Why you should focus on customer lifetime value

Professor of marketing, predictive modelling expert and author, Dr Peter Fader, shares his advice on why it's better to put the emphasis on a customer's strategic value, not mobile moments

Marketers trying to identify every customer in their moment of need through complex sets of digital, social and mobile data would be better off spending more time on retaining and developing their most valuable and profitable customers using predictive modelling.

That’s the view of Dr Peter Fader, professor of marketing and co-founder of the Customer Analytics Initiative at Wharton University of Pennsylvania, and author of Customer-centricity: Focus on the right customers for strategic advantage.

Fader will be discussing how to tap into customer lifetime value and identifying the right customers for strategic advantage using data and predictive analytics at the upcoming Customer Centricity Collective event in Sydney on 16 October.

“Customers are vastly different from each other and it’s the variations across that base that’s the source of great value if you can use data in the right way,” Fader told CMO.

“If we can figure out the most valuable customers from a future standpoint, not historical value or profitability, come up with ways to enhance that value, extract value for shareholders, then use that understanding to find more customers like them, we can potentially make far more profits than the typical ‘one-size-fits-all’ approach that comes from trying to boost overall satisfaction ratings and keeping them all happy.”

Peter Fader
Peter Fader

According to Fader, most organisations concentrate on producing blockbuster products and services that are broadly appealing to the ‘average’ customer. What they should be doing is basing every business decision on the distinct group of customers offering the best lifetime value in terms of profit and growth.

“The honest, bitter, horrible truth, is that marketing often exists for the most part to keep demand in line with supply,” Fader claimed. “Companies have these great ways of producing and distributing things and are calling on marketers to get some more sales so they can justify current production levels.

“Instead of putting the product front and centre, a lot of companies could make more money if they discover which customers are most profitable, then let that understanding drive all other decisions around the organisation.

“Let’s figure out who these most valuable customers are, then let’s go to the R&D people and get them to develop something for that group, not the masses.”

To do this, Fader advocated adopting ‘customer lifetime value’ as the key business metric.

“This is about a future-looking expectation of what every customer is worth and making that the gold standard metric so that every corner of the organisation understands why the focus on customer metrics are in their best interests,” he explained.

“In marketing, it’s obvious – if we knew the value of customers, we’d understand what we should pay for customer acquisition, who to give special discounts to, and which ones to ignore.”

But it’s not enough to just figure out which customers are more valuable – businesses also have to act on that insight.

“Instead of incentivising product people on how many units of the new stuff you’re going to sell, incent them on the basis of the incremental boost to the lifetime value of the customers who buy that product,” Fader advised. “If they’re just buying the new product instead of the old product, you’re not making any more money. But if you can find ways of enhancing the value of these customers to the company, you deserve that bonus.”

Looking at the future value of customers also gives you a good idea of the value of the firm, Fader continued.

“Every dollar a finance company makes, for example, is going to manifest through its customers,” he said. “Adding up those values of customers gives us a different way to do corporate valuation, or a different way for firms to go to the stock market and show investors how well they’re fulfilling their fiduciary responsibilities.

“Forward-looking customer metrics can be transformative across the entire organisation, not just be flavour of the month for marketing.”

To do this, Fader uses tried-and-tested predictive modelling based on three well-established metrics: Recency, frequency and monetary value.

“Showing how value varies for different kinds of customers, and how we can drive tactful decisions on that insight, is the easy part,” he said. “The hard part is getting people to buy into it, trust the numbers and start making significant changes to the organisation chart and incentives structures to use as the basis for decisions.”

Don’t get obsessed by new data sets

One of the potential inhibitors may well be the mountains of data organisations are tapping into through digital, social and mobile channels. While there’s no doubt it’s easier to access much more data more quickly today, Fader claimed most of it has “surprisingly little” impact on predicting a customer segment’s lifetime value.

In fact, he suggested tracking every single customer in the micro-moment in order to decide which coupon to should serve up to them on their mobile phone and secure a sale is as “mythological” as it sounds.

“A lot of new stuff, such as social or neuro, is nice-to know but not really helpful for this evaluation exercise,” he said.

“Where I come from, with decades of support behind it, is a recognition of my inability to predict every little movement of each individual customer. But, if I come to you with well-defined, sub-segments of people who share relevant, behavioural characteristics, my ability to say things about that group as a whole is remarkably accurate.”

As an example, Fader said it’s impossible for actuaries in the insurance industry to set rates on how old an individual is going to be when they die.

“But if they look at a well-defined people with the same types of habits, it’s easy for them to say which percentage of them will live to be over 85-year olds,” he explained. “It’s the same with customer behaviour: You can’t slice it too thin, but with the right models, and by defining your segments in the right way, can make amazing statements about these collections of people.”

Lessons for CMOs

Fader’s advice for CMOs striving to be more customer-oriented is to stop obsessing over brand and put equal attention on acquisition, retention and development.

“You don’t just want to boost retention rates as high as possible, because many of the customers are not that good,” he said. “Make sure you have the right retention rate for the really good group of customers.”

Customer development, meanwhile, is about make customers even more valuable to the organisation through cross-selling, upselling, and so on, Fader said.

“The last point is how do we come up with the right trade-offs across all three? If we have a limited budget, how should we allocate it on acquisition versus retention and development?” he asked.

“I want these kinds of decisions to be made at higher levels in the organisation and with data-driven smarts, instead of conventional wisdom or guesswork.”

Read more about how other brands are building on customer lifetime value:

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