Manage Marketing by
over the expected life of that customer. Then we better than people at combining simple predictions
discount the expected contributions to a net pres- to address a larger issue. The result of using deci-
ent value at the company's target rate of return for sion calculus is only as good as the managers in-
marketing investments. Finally, we add together volved in the process, but the tool allows managers
the discounted, expected contributions of all cur- and models to do what they do best in the face of
rent customers. a complex dilemma.
Appraising customer equity is conceptually simi- In this case, we approach the larger question-
lar to appraising the value of a portfolio of income- What is the optimal balance between customer ac-
producing real estate. Two of its main determinants quisition and customer retention at my company? -
by asking several smaller questions
about acquisition and retention. The
The appropriate question for curves we will create reveal the
points at which a company is spend-
judging new produets and ing more than a customer is worth
to acquire or retain. Those points,
along with consideration of several
customer service initiatives is, other factors, show managers how
W i l l it g r o w o u r c u s t o m e r e q u i t y : their acquisition and retention ef-
o 1 ^ forts should be balanced.
Let's look at a practical example,
are tbe cost of acquiring customers and the future using, for ease of description, a case in which a
profit stream from retained customers. But a host of company markets a single product that customers
other factors, including remarketing costs and buy once or twice a year. By keeping the case sim-
brand strategy, can also have significant influence. ple, complications-such as the problem of ac-
Ultimately, we contend that the appropriate counting for ancillary sales or of allocating the ef-
question for judging new products, new programs, fect of one marketing investment to more than one
and new customer-service initiatives should not be. product-will not distract from the essence of the
Will it attract new customers? or. Will it increase process. Amending the method later to accommo-
our retention rates? but rather. Will it grow our cus- date refinements will be a straightforward task.
tomer equity? The goal of maximizing customer We have chosen to work with a product that is
equity by balancing acquisition and retention ef- purchased at least once a year to make it practical
forts properly should serve as the star hy which a to express retention rates on a per-year basis. If cus-
company steers its entire marketing program. tomers' purchase cycles are longer than a year, as
they are with automobiles and other durables, it is
better for managers to estimate retention rates on
Finding the Balance aper-cycle basis.
To use customer equity as the criterion that bal- Finally, and again simplifying for the sake of ex-
ances spending on getting and keeping customers, position, we gloss over the question of the lapsed
we need to express it as the sum of two net present customer. If a customer is not retained, we will as-
values: the returns from acquisition spending and sume that the cost of reactivating that customer
the returns from retention spending. We use a tool will be the same as the cost of acquiring a prospect.
called decision calculus to build a model of this re- In practice, it usually costs less.
lationship by creating two curves. The first curve We begin hy estimating the shape of the compa-
relates acquisition spending to the resulting acqui- ny's acquisition curve. To do this, we ask the man-
sition rate, and the second curve relates retention ager to provide two points on the curve: first, the
spending to the resulting retention rate. These company's current level of acquisition and second,
curves characterize the company and its industry. the ceiling-the highest possihle number of cus-
What is decision calculus? It is an approach to de- tomers the company could reasonably acquire in a
cision making in which a manager breaks down a given time period. (Acquisition and retention do
complex problem into smaller, simpler elements, not increase without limit as spending increases.
forms judgments about each element separately, There is a ceiling, which will vary from industry to
and then uses a formal model to turn those small Industry. For example, the ceiling is much lower for
judgments into an answer to the larger question. a property and casualty insurance company using
Studies have shown that people can predict simple direct mail to acquire new customers than it is for
events better than complex ones, and models are the average catalog retailer. Similarly, the retention
1 2 The peak of
th« value curve
Maximizing Customer Equity
Q
m
in the first year...
u The balance between acquisition and retention
1 spending is never static. Managers must constantly
reassess the spending points determined by the de-
0 cision-calculus model, keeping in mind a host of
10 15 $20 considerations. The following guidelines should
X
ocquisition budget help frame the issue.
