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Customer Modeling for Finance Folks

DataBase Marketing, Driller Q & A, Measuring Engagement, Newsletters,

Jim answers questions from fellow Drillers
(More questions with answers here, Work Overview here, Index of concepts here)

Q: My boss (VP of Phone Sales) is really looking to try out some new ideas and RFM is one he has latched onto. He actually has explored this concept for a few years but never acted upon it. Anyway, he just purchased your book and after finding that he did not have time to read it he gave it to me. My job was to read and understand at a high level and to lead a discussion with the marketing group to get them excited about the concept. I am a finance guy by trade so this concept was very interesting.

A: That’s funny, the people who really “get it” the most are Finance people and IT people, because my approach is very numbers driven.  Stuff either works or it doesn’t – did you make money or not?  Many marketing people seem to dislike the idea of accountability…..hmmm…

Q: Obviously I either did not do a good enough job explaining RFM, Latency Tripwires, etc. or they just are unwilling to have someone from their team tackle the concept. My feeling is they felt this is a sales tool. The question they always wanted answered was “Why did the customer behave the way they did? We find that out and make a sales call, not engage in ‘marketing air cover’ tactics.”

A: Not sure what you mean by this…in fact, depending on the value of the customer, a sales call might be exactly what is needed. If you have a formal “wall” between sales and marketing, usually the issue can be decided by “degree of pain” e.g. how painful will it be to lose the customer?  Generally, a personal call is more effective than Marketing but more costly, so you use those guns sparingly.

If you have a small number of very high value customers who look to be defecting then a sales call is triggered. If you have lots of medium to low value customers who look to be defecting, then a direct mail campaign is probably what you need, which is probably Marketing. Match the value of the effort to the value of the customer; this is how you get gigantic ROI’s (or since you are a finance guy, more accurately something like ROME’s – Return On Marketing Expense). The scoring approach to customer value is about allocating scarce resources to the highest and best use.

I think what Sales is saying is this: if you know a specific thing about a customer, we handle that “one to one” thing; Marketing does the “all customers” messaging. And this is precisely the point of customer models – they allow Marketing to do the “one to one” thing, as opposed to the “air cover” thing.

Q: So it has fallen upon me to develop a project plan and come up with some ideas to implement.  If we can not get marketing support we will run with it ourselves.

A: Good for you! A good old fashioned skunk works operation, I love that! And led by a Finance guy on top of that.  Bravo!

Q: I am now reading the book for a second time and I have a slight problem with how to best implement with our business. I can see how this concept could be used to radically change our sales channel, but I do not think I have that much pull.

A: Well, let’s take a look at it. Typically, and particularly since you are in Finance, what you do is look to prove out a high value concept, then share financial success up the chain. This builds momentum for the approach and gets people really interested in knowing more, which leads to taking concrete action.

So for example, find your very highest value potential defectors using either Recency or Latency. Then split them into two equal groups – test and control. Have sales call the people in the test group and find out what is causing the defection behavior, try to save the customer.

Then 90 or 180 days later, look at the number of test and control that stuck with the service. Subtract the control number from the test number, this is the “net” retained due to your calls. Multiply by value of the contracts, and you have sales due to your program.

Q: We are a subscription service in which customers pre-pay for the service they expect to use. Our sales (and I guess marketing to some extent) are responsible for driving customers to use their service throughout the year. Usually if a customer uses more than they committed to then they raise the commitment the following year. For us sales leads to higher revenues leads to higher sales, etc, one big circle. So I guess my question is this: Can RF scores be used for a pre-paid subscription service?

A: Sure, but perhaps not in the “classic” sense of transactional revenue. For many service biz, particularly subscription ones, you profile activity other than billing, since the billing tends to be static.? Sounds to me like what you want to profile is **usage** – the more Recently and Frequently a customer has used the service, the more likely they are to continue using it. I assume you are authenticating subscribers to the service on your web site, so this shouldn’t be a big deal.? Then your scores would rank customers by likelihood to “continue using the service” and their value.?

High value customers with falling or low likelihood (falling RF score) to continue using  the service get a sales call, mid to low value customers with low likelihood to continue get a direct mail piece from marketing.  Dramatic changes in score require the most urgent attention, in terms of allocating resources.

