 2 months

JKL 6 months FREQUENCY (F)

MNO 8 months JKL 1 O purchases

XYZ 12 months XYZ 8 purchases

ABC 6 purchases

DEF 4 purchases

MNO 2 purchases

MONETARY (M)

ABC

DEF

JKL

MNO

XYZ

$25

$10

$50

$75

$100

Module 2 I Unit 3: Meesurina;CRM Outcomes

MAR 4860 – Customer Relationship Management MODULE 2 UNIT 3

RFM Method 1

Now let’s look more closely at RFM which stands for recency, frequency and monetary. RFM is a method used for analyzing customer value. It is commonly used in database marketing and direct or digital marketing, particularly in retail and professional services industries.

RFM sorts customers based upon the common notion in marketing that 80% of your business comes from 20% to your customers. So this segmentation method categorizes customers according to how recently they purchase something, how often they purchase or how frequent, and then the monetary value of their purchases or how much money they actually spent. For each of these categories then, customers are sorted and then the top 20% are given a score of one. The next 20% are given a score of two down to the last 20% who are given a score of five so that the top 20 customers who made purchases more frequently are given a one and the 20% who purchased most frequently are given a one and so on.

This slide shows three separate files. ABC, DEF, and so on, represent a B2B customer, or company. Assume that these are three Excel files or tabs. Now, again these are very, very simple and easy. In the real world, if we were doing an RFM analysis on a company that had 100,000 customers, think about how complex all of the tables would be and how difficult it would be to do this manually. This is where analytical CRM would help us do this a lot more efficiently.

RFM analysis helps you pinpoint your best customers easily and accurately. So instead of considering only one factor in defining the best customer, the process considers all three components: the recency, the frequency, and then the monetary value. First, each file is organized based on the highest to the lowest 20%. Next, we will take the monetary file and expand on that in the next slide. We will sort the monetary values in descending order.

©2021 Sarah Cherres 9

RFM Method 2

RECENCY (R)

ABC 1 months

DEF 2 months

JKL 6mont FREQUENCY (F)

MNO 8 mont JKL

XYZ 12 mor XVZ ABC

DEF

MNO $75

$50

$25

$1

M<>dule 2 I Unit 3: Mnsurin C~M Outcomes

MAR 4860 – Customer Relationship Management MODULE 2 UNIT 3

RFM Method 2

We took the monetary file and we sorted the companies in the order of the ones that spent the most money to the ones that spent the least money and we ranked them and gave them a numerical value. The five was assigned to the company that actually bought the highest amount and the four to the next one, and so on. So now they're ranked in monetary value.

On a piece of paper, do the same thing with the frequency and the recency files and then rank them in the order from the highest to the lowest and adding a numerical value from 1 to 5.

Once you’re done with that, let’s look at the next slide.

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RFM Method 3

Co. Name I R Value I F Value I M Value I Total Score

ABC 5 3 2 10

DEF 4 2 1 7

JKL 3 11

MNO 2 7

XYZ 1 10

BEST SCORE

Cl~r8nCherres Modu le 2 I Un it 3: Me8sur ln1CRM Outcomes

MAR 4860 – Customer Relationship Management MODULE 2 UNIT 3

RFM Method 3

After ranking all of the companies by R (recency) value, the F (frequency) value and the M (monetary) value, we then develop a total score by adding the rankings of each of these values.

In this diagram, here that JKL has the best score at 11. Keep in mind that you can use weights. For example, if the monetary value is twice as important as recency or frequency, your equation to add the values would be R plus F plus 2M so you put double the weight on the monetary value. So you can adjust the importance level of each of these factors.

So how could this method help you in your marketing and sales efforts? What would you do?

RFM analysis helps a company answer these questions:

• Who are my best customers?

• Which customers are about ready to churn?

• Which group of customers is most likely to respond to your current campaign?

• Who has the potential to be converted into more profitable customers?

• Who are lost customers that you don’t need to pay much attention to?

• Which customers must you retain?

• Who are your loyal customers?

The key is that this is not just a one-time exercise! This has to be done regularly. It’s an ongoing process. As you collect data, you can analyze the trends and patterns in the data. This is analytical CRM. There are analytical technology tools that can develop the insights from the data so that marketers can make better and smarter decisions on how to spend their dollars and gain the greatest return for the company and the customer. CRM is about the customer but we’re in business to make money too.