10% Invest in highest-value customers first. In the
model just described, we showed how to allocate
marketing investments between only two groups,
prospects and customers, and we used averages to
1 20 characterize the responsiveness of eacb group. This
...is set by the
.0 shape of the logic should be applied to much finer distinctions
'in
'3
t acquisition curve. among the company's customer base and prospect
u- list. Instead of using averages drawn across the en-
optimal tire customer base, for example, a more subtle
acqu isi lion leve analysis would partition the base into behaviorally
^ 30 and attitudinally homogeneous groups that spend
at different levels, and it would estimate the shape
acquisition rate limit of acquisition and retention curves for each group.
The analysis would then proceed to evaluate the
40
customer equity of each group, starting with the
most valuable and proceeding to the least. For each
the insert "Calculating the Optimal Level of Reten- group, the analysis first would determine the opti-
tion Spending.") We use the answers first to gener- mal investment required to retain members of that
ate a eurve that relates retention spending to suc- group and then how much to spend to acquire more
cess at retention. (See the graph "How Customer people who fit that group's profile.
Equity Depends on Retention Spending.") Again,
the eurve reflects the diminishing returns in efforts Targets with particularly high equity might jus-
to retain customers. Next, we generate the curve in tify major investments. Airlines, for example, know
the upper half of the graph, a curve that grows as re- that a large investment in retention incentives pays
tention spending gives the customer more reasons off. One result is the progressive structure of airline
to remain loyal, and then declines as customers no frequent-flier incentives: The more a customer
longer value the retention service enough to cover flies, the easier it becomes for that customer to earn
its cost. more generous benefits. Similarly, long-distance
Despite the simplicity of this example, it illus- phone companies in the United States recognize
trates how the decision-calculus process-in this that one of their highest-value customer groups is
case, using four small, explicit decisions and a model recent immigrants, who maintain phone contact
to solve one large, messy problem-can pay off. Do with relatives and friends in their countries of ori-
this manager's actions coincide with his or her intui- gin. The phone companies work hard at retaining
that segment, serving it with native-language replace it in 100% of the products in inventory. His
phone operators and offering special promotions. calculation accurately assessed the single-period
Transform product management into customer cost to the company of each course of action but
management. The eustomer-equity perspective fa- took no account of tbe impact on customer satisfac-
vors customer management over product or brand tion or the probability of repeat purchases. When
management as an organizing principle. When eval- the problem was reframed from the perspective of
uating new products and services, keep in mind the potential for losing customers, the managers
that small changes can have a big impact. Indeed, saw immediately tbat replacing the component in
the value of improvements in customer equity is of- the warehouse was the better alternative.
ten not fully appreciated until it is expressed as a American Airlines' introduction of the frequent-
capitalized amount. Consider what happened when flier program in 1981 inspired an astonishing range
a major manufacturer of durable goods discovered of industries to create membership clubs, includ-
that a component of one of its products was failing ing car rental agencies, restaurants, cosmetics com-
at a rate of 35% within one year of purchase. The panies, ski lodges, pbotofinishing shops, and over-
operations manager determined tbat it was less night package shippers. Some critics argue that
costly to replace tbe component in the 35 % of prod- competition has negated tbe influence of the bene-
ucts that failed in customers' homes than it was to ^ We would argue, on the contrary, that reten-
tion programs, if skillfully designed, can be much
more than volume-discount programs. They can in-
How Customer Equity Depends spire loyalty from the market's biggest spenders.
on Retention Spending The key is to deliver benefits that appeal more to
heavy users than to light users, that draw attention
to a brand's claimed distinction, and tbat enliven
the buying experience so that tbe heavy user be-
comes an even heavier user. For example, Nintendo
and Lego designed elubs that showed members new
ways for kids to enjoy their games and toys.
Through the clubs, children also came into contact
with other heavy users. For adults, Harley-David-
son and Corvette bave designed cluhs with a simi-
lar impact on users. And hotels have made club
membership a source of customer recognition and
a way to ease the strains of the traveling life.
Consider how add-on sales and cross-selling can
increase customer equity. Tbe value of a customer
is reflected not only in the revenue earned from the
initial purchase but also in the present value of fu-
ture revenues contingent upon that purchase. In
other words, if the customer buys product A, will
he or she buy products tbat supplement or comple-
ment product A? A customer who purchases a laser
printer may well buy additional memory, toner car-
tridges, special paper-handling devices, and supple-
mental fonts in the future. Someone who buys a
new car will later need service visits, body repairs,
and new parts. An accounting partnership can be
confident that if it wins the contract to perform au-
dits for a client, it will probably he able to sell other
accounting services to tbat same client. Additional
sales enhance the value of the customer relation-
ship over time.
