Customer Profitability and Lifetime Value Analysis

As the growth of customer-centric strategic management become more beneficial to the company, thus there's an increasing needs to assess customer profitability and value.

Customer Profitability Analysis (CPA):

• Based on the principal of Activity Based Accounting (ABC).
• Takes into account the profitability of product mix purchased by customers and customer-driven costs generated by servicing these customers.
• Another way to understand how resources can be allocated most effectively to cultivate the most profitable customers.
• Ability to price on basis of cost-to serve a particular customer or segment.
• Nature and targeting of advertising and marketing campaigns (to target profitable customer segments).
• Reconfiguring & classifying a firm's customer portfolio.

Strength & Weaknesses of CPA:

• Strength:
• Focus better on customers and generate greater SHV: optimise allocation of scarce resources, pricing decisions, discount (when necessary). concede permanent loss customers.
• Weakness:
• Static, single period snapshot of customer profitability.
• Historical performance only.
• Does not consider how customer profitability may change over time.

Types of customer to consider:

• High Profitability & Short Term Customers --> Butterflies
• Good fit between company's offering and customer's needs.
• High profit potential
• Action:
• Aim to achieve transactional satisfaction, not attitudinal loyalty.
• Milk the accounts only as long as they are active.
• Key challenge is to cease investing soon enough.
• High Profitability & Long Term Customers --> True Friends
• Good fit between company's offering and customer's needs.
• Highest profit potential
• Actions:
• Communicate consistently but not too often.
• Build both attitudinal and behavioural loyalty.
• Delight this customers to nurture, defend and retain them.
• Low Profitability & Short Term Customers --> Strangers
• Little fit between company's offerings and customers needs.
• Lowest profit potential
• Actions:
• Make no investment in these relationship.
• Make profit on every transactions.
• Low Profitability & Long Term Customers --> Barnacles
• Little fit between company's offerings and customers needs.
• Low profit potential
• Actions:
• Measure both the size and share of wallet.
• If share of wallet is low, focus on cross-selling and up-selling.
• If size of wallet is small, impose strict cost controls.

Lifetime Value (LTV)

• Focus on multi period, future oriented economic value rather than single period profitability of customer/segment.
• Measured as the present value of net expected future cash flows that are expected over the life time of firm's relationship with a customer.

Pros and Cons of LTV:

• Advantages :
• Future oriented
• Multi-period analysis
• Considers relative profitability changes according to the customer's lifecycle stage with the firm
• Considers impact of tenure on value a customer represents.
• Limitations :
• Not as well-grounded as CPA (not based on ABC concepts)
• Difficult to estimate impact of LTV factors
• Difficult to operationalise some of LTV factors.