If you want to learn more about RFM, visit this page: https://www.putler.com/rfm-analysis/

We will now take a look at various metrics developed by subject matter experts in the areas of customer loyalty, customer experience and customer effort. I have selected a representation of what may be available on the market for companies looking to implement these types of metrics.

©2021 Sarah Cherres 11

Customer Loyalty

Extremely Li ely

How likely 1s 11 you would recommend us to a friend?

10 ' 8 7

~

L

6 4

%

3 2

Net Promoter core

0

J

Not atal ely

Modu le 2 I Uni t 3: Mensurln1CRM Outcomes

MAR 4860 – Customer Relationship Management MODULE 2 UNIT 3

Customer Loyalty One of the most popular gauges of customer loyalty is the Net Promoter Score (NPS). Earlier, we spoke about behavioral and attitudinal loyalty. It is incorrect to assume that a customer is loyal just because they continue to buy from you. Remember that true loyalty is more than a rewards program. There are many reasons why a customer continues to buy from a company. The customer’s motivation may have little to do with being really loyal. Consider the following reasons:

• There is a contractual arrangement

• It takes too much effort or money to change suppliers (switching costs)

• Your company is currently the lowest cost provider

• The relationship is with one of your employees and not with your company

• Habits are hard to break

True loyalty is when a customer continues to believe that your company’s product/service offer is the best option, always. It best fulfills their value proposition. The customer always takes your offer whenever faced with that purchasing decision. It means hanging in there even when there may be a problem.

So how can you measure this loyalty besides RFM. Conventional customer-satisfaction surveys often don’t work for this purpose, because the results don’t make it back to the front line in a timely and individualized manner to actually drive behavior change.

Some years ago, Fred Reichheld, the loyalty expert and a Bain Company team launched a research project to determine whether a different approach would be more valuable. Working with data supplied by Satmetrix, they tested a variety of questions to see how well the answers correlated with customer behavior. The results was the development of a new metric called NPS. As it turned out, one question worked best for most mature, competitive industries: What is the likelihood that you would recommend Company X to a friend or colleague? This is called “The Ultimate Question”, also a book by Reichheld.

NPS is based on how likely a customer is to ‘promote’ the company to a friend, colleague, family member or even strangers. Are you willing to put yourself out there?

To learn more about NPS, visit the website: http://www.netpromotersystem.com/index.aspx

©2021 Sarah Cherres 12

Customer Experience Index …….. – . —

113.3 =– r • – ·-

==–=—c– ·- ·- · – CX INDEX ———–Sourrf': https://forr.com/cxindexplatform — —

CISerehCherres Module 2 I Uni t 3: Musurln1CRM Outcoll'l6

MAR 4860 – Customer Relationship Management MODULE 2 UNIT 3

Customer Experience Index A key question that most executives ask is “What’s an improvement in our customers’ experiences worth in dollars and cents?” Or another one is “How’s that campaign or new customer experience initiative going to increase profits?” Forrester Research, a well-known company, developed a Customer Experience Index (CX Index™) and modeled the revenue impact of improving the customer experience. Forrester focused on answering three questions:

• What is a customer’s loyalty (retention, enrichment and advocacy) worth in revenue dollars?

• Is there a relationship between CX quality and loyalty-based revenue?

• How does the relationship between CX and revenue potential differ by industry?

Forrester discovered the following (Source: https://go.forrester.com/blogs/17-01-18- drive_revenue_with_great_customer_experience_our_2017_analysis_will_help_you_make_the_ca/) :

Advocacy loyalty (NPS) is a small share of the overall revenue impact. That’s because not every recommendation will result in net new customers. For one thing, if the recipient of a recommendation is already a customer, then the recommendation is moot. Therefore, the higher a company’s market share, the lower the chance that a recommendation will reach someone who isn’t a customer already and result in a net new relationship. Additionally, the recipient must need the services that were recommended. For example, Amazon offers easy access to a broad range of products — more than 250 million in all. In contrast, Etsy offers about 40 million products, many of them “vintage go

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