In the terminology used by direct marketers, the
cost of marketing additional products and services
to the installed, or existmg, customer hase is called
remarketing cost. Customers who like a company's
products and services are less expensive to serve than normal for the industry, introduced prequali-
with new products and services. In this way, re- fication procedures in order to discourage agents
duced costs of remarketing are one of the less visi- from pursuing prospects when the likelihood of
ble rewards of investment in eustomer satisfaction. writing a policy was low. Although the procedures
Look for ways to reduce acquisition costs. Acqui- reduced the company's rate of sales, they reduced
sition costs have a strong impact on customer equi- the cost of acquiring customers by even more and
ty. With high acquisition costs, retention rates and boosted both the company's profits and its cus-
add-on sales must he high to make the product or tomer equity.
service viahle. Therefore, if the company can ac- Track customer equity gains and losses against
quire customers at a lower cost, the long-term pay- marketing programs. A customer-value flow state-
off improves significantly. Despite this potential ment-much hke an organization's cash flow state-
henefit, many companies do not know what per- m e n t - c a n highlight problems that the income
centage of their marketing budget is being used to statement conceals. A company that churns its cus-
acquire new customers and what percentage is he- tomer base (acquires eustomers just as fast as it
ing spent on existing customers. Is the company's loses them) can report good sales and profits even as
general advertising building loyalty, acquiring cus- its customer equity is evaporating. As it churns,
tomers, orhoth? the company has an increasingly difficult time ac-
For example, a Ufe insurance company, noticing quiring new customers cost-effectively, and, finally,
that its customer acquisition costs were higher when it has churned all prospects through the sys-
tem, acquisition eosts become impossibly high. ferent brand manager bent on maximizing share in
Whereas an income statement gives no indication his or her market, and the manager of the strong
of churning, a customer-value statement reports hrand resisted allowing the weaker siblings to ride
whether the company's marketing programs are on its coattails. But research showed that the strong
building or eroding the customer base. brand had as much to gain from cooperation as the
When American Express Company acquired IDS other two. When experiments were conducted to
Finaneial Services, a company that markets insur- measure the response to coupons for one product
ance and mutual fund products through a 5,000- delivered only to users of the other two, all three
member sales force, it found that behind IDS's at- hrands showed impressive results. It was easier to
tractive rate of sales and profit growth lurked a high persuade a user of two of the products to try the
rate of churning. IDS was losing a client almost third than to persuade a nonuser of any of the prod-
every time it gained one. And marketing programs uets to try one. Brand-management myopia had
implemented at headquarters were fueling the been preventing the eompany from discovering that
churning. IDS was spending $16 on marketing pro- it could he good at customer management; it could
grams to generate leads for the sales force for every cross-sell to increase a customer's equity more effi-
$1 that it spent on programs to strengthen the rela- ciently than it could acquire a customer three times
tionship between the eompany and existing clients. over - once in each market.
When an American Express study found that IDS
was managing only 15% of a typical client's finan- Monitor the intrinsic retainability of your cus-
cial assets, the company immediately shifted its tomers. Intrinsic retainabiiity is determined by the
focus from acquisition marketing to retention mar- way the eustomer uses a product or service. When
keting. The key was to encourage sales representa- that use changes, retainability changes at the same
tives to open up a relationship with a customer by time, and companies must scramble to adjust their
selling a personal financial plan as the first transac- allocation of marketing funds.
tion, rather than an insurance policy or a single in- For years, marketers in the air freight industry re-
vestment. By promoting personal financial plans, quired expertise in customer acquisition. An effi-
IDS made it easier for reps to make additional sales cient acquirer earned a higher return than a skilled
to existing customers than it had been. The result retention marketer beeause eustomer satisfaction
was not seen in annual sales, which continued at was out of the hands of the shipper and in the con-
their steady clip, but rather in much more rapid trol of the airlines that carried the freight. Federal
growth in the lifetime value of the eustomer base, Express's innovation, the creation of an airline ded-
which promised a more seeure future for IDS. icated to nothing but freight, gave shippers more
control over customer satisfaction and sharply in-
Relate branding to customer equity. Brands don't creased the returns that could be earned through re-
create wealth; customers do. Despite the fashion- tention marketing. Suddenly, the successful com-
ahle concern with brand power, few would dispute panies were successful retainers.