Q: As an FYI, we have customers who pay as they go and customers that sign a yearly commitment. Would it be best to segment the two groups individually for the RF model and Latency tripwires?

A:  Yes. Annual subscriptions and Pay As You Go are two fundamentally different behaviors and mindsets, so mixing them will confuse the scoring. You have a Long cycle (annual) and a Short cycle (PAYG) decision being made; both the models and the actions would be different. For example, PAYG will be a more sensitive model with action required more immediately. Also, these are probably low value customers so you’re talking about e-mail or direct mail.

And, your measurement cycle would be different. Taking the test example above, you would check for “net results” on PAYG probably at 60 days; annuals you would wait for renewal date unless the offer affected this date in some way.

Q:  We also have different size customers some spending more than $10K / year and some $1K, should we segment based upon dollar values as well since the more they committed to the higher their FM scores (you would expect)?

A:  You can make anything really complicated with segmentation if you want to! Just starting out, my answer is Segment in terms of message yes, but Segment in terms of scoring and triggering action, no.

Keep in mind the Current Value / Potential Value model; don’t confuse the two behavioral vectors and their meaning. Current Value – what they have paid so far – is about how valuable the customer is to the company and determines what action is taken. This is the “personal call” versus “send e-mail” part of the equation; the cost component.

The Potential Value (Recency, Latency) is about predicting the likelihood for future business, it’s about “when” to act. This is the risk of losing the business in the future.

So I would not segment by value in terms of predicting defection, because thelikelihood of losing the business is really unrelated to the Current Value of the customer.You can have High Value and Low Value customers with the same defection likelihood, whether “value” is measured as Sales, Page Views, Engagement, whatever. Value is largely independent of likelihood to defect. But once defection is predicted, you then segment between High Value and Low Value and take action based on the value of the customer or visitor segment.

The two primary rules of High ROI Customer Marketing are:

1. Don’t spend until you have to
2. When you spend, spend at the point of maximum impact

Current Value = What to do
Potential Value = When to do it

That’s why this approach is so much more profitable then dropping Marketing on a “batch and blast” calendar schedule (you called it “marketing air cover”). Right message, to the right person, at the right time.And itworks especially well online because Relevancy (right message, right time) is so important and switching costs are low.

Q: What kind of Marketing should we do?  Is there any other segmentation we should try?

A: Well, that’s a little tough without knowing more about the business, but there’s a good way for you to find out!

With a service, you hopefully know why people stop using it. To prepare for these campaigns from a Marketing perspective, find defected best customers (high value cancels) and look at why they stopped using it (or interview them if you don’t know, offer a free month or whatever to get them to talk to you). Create Sales / Marketing – pitches / materials / offersto address their issues.

Then when you see a client engaging in a defection pattern on usage (drop in RF score, Latency Tripwire), engage the appropriate response (Sales or Marketing) based on the value of the customer.

And sure, the more you segment your customer base, the better it works. You should start at the bottom, however. Don’t “out-think” the segmentation; let the data speak to you. Try something at a very basic level and look for the hands to be raised; this will tell you what works and put you on the right track for more complexity.

For example, let’s say (and I imagine it would be true) that SIC codes play a role in your sales and retention. Certain types of businesses are simply going to be more likely to realize value from the services. So you do a campaign (sales, marketing, or both) to *all* customers in a particular defection state and let the SIC data speak.

Let’s say for simplicity that you find if a PAYG subscriber doesn’t use the service for 10 days that’s a warning flag for defection. You prepare and drop the retention campaigns to any accounts that “trip” this trigger – right message, at the right time.

What you see when the data comes back is certain SIC codes had a very high response and “activation” and start using your database again, and others do not. The data has now spoken, told you which SIC’s it is worth spending time / money on.

Then you look at bit deeper, and find that within an SIC code that looks to be a “bad idea” overall, the results are pretty good as long as the offer is made by direct mail in the South.  So you keep this particular segment of the “direct mail” campaign and kill the rest of the marketing activity for that SIC code.

You can look for other segments by value, by region, by services subscribed to, by type of data they look up, whatever. As you subdivide segments, you will find new pockets of profitability. You could spend a LifeTime chasing down all the segments – I have never, ever finished this task on any particular engagement. In fact, clients call me years after they have stopped using my services to tell me they have discovered unique new segments that are extremely profitable.

I’m not saying you should?abandon traditional customer communications,the batch and blast that you do. What I am saying is there is a deeper, more Strategic Objective you can drive through either customization of current programs or by adding an additional layer -maybe cut back on a little of the blasting at the same time?

The basic idea is really no different than optimizing Campaigns – except you’re optimizing Customers by recognizing problems with individuals and offering solutions, instead of always being in their face asking for something – especially when the customer is already demonstrating to you there is a problem of some kind. A little “Is there something we’ve done wrong”? or “Can we help you use our product more efficiently?” or “Would you take a survey?” to specific customers could not hurt.

Sound like a good idea?

Jim

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Download the first 9 chapters of the Drilling Down book: PDF 

Incremental Value of Gift Cards

DataBase Marketing, Driller Q & A, Newsletters, Web Analytics

Jim answers questions from fellow Drillers
(More questions with answers here, Work Overview here, Index of concepts here)

Q: I found your web site through a Google search on “incremental business” and “gift cards”– but, then again, you probably already know that.  Didn’t find anything specific to “gift cards” on your site, but I’m wondering your opinion of them as CRM tools?

A: Well, as I’m sure you know, they can be used in lots of different ways. From an incremental perspective, some approaches are not so profitable and others quite profitable.

Q: My quest at the moment is to try to help a client “prove” the incrementality of the business produced through gift cards and what avenues of sale might be more profitable than others. Is there a correlation to this quest and information in your book, i.e., marketing model versus financial model, success based not on “response” but on “profit” of the program?

A: That’s pretty much what the entire book is about – how do you set up, test, and measure these kinds of ideas? The marketing model IS the financial model, from my perspective.

Q: By the way, I’m not the only one pondering this in my industry. Might be a topic you want to explore in your future endeavors which would be of interest to a host of us.

A: OK, let’s do some of that. My answers to e-mails like this frequently become newsletter or blog material (and I won’t reveal who asked the question), so perhaps I can both help you and get some writing done!

From a broad perspective, I don’t think there is any way to know the answer to your question without testing using control groups, and the ability of the client to execute on that idea can be limited if they are a mass retailer. Plus, you have not told me anything about your client or how they promote the cards. So we probably have to speculate based on what we know about behavior in general from other sources – loyalty programs and so forth.

In my mind, there’s no question that some portion of the gift card business is incremental.

You start with the breakage – cards not ever redeemed. If I give a gift card to someone who doesn’t use it – $8 billion in gift card sales last year are in this bucket – then as the retailer ISSUER (as opposed to the gift card seller) I have to be in the black on it, from an operational  perspective. I can’t see any way there’s no incremental profit in that idea. Incremental SALES, maybe not, but profits?  Have to be there, industry as a whole.

In case the above is not clear, the issuer would be where the card is redeemed. Originally this point of clarification would not be required but as you know, now there are lots of stores that sell gift cards from other retailers! Whether that kind of operation is incremental to the SELLER of the card is a merchandising issue, but I’m pretty sure it is incremental to the ISSUER – the store where the card is to be redeemed – based on the industry breakage.

So, if your client is a retailer, an ISSUER that sells their own cards, either through their own store or other stores, than I’m pretty sure there is incremental business there. If they are a seller of other store’s cards, or a processor of some kind, then I’m not sure.

But let’s say 100% of cards are redeemed. Now it’s a little more tricky, you have to look at the incremental cost of the cards / processing versus the “float” on the money. This is a pretty simple equation. The costs are whatever premium may be charged for the creation / processing of the cards versus the interest on the money taken in from the sale of the cards.

For example, if the average “days to redemption” of a card is 90 days, and the average value of a card is $100, and the interest I can get on that $100 is 4%, then I make $1 ($100 x 4% / 1/4 of a year) for every $100 card I sell just on the “float”. If the incremental costs (say, versus a regular credit card transaction) to issue and redeem this card is less than $1, then as the Issuing retailer I am making the difference as incremental profit – even if there is 100% redemption, which for sure is not the case.

Now, if the retailer is doing something else with these cards – using them as rewards, store of value, etc. – the story could be different. For example, “buy $100 worth of merchandise and we will give you a $5 gift card” or “redeem your loyalty points for a gift card”.

That’s a different story, now the card is not a “product” it’s a transactional device / store of value and that changes the dynamics. In this case, the card is no different than issuing coupons and you get into problems because these kinds of promotions tend to attract best customers, and their purchases using the card may not be incremental.

As far as incremental profit goes, now you stand a good chance of being in the hole, at least with the best customer segment. And since frequently the volume of losses in this “best” segment for promotions like this will dwarf any gains from these promotions on any other segments, you end up in the hole with incremental profit.

Put another way, the best, most engaged customers are highly likely to purchase anyway and giving them a discount changes nothing about their spend, they simply buy the same amount at a discount. This aggregate discount is usually greater than the aggregate incremental profit on not-so-best customers, so the entire promotion operates at a loss.

The good news is this: the actual incremental profit of programs like these is simpler to measure, because you have all the transactional data and you can control / put parameters around the issuance. Typically in a scenario like this you would  set issuance rules that threshold above the average spend rate of the customer segment.

So, for example, let’s say the average monthly spend of a best customer is $80 or $960 a year. The correct promotion then looks like this: buy $100 worth of merchandise **this month** and we will give you a $5 gift card. Hopefully, at minimum you would see a total spend of $980 that year – $20 more than average. You would be on your way to incremental profits at this point, depending on what margins are in the business.

What you *do not* want to see is the customer spend $100 during the promo month and then spend $60 the month after, which is a typical thing that happens with best customers. This is a sign you are not driving incremental sales, you are simply moving the existing spend around and giving up $5 in profit as you do it. Not good.

For more on setting up these kinds of tests and measuring these types of effects, see this article. Hope that gives you – and the rest of your industry – a starting place!

(Follow-up Question)

Q: You have however validated my thinking that we can’t measure incrementality without creating control groups. In asking the question, I was second guessing myself and wondering if there was something I was missing. I think to some degree we can use existing sales data to measure uplift (either over the value of the card itself or over the client’s average transaction) for the current purpose which would move them to the next phase of specifically measuring incrementality. For this, I’m sure your book will be helpful and I shall use it accordingly.

A: Yes. Along those lines, in the “threshold” example, we have seen a $10 off $50 generate an average sale of $120.  Given the customer segment had an average purchase of $45 – hence the $10 off $50 – it would be safe to assume there’s some incremental in there, and long as the customer segment spend doesn’t tank by $70 or so over the next several months, you could assume pretty safely you have incremental profit.

“Proof” is another thing, but if you’re dealing with pure retail, proof is a matter of degree, you take what you can get.

(Follow-up Question)

Q: P.S. Your point about the promotional use of cards, this company has separate business units which are their own P&L centers. So, while the promotional use of cards might be incremental to the business unit which runs gift cards, it’s only incremental to the company to the degree that it produced new business or “stole” it from a competitor less than value of the gift cards it took to produce.  Again, greatly value your time and input.

A: Yes, well, that’s quite another matter, and gift cards are not the “root cause”, if you know what I mean. There is a long tradition of “intra-company sales theft” between divisions that seemingly goes unchecked. A lot of direct marketing companies are sensitive to this issue, but that’s because they can measure the effects.Even then, there are only a few who have really unlocked the riddle of how much / where / when it happens, especially relative to web sites versus catalogs and retail stores. Segmentation of Recent customer buying patterns is the key.

Anyway, this is a “governance” question (strategic), not a marketing / gift card question (tactical). If a company really wants to measure channibalization, they can by setting up specific tests and using control groups to measure outcomes.

The question is, do they really want to know the answer?

Jim

Get the book at Booklocker.com

Find Out Specifically What is in the Book

Learn Customer Marketing Concepts and Metrics (site article list)

Download the first 9 chapters of the Drilling Down book: PDF 

Marketing into a Downturn

Analytical Culture, DataBase Marketing, Driller Q