• Customer equity is the total combined customer lifetime values of all of a

company’s customers.or Customer equity is the total combined customer lifetime values of

all the company’s customers .

In deciding the value of a company, it is important to know of how much value its
customer base is in terms of future revenues. The greater the customer equity (CE), the
more future revenue in the lifetime of its clients; this means that a company with a higher
customer equity can get more money from its customers on average than another
company that is identical in all other characteristics. As a result a company with higher
customer equity is more valuable than one without it. It includes customers' goodwill and
extrapolates it over the lifetime of the customers.

Companies often attempt to gain more customers and increase revenues by improving
customer equity. They do this by:

• improving consumer service

• improving the value or desirability of the brand
• improving goodwill
• improving brand popularity such as by advertisements

Understand your customers’ value individually

Because of the wide disparity in the value of each customer, it is
imperative to understand your customers’ value at the individual level.
By doing this, you can effectively manage their experience with you, and
subsequently, maximise their profitability.
In order to accurately calculate the customer’s value to the organisation,
a ‘single view’ of the customer within the company must be enabled.
This single view allows a company to accurately understand a customer’s
purchases, interaction, and longevity, for all of the products the customer
has purchased from the company. This, in turn, allows the company to
compute the customer’s overall value to the company.
The key characteristics to understand about each customer are longevity,
share of wallet, and profitability. (Loyalty is the combination of longevity
of relationship and share of wallet.) Although it is generally accepted
that there is a strong link between longevity of the relationship and
profitability, research
3

indicates that this relationship is subtler, and has

nuances, that must be taken into consideration. Specifically, some long-
term customers are not profitable, while some short-term customers are
very profitable
‘Leeches’ – These customers are short term and low profit. They are not a
good fit for the company’s products. They should not be invested in and
only minimal customer support should be provided.
As mentioned above, determining the size of wallet for the ‘barnacles,’ and
share of wallet for the ‘true friends’ and ‘butterflies,’ is critical. There are
many ways to achieve this, but a typical method is to research a sample
of customers and then use and apply sophisticated modeling based on
customer behaviour and characteristics
Page 1
IBM Business Consulting Services
January 2003

Unlock customer profitability

through a tailored customer
management program
by Dick MacDonald, Peter Cantor
and Jon O’Donnell
Page 2
2
Management Summary
3
Challenges in Customer
Management
4
Drive Your Customer Management
Program from Your Customer Strategy
6
Ensure Your Customer Management
Program is Defined in Terms
of Your Brand Value
8
Understand Your Customers’
Value Individually
10 Run the Right Initiative for the
Right Customer
12
Continually Assess What Your
Customers Want and How You
Are Performing, and Then Execute
Programs to Address the Gaps
13
Making It Happen
14
Conclusion
15 About the Authors & Footnotes
Contents
Unlockcustomerprofitabilitythroughatailoredcustomermanagementprogram
Page 2
Management summary
With markets around the world saturated, and industries mature, companies
have moved from a strategy of growth to one of profitability. Complicating this
strategy is the fact that all customers are not of equal value. In fact, typically
only 20% of a given company’s customers produce 80% of the company’s
profits. With this wide disparity in customer value, the key consideration is to
acquire and retain the high-value customers, while optimising the low-value
customers. But how should a company go about this?
This paper describes our approach to achieve higher profits through a
tailored customer management program. Our approach contains four key
parts: First, drive your customer management program from your customer
strategy. That is, ensure that the right customer experience is defined, and the
processes implemented, well ahead of any technology implementation. Second,
clearly define your customer management program in terms of your brand
value. Ensure that you are not trying to be all things to all customers – you
need to focus. Are you a product leader, best value, or customer intimate?
Each of these positions has different consequences on customer management.
Third, understand your customers’ value individually. You cannot effectively
manage a customer relationship unless you understand the value that each
customer has to your company. And fourth, run a customer tailored customer
management program. That is, manage customers according to customer
value. Some customers must be optimised, while others invested in and
retained at almost any cost, while still others need to be milked.
By executing a tailored customer management program, our analysis indicates
that a company’s profits can be increased by 10 to 20% annually.
Page 3
Unlockcustomerprofitabilitythroughatailoredcustomermanagementprogram
Page 3
Challenges in customer management
Through our extensive work with clients throughout the world, we have
found consistency in the problems they face in managing their customer
relationships. As a result, they are failing to optimise profitability per
customer. These problems include:
• High churn rate, especially with ‘good’ customers
• High costs, but not knowing how to cut them without jeopardising the
customer experience
• Ineffective marketing and selling initiatives
• Lack of return from the investment in technology
• Inability to provide differentiated, but profitable, customer management
for the ‘best’ customers.
As big as these challenges are today, they will only grow larger in the future.
Why? Two reasons: First, new products will continue to be introduced on new
devices, such as mobile devices, especially in the communications, financial
services, high technology, and consumer products industries. These new
products and devices will continually increase customer interaction complexity
that, in turn, will increase customer management cost.
Second, many markets around the world are saturated, and their industries
mature. Customers are now a ‘zero-sum game’ – for every customer you gain
someone else loses, and vice versa. In addition, with products no longer highly
differentiated, the customer relationship becomes more significant as both a
source of differentiation and as a factor in retention.
Underlying this, however, is the fact that all customers do not produce equal
profit for a company. In fact, there is a wide disparity between customers
when compared on a real and potential profit per customer basis, or what we
call a ‘value basis.’ In our work with clients, we have found many cases where
less than 20% of a company’s customers produce over 80% of the company’s
profit. In one extreme case, in the mobile industry, we found that less than
10% of the customers were responsible for over 80% of the profit.
This discussion makes clear the need for an individually tailored, value-based
approach, to customer management – an approach that focuses the right
resources on the right customer while, at the same time, optimising the level
of service to the low-value customer. Our analysis indicates that by adopting
such an approach, the average company, for the industries mentioned above,
could increase their profits by 10 to 20% annually.
Customer Management challenges will
only grow larger and more complex in
the future.
Highlight
Page 4
Unlockcustomerprofitabilitythroughatailoredcustomermanagementprogram
Page 4
Drive your customer management program from your
customer strategy
According to a recent report, approximately half of all customer management
initiatives during the last few years have failed to produce positive results, and
20% of these initiatives have actually harmed, rather than helped, customer
relationships.
One of the principal reasons for this is that many organisations let the
capabilities of technology drive their decisions concerning their customer
management program. They become seduced by the potential of the
technology, and then implement that technology expecting to see those
benefits materialise. The fatal flaw of this approach seems obvious, yet this is
the all too common approach taken.
One example of where this occurred is at a company in the communications
industry. This company had implemented a CRM package to improve its sales
force effectiveness. Although the CRM package had been used successfully
by other companies before, this company had merely automated its existing
processes. No benefits were gained from the CRM package because no
attention was paid to determine which business processes could be changed
to improve the effectiveness of the sales force.
Simply put, technology is merely an enabler. Although technology is
important and its capabilities must be kept in mind during all phases of
the customer management definition process, it is the last item that needs
to be fully defined.
From our experience, the critical first step, and the one that many
companies fail to thoroughly execute, is to clearly define the customer
strategy. A clearly defined customer strategy must contain both a clear
articulation of the customer value proposition and a clear definition of the
customer experience (see Figure 1).
The customer value proposition effectively defines what the customer can
expect from the company in terms of the products that it offers, and the
support services it provides. Once the customer value proposition is clearly
articulated, the customer experience definition can then be completed.
Technology is merely an enabler.
Highlight
Page 5
Unlockcustomerprofitabilitythroughatailoredcustomermanagementprogram
Page 5
The customer experience definition describes in detail what the customer
will experience at each customer touchpoint. These touchpoints include
acquire, service, grow and retain. The customer experience definition
then drives the definition of the required business process, organisation
and people skills that need to be in place. Taken together, these items
define a new business operation.
Defining the technology that will enable and support the new business
operation is the last step. Technology enables the operation to function in
new and better ways, so leveraging the capabilities of technology is a key
consideration. Still, the heavy lifting is around defining new and better
processes, an effective organisation to support those processes, and
building the right people skills that support the overall customer strategy.
By starting with a clear articulation of the customer value proposition and
a clear definition of the customer experience (i.e. the customer strategy),
you ensure that all the components of the customer management program
will support the overall goals of the business.
A clearly articulated customer value
proposition ensures that all components of
the customer management program will
support the overall goals of the business.
Highlight
FIGURE 1
Customer Management Definition Process
High
Low
Organisational
Impact
High
Implementation Effort Required
Low
CustomerStrategy:CustomerValueProposition/
CustomerExperienceDefinition
BusinessProcessDefinition
OrganisationDefinition
PeopleSkillsDefinition
Technology
Definition
Step 1
Step 2
Step 3
Step 4
Step 5
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Unlockcustomerprofitabilitythroughatailoredcustomermanagementprogram
Page6
Ensureyourcustomermanagementprogramisdefinedintermsofyour
brandvalue
In order to achieve a highly effective customer management program,
you must provide consistent, superior service (delight) to your high-value
customers, and optimise your low-value customers, but this must be done
in the context of your brand value. Your brand value is determined, in
large part, by your customer value proposition.
There are three generic customer value proposition strategies: product
leader (a company that consistently delivers the latest, most innovative
products); best value (a company that delivers the best price in
combination with other factors); and customer intimate (a company that
provides superior service for any issue or problem the customer may have).
Usually a company stakes out one of these positions in order to achieve superior
performance. In a mature market clearly staking out one of these positions is
even more critical. As Michael Porter (‘Competitive Advantage’, Michael Porter,
New York: The Free Press, 1985, Page 17) points out: ‘Industry maturity tends
to widen the performance differences between firms with a generic strategy and
those that are stuck in the middle, because it exposes ill-conceived strategies
that have been carried along by rapid growth.’
2

A clearly articulated customer value proposition drives superior performance

in two ways. First, it clearly explains to your customers what they can
expect when they do business with you. This allows you to attract the right
customers to your products. And second, it allows you to make appropriate
investment choices with regard to your customer management program
– investments that support your brand value, no more, no less.
IBM Business Consulting Services uses eight main attributes to assess the
investment choices that companies make in support of their customer
management program, or customer management capability. We use a scale
of one (lowest) to five (highest) to assess this capability (see Figure 2).
The level of capability required for each attribute is dependent on the
customer value proposition selected by the company. The eight attributes
are described as follows.
Customer Experience Consistency – This measures the consistency of
the customer experience along all of the customer touchpoints. Having
consistency is one key driver of customer satisfaction.
Customer Process Effectiveness – This measures the effectiveness of the customer
processes in terms of achieving delight, especially for high-value customers,
and optimisation, for low-value customers. A key in measuring this attribute
is comparing the existing processes to best practice for a given brand value.
A company must stake out one of three
customer value propositions - product
leader, best value or customer intimate,
in order to achieve superior performance.
Highlight
Page 7
Unlockcustomerprofitabilitythroughatailoredcustomermanagementprogram
Page 7
Customer Facing People Skills – This measures the skills of the customer-
facing people to requirements in terms of the brand value of the company.
Customer Technology Robustness – This measures the level of technology
used, and how well technology is being leveraged, to enable effective
business processes.
Customer Understanding Sophistication – This measures the level of
understanding around the customers’ needs, wants and desires in terms
of both the product and their relationship with the company. This is
dynamic due to the constantly shifting customer priorities.
Customer Value Calculation – This measures the ability and robustness of the
company to calculate the past and future value of each of its customers. Key
to this calculation is understanding which segment each customer belongs to.
Customer Satisfaction Measurement – This measures how well the company is
measuring customer satisfaction, and the root causes of this satisfaction, both
positive and negative. The key events of a customer joining and leaving the
company are looked at in particular to understand the rationale for these events.
Customer Information Collection – This measures how well the company
is collecting information that assists the company in improving its
relationship with its customers. This information includes items such as
product preferences, demographics, and household information.
Different customer value propositions
dictate different customer management
capabilities.
Highlight
Customer
Experience
Consistency
Customer
Satisfaction
Measurement
Customer
Information
Collection
Customer
Value
Calculation
Customer
Understanding
Sophistication
Customer-
Facing
People Skills
Customer
Technology
Robustness
Customer
Process
Effectiveness
‘CustomerIntimate’
‘BestValue’
‘ProductLeader’
FIGURE 2
Customer Management Capability Profile
1
2
3
4
5
1
2
3
5
4
1
2
3
4
5
5
4
3
2
1
1
2
3
4
5
5
4
3
2
1
1
2
3
4
5
5
4
3
2
1

Page 8
Unlockcustomerprofitabilitythroughatailoredcustomermanagementprogram
Page 8
Understand your customers’ value individually
Because of the wide disparity in the value of each customer, it is
imperative to understand your customers’ value at the individual level.
By doing this, you can effectively manage their experience with you, and
subsequently, maximise their profitability.
In order to accurately calculate the customer’s value to the organisation,
a ‘single view’ of the customer within the company must be enabled.
This single view allows a company to accurately understand a customer’s
purchases, interaction, and longevity, for all of the products the customer
has purchased from the company. This, in turn, allows the company to
compute the customer’s overall value to the company.
The key characteristics to understand about each customer are longevity,
share of wallet, and profitability. (Loyalty is the combination of longevity
of relationship and share of wallet.) Although it is generally accepted
that there is a strong link between longevity of the relationship and
profitability, research
3

indicates that this relationship is subtler, and has

nuances, that must be taken into consideration. Specifically, some long-
term customers are not profitable, while some short-term customers are
very profitable.
There is a wide disparity in the value
of each customer, so it is imperative
to understand your customers’ value
at the individual level.
Highlight
FIGURE 3
Customer Profitability By Segment
High
Customer
Profitability
Low
Customer Segment
‘True Friends’
(Long-term customers)
‘Barnacles’
(Long-term customers)
‘Leeches’
(Short-term customers)
‘Butterflies’
(Short-term customers)
Determine
Share of Wallet
Determine
Size of Wallet

Page 9
Unlockcustomerprofitabilitythroughatailoredcustomermanagementprogram
Page 9
Based on these findings, customers can be grouped into four distinct
segments. These segments are: ‘True Friends,’ ‘Butterflies,’ ‘Barnacles,’ and
‘Leeches’ (see Figure 3). Each customer segment is described below. These
segments should be used as an overlay on the more traditional customer
segments used by companies, such as ‘business,’ ‘students,’ ‘young
professionals,’ etc.
‘True Friends’ – These are long-term customers that are highly profitable.
These customers are a good fit for the company’s offerings. These customers
must be given a consistent, superior customer experience that lives up to the
brand value. Within this segment, it is important to ascertain the share of
the wallet for each customer. For those whose share of wallet is small, there
represents an opportunity to cross-sell additional products.
‘Butterflies’ – These customers are highly profitable but short term. They
are a good fit to the company’s offerings, but they are fickle, and move on
to other companies’ products regardless of the enticements to stay. The
mistake a company can make with this group is to spend too much money
in trying to retain them or to win them back. Within this segment too,
it is important to ascertain the share of the wallet for each customer. For
those whose share of wallet is small, there represents an opportunity to
cross-sell additional products, albeit for a limited time.
‘Barnacles’ – These customers are long term, but low profit. This group is
made up of two sub groups: those that have a big wallet, and those that
have a small wallet. The customers with a big wallet have the potential to
become highly profitable long-term customers (‘true friends’), while those
with a small wallet simply ‘drag’ on the company’s profitability and must
be optimised.
‘Leeches’ – These customers are short term and low profit. They are not a
good fit for the company’s products. They should not be invested in and
only minimal customer support should be provided.
As mentioned above, determining the size of wallet for the ‘barnacles,’ and
share of wallet for the ‘true friends’ and ‘butterflies,’ is critical. There are
many ways to achieve this, but a typical method is to research a sample
of customers and then use and apply sophisticated modeling based on
customer behaviour and characteristics.
Customerscanbesegmentedbehaviourally
into four profit-related groups: true
friends, butterflies, barnacles and leeches.
Highlight
Page 10
Unlockcustomerprofitabilitythroughatailoredcustomermanagementprogram
Page 10
Customer Segment
‘True Friends’
‘Barnacles’
‘Leeches’
‘Butterflies’
Milk
Cross-Sel
Acquire
Delight (Retain)
Save & Win
Back
Up-Sel
Optimise

Run the right initiative for the right customer

Having identified which customers fit into the each of the four segments,
each segment must be addressed in a unique way in order to maximise the
customer experience and customer profitability. Or, to put it another way, you
have to run the right initiative for the right customer.
There are seven basic customer management initiatives in our framework.
They are: Delight (Retain), Optimise, Acquire, Save & Win Back, Cross-Sell,
Milk, and Up-Sell. Each of these initiatives is designed to match the customer
experience and cost to serve to the appropriate customer segment (see Figure 4).
Delight (Retain) – You need to delight your highest-value customers to
earn their loyalty. This group includes both the ‘true friends’ and ‘butterflies’
segments. This requires:
• Understanding explicitly which aspects of service these customers consider
to be important
• Providing superior and consistent customer experience that
exceeds expectations
• Providing a higher level of service by focusing resources toward them
to ensure deligh

Cross-Sell – Your high-value, long-term customers (‘true friends’) are your

best source for using your existing product line. This requires:
• Understanding the exact profile of the customers who purchase new
and existing products from you
• Using information on customers’ characteristics and preferences and
selling the appropriate products to these customers
• Contacting these customers sparingly – that is, do not stalk them
Butterflies’ – These customers are highly profitable but short term. They
are a good fit to the company’s offerings, but they are fickle, and move on
to other companies’ products regardless of the enticements to stay. The
mistake a company can make with this group is to spend too much money
in trying to retain them or to win them back. Within this segment too,
it is important to ascertain the share of the wallet for each customer. For
those whose share of wallet is small, there represents an opportunity to
cross-sell additional products, albeit for a limited time

Barnacles’ – These customers are long term, but low profit. This group is
made up of two sub groups: those that have a big wallet, and those that
have a small wallet. The customers with a big wallet have the potential to
become highly profitable long-term customers (‘true friends’), while those
with a small wallet simply ‘drag’ on the company’s profitability and must
be optimised.

rue Friends’ – These are long-term customers that are highly profitable.
These customers are a good fit for the company’s offerings. These customers
must be given a consistent, superior customer experience that lives up to the
brand value. Within this segment, it is important to ascertain the share of
the wallet for each customer. For those whose share of wallet is small, there
represents an opportunity to cross-sell additional products