that highly visible brands are just
one instrument among many with
customer-value statement
reports whether a company's
they reach. Once Sears reanalyzed marketing programs are building
its transaction records-asking not,
What are our most valuable brands? or eroding the customer base.
but rather. Who are our most valu-
able customers?-the eompany began to seek shop- Traditionally, IBM ran its mainframe computer
pers for new clothing much more vigorously than business as a retention business, training its sales
ever before. foree to follow the initial sale with attempts to sell
Managers should watch for signs that brand man- peripheral equipment, software, a contract with its
agement is impeding eustomer management. Con- service bureau, and so on. Customers were prized
sider a Canadian manufacturer that makes prod- because they became lifetime IBM users. But as
ucts in three distinct markets under the same brand microcomputers displaced mainframes for many ap-
name. One product is strong; the other two are phcations, the company was compelled to deploy
weak. Several years ago, each was managed by a dif- more of its marketing funds for acquisition. The
pace of technological evolution weakened brand used the airline to fly within Europe but did not use
loyalty, and a new eonsumer emerged who ascrihcd it to fly from the United States to Europe. The com-
much less value to relationships. For a time, IBM pany then formed a team to address acquisition ef-
tried to exploit past loyalties by endorsing selected forts for that customer segment. Next, it charged a
software and attaching its brand name to peripher- retention team with the task of finding what it
als, but the game had changed. Today the company would take to keep those customers. The team
has cut back on its famed sales force in favor of less came up with a fast track for arriving transatlantic
expensive retention tools such as database technol- passengers that included accelerated processing of
ogy and catalog-based direct sales. customs and immigration documents, private
suites, and valet services.
An organizational structure built
When managers strive to grow around getting and keeping cus-
tomers, not simply selling products,
customer equity, they put the has some significant benefits. It al-
lows the marketing organizations to
use tactics that are appropriate for
customer at the forefront of their different customer segments. Mar-
keting research can be used to under-
strategic thinking. stand the needs of existing cus-
tomers as distinct from the needs of
prospective customers. And the performance and
when the time is ripe to change direction, the
compensation of marketing managers can be linked
signal usually comes from the environment, not
to increases in the customer equity between these
from the organization. The winner is the company
two groups.
that reads the signal first.
Consider writing separate marketing plans-or
even building two marketing organizations - for ac- When managers strive to grow customer equity
quisition and retention efforts. Loeating eustomers, rather than a hrand's sales or profit, they put the
attracting them, and then managing the ongoing re- eustomer and the quality of customer relationships
lationships are very different tasks. They require at the forefront of their strategie thinking. Product
different kinds of market research, different cost sales, brand strength, and short-term financial per-
analyses to calculate the return on investment, and formance are mere secondary indicators of success.
different measures to monitor compliance. There- Furthermore, when managers ask how much a
fore, we recommend that once managers have de- marketing investment will increase a eompany's
termined the most appropriate ratio of acquisition customer equity, the interests of the marketer and
and retention spending, they plan for each task sep- the company's shareholders are precisely aligned.
arately. In direet-marketing organizations and in in- Just as an investment firm's interests are served if
dustries with a large customer-serviee component, its investment managers are judged hy the ehange
such as airlines, it may in faet be advantageous to in portfolio value from one period to the next, so a
place acquisition activities under separate control company is well served if its marketers are judged
from retention activities. by the increase in the company's customer equity
Separate marketing teams to manage customer over time. If a marketing organization backs away
acquisition projeets and retention projects have from the challenge to link its fortunes to the cus-
proved effeetive in many companies, especially tomer-equity criterion, it either misunderstands
when the projects can be sharply defined by the the purpose of the marketing function or lacks the
needs of particular eustomer groups. British Air- authority to carry out that purpose. ^
ways, for example, identified U.S. residents who Reprint 96402 To order reprints, see the last page of this issue.