Peppers & Rogers: Return on Customer Maximizes Value

It’s always been difficult to plan effective marketing programs because we can’t accurately project how much a program will contribute to the bottom line. There are several reasons for this, including

  • Lack of data about past marketing programs
  • Uncertainty about future programs
  • Lack of clarity about how marketing campaigns work together to affect actual customer behavior

With that lack of detailed data about past results, it’s amazing that strategic marketing plans can be developed at all!

Another issue that’s even larger than a lack of past data is forcasting the future. It can take years for strategic marketing plans to be fully implemented and have a significant effect on revenue. However, all marketing programs, such as advertising, promotion, and sales are expected to produce results in the current period.

So, how can marketers plan for long-term growth when they’re measured on short-term results?

There hasn’t been an effective way to evaluate the overall long-term benefits of current and future advertising, promotion, sales, and other marketing activities. These are the problems that are dealt with in the new book by Don Peppers and Martha Rogers, Return on Customer. Peppers and Rogers provide the financial building blocks we can use to measure the long-term value of all marketing programs.

If you’ve read their previous books on one-to-one marketing, you’ll recognize stories about airlines, banks, and retailers that focus on their customers. However, if you’ve not read any of the Peppers and Rogers books, this is a good one to read to understand their philosophy.

The book Return on Customer is filled with the concepts of identifying the needs and problems of each individual customer, and how to treat different customers differently, which is the key concept of one-to-one marketing.

Their idea is that “return on customer” can be calculated in the same way that the financial health of a company is calculated using “return on investment” techniques.

Peppers and Rogers define “return on customer” as the sum of a firm’s current-period profit from its customers, plus any changes in customer equity (the sum of the lifetime values of all current and future customers served by the firm), divided by the total customer equity at the beginning of the period.

The concept of return on customer sounds a lot like the concept of lifetime value of the customer, mostly because they use customer lifetime value as part of their equation. Then, they apply the same financial metrics used in return on investment calculations to calculate a return on customer.

Sounds simple enough — just measure the change in the current and future profit from each customer, then sum all those profits. But you also have to include the expected future profit from each customer you don’t yet have.

It starts to sound like an impossible task, but Peppers and Rogers include a number of concepts in the book Return on Customer on how to accomplish this.

Even though it’s hard to implement, the benefits of adopting the return on customer concept can be tremendous. Peppers and Rogers make the case — quite convincingly — that their concept can help marketers identify how much to invest in each customer, how much to expect to get back from each customer now and in the future. And, yes, they have a rather sound approach to calculating future profits from future customers.

The return on customer concept is built on thinking about customers as economic assets — much the same way that CFOs think about whether to invest in a new warehouse, a new plant, or a new type of manufacturing equipment. For CFOs, their financial analysis consists of projecting the future expenses and revenues for a new plant or piece of equipment. Then, calculating the compounding “interest rate” that would produce the same result, which is called the Return on Investment (ROI).

In Return on Customer, Peppers and Rogers encourage marketers to do the same thing for each customer. This means we need to allocate revenue generated by a customer, and the expenses incurred in obtaining and supporting that customer, in order to calculate the net cash flow from each customer — for every activity, response, behavior, and interaction with each customer.

The challenge, of course, is in obtaining the revenue and expense data attributable to each customer.

Step 1
Customer Tracking
The first step is to implement tracking techniques so you know what each customer costs — from the very first contact through every interaction at every touchpoint. This requires a unified approach to tracking responses to advertising, direct marketing, and sales activities.
Step 2
Marketing Cost Allocation
The second step is to allocate all marketing costs to each customer who makes a purchase. Determining the marketing expense of obtaining each customer requires knowing which customers responded to, or were influenced by, every ad, direct mail piece, and sales call. There are a number of techniques that can be used to allocate marketing costs depending on whether you sell to consumers, through distribution channels, or directly to business customers.
Step 3
Revenue Allocation
Determining the revenue from each customer is relatively easy — that’s an accounting function that already exists. One of the more difficult parts of implementing the return on customer concept is allocating future marketing costs and revenues to future customers. Peppers and Rogers suggest using historical data on response rates, per customer costs, and per customer revenues to project what similar marketing activities will generate in the future.But of course, there is no “typical” response rate for an ad or direct marketing campaign. It’s important to look at historical data by market segment, product category, and stage in the product life cycle, and other factors.

By calculating the sum of all cash flows from all present and future customers, you can estimate your customer’s “customer equity.”

As you collect more and more historical data on revenue and marketing expenses by customer, it will become possible to develop a return on customer model that can help you predict how proposed marketing programs will affect both short-term and long-term customer equity.

This is important because total customer equity — the present value of all future net revenues — is a key component in determining shareholder value.

In other words, by calculating the long-term future benefits from current marketing programs, you can more easily justify investing in, say, a brand awareness campaign, adding a new product line, or expanding sales into a new country.

The basic concepts in Return on Customer are not new — CFOs have been using financial metrics like net present value, discounted cash flow, and return on investment for years. What is new is the idea of applying these financial metrics at the individual customer level.

It’s challenging to implement because every company implements marketing activities differently.

Don’t expect individual departments to implementing the concepts in Return on Customer because it requires a strategic decision by top management to apply these concepts across all marketing functions — advertising, promotion, sales, and customer service.

So, if a company is to have long-term success, and not be buffeted by short-term variations in the market, it’s important to take a long-term view toward increasing customer equity — and, therefore, shareholder value.

By Cliff Allen, cofounder of Coravue and SureToMeet