Data & Analytics / Insights / Loyalty
Leveraging return-on-customer – Don Peppers
- 16th May
- Grant Arnott 7
In an increasingly volatile and competitive economy, nurturing and building customer loyalty is fundamental to achieving business success. Yet gaining a precise picture of the true lifetime value of customers is a concept that eludes many businesses – until now. World-renowned one-to-one marketing guru Don Peppers introduces ROC – the new methodology for tracking customer value.
Return-on-investment (ROI) has penetrated the business vernacular of the Western world to such an extent that few would not immediately recognise the acronym. Its application in improving the focus of businesses on achieving reward for effort has become ubiquitous, but it’s no longer enough.
In broad terms, ROI measures how effectively and efficiently a company uses its capital to generate profit. However, the term is adaptable more specifically to every activity of a business, from marketing campaigns to procurement to supply chain management and even human resources. Those businesses who understand ROI, measure it, set targets and strategise how to achieve those targets are invariably more successful than those who don’t.
However, as strategic ROI thinking has now become the norm rather than the exception for modern companies small and large, businesses are seeking a new edge for competitive advantage.
Enter ROC – return-on-customer. The brainchild of customer relationship marketing thought leaders Don Peppers and Martha Rogers, ROC delivers a new methodology for businesses to better understand and increase customer value. In a world where it is more difficult than ever to acquire new customers, every single one is precious – ROC gives businesses the means to monitor, manage and leverage the value of each customer.
For many years, the Peppers Rogers Group has been at the forefront of customer-centric marketing strategies. Founding partner Don Peppers, an acclaimed author and keynote speaker, is credited with creating the term ‘one-to-one’ to describe best practice direct marketing.
Now he’s spreading the word on ROC, and businesses are responding. During a recent visit to Australia, Peppers spoke at length to senior marketing professionals about the importance of ROC as a business principle, and detailed how to implement ROC methodologies into companies’ strategic planning.
“We’ve been talking for years about the importance of putting the customer at the centre of the business,” says Peppers. “We all know intuitively that one of the benefits in doing that is you incur customer goodwill later. When a customer is loyal that is of obvious value to the business. Plus, when the customer refers others that can be exponentially valuable.”
But how valuable? One of the issues Peppers and Rogers felt was affecting businesses was a too-heavy focus on ‘short-term-ism’ – counting only the sales made immediately to a customer, less the cost of serving that customer right then, as a measure of customer value.
“Too often, businesses weren’t looking at the future contribution that customer would make and the way that contribution might increase if the customer were happy with the business,” says Peppers. “We wanted to come up with a solution that would simplify how businesses can better take account of the way customers create value in the future, as well as in the present.”
Peppers and Rogers realised that the basic limitation of businesses focusing on ROI analysis and payback analysis was the presumption that cash is the scarcest resource, and maximising your return on the cash you use must be the goal of a business. Looking deeper into modern business practices, the pair realised that it is far harder to source customers than it is to source cash, and this epiphany catalysed the development of the ROC model.
“The truth is, to create any kind of value at all, customers must engage with a business,” explains Peppers. “Therefore customers are scarcer than cash. In cash terms, if I have a good investment I can go the bank and borrow against that investment and get a return. But there’s no secondary market for customers – you can’t go to a bank, borrow some customers, create some value and pay them back later with interest the way you can with cash.
“We realised that if businesses were really going to create long term value from those customers rather than short term value, then they had to have a financial metric that addressed three fundamental issues – that customers create all value; that it is both long term and short term value that customers create; and that customers are a scarce resource, so you want to maximise the value you can create from a customer.”
In theory, this would be a godsend, but the next challenge for Peppers and Rogers was to model the concept into a practical tool that businesses could understand and implement effectively.
APPLYING ROC TO A BUSINESS
In simple terms, the ROC metric works just like the ROI metric, and Peppers explains it thus.
“Imagine you are going to buy a stock and measure the return on your investment,” he says. “If you bought the stock for $100 and it gave you a dividend of $5 during the year, and it increased in value by 10% to $110, then your ROI during that period is $15.
“ROC works the same way, only instead of talking about cash value we talk about customer lifetime value. So if I have a customer who I think has a lifetime value of about $100, and I sell that customer something worth $5, and I can increase that value over the course of the year by 10%, then my return on customer (ROC) is 15%.”
All well and good if you’re the chief financial officer at a large firm with millions invested in complex analytics, but how can all businesses understand and track customer value?
To break it down, the lifetime value of a customer is the net present value of the future stream of cash flow attributable to that customer. The formula for measuring ROC is the profit made on a customer for a particular period plus the change in lifetime value of that customer over the same period, divided by the original lifetime value.
For smaller businesses, Peppers concedes there are challenges in setting up a fully capable ROC model. The degree to which a business can measure, predict and leverage ROC is determined by its analytics capabilities. However, any business can implement the fundamental principles of ROC using some basic formulas to understand customer value.
“In order to maximise ROC, you need to know how to predict customers’ likely lifetime values based on historical records,” he says. “You also need to enter into that calculation on ROC any change in the customer’s lifetime value that might be caused during the current period.
“For instance, if you have 10,000 customers with an average retention rate every year of 8o percent, and through effective marketing you’re able to increase that retention rate to 81 percent, that will affect a change in those customers’ lifetime values. ROC is the profit you make on the customer plus the change in the customer’s lifetime value. For companies to really be able to implement ROC and use it, they’ve got to not only have analytics capable of modelling the customer lifetime value, they also need to be sophisticated enough to be able to identify the events that occurred today that are likely to have implications for those customer lifetime values.
“That’s the key issue. It’s complex, but it’s not rocket science in a company with a good customer database that’s reasonably sophisticated with analytics.”
MAKING ROC WORK
While the ROC model is still in its infancy, there are very few companies actually using this kind of tool on an ongoing basis. However, there are many that apply the principles of ROC without applying the calculations.
“There is much research that says customers choose one vendor over another primarily because of trust,” says Peppers. “Customers buy from Vendor A instead of Vendor B because they trust Vendor A more than B. That might boil down to the fact that they have heard of Vendor A and never heard of Vendor B, or it might be that their friends have dealt with Vendor A and liked them. Or, it might be that they have dealt with both those vendors before, but always felt that A acted in their interests and considered their preferences. One way or the other, customers buy from the companies they trust.”
Only by earning customers’ trust can a business actually create long term value from the customer. Peppers cites a great example from a leading customer-focused business.
“I’m a very frequent Amazon customer – I buy five to 10 books a month,” he says. “One day I read an article on a book I thought I wanted, so I visited Amazon and ordered the book with one click as per my usual routine. Suddenly a message popped up: ‘WARNING: You already purchased this book from Amazon.com – do you want to buy it again?’
“They had my money! But they didn’t want my money, they wanted my trust because to Amazon, trust was worth a lot more than money. Because trust is worth more money in the future. That is the foundation of ROC.”
As Peppers spreads the ROC message throughout Australia and other parts of the world, businesses battling the difficult economic climate are highly receptive to the concept, but daunted by the analytical complexity of the ROC metric. As a compromise, many businesses are applying the ROC model with non-financial metrics, such as ‘willingness to recommend’, ‘net performer scores’, ‘customer service satisfaction’ or other factors easily measured via market research.
There’s no problem with that, says Peppers, who is pleased to see businesses adopting the ROC approach at whatever level they are comfortable with. However, the ultimate advantage of ROC lies with those businesses who find a way to apply the full financial metric, especially in the current climate.
What we have found overwhelmingly is that chief financial officers are way more interested in ROC than chief marketing officers are,” says Peppers. “In a competitive situation, or a downturn, if you build your entire customer strategy around non-financial metrics, and a financial officer doesn’t want to see non-financial figures, he wants to see exactly what the pay-off is, ROC can give you that ammunition.”
With businesses focused more on accountability than ever before, ROC looks set to make a significant impact, and with Don Peppers’ track record of introducing new business thinking, expect to see this three-letter-acronym sweeping the marketing world as a new wave of customer-centric strategies emerge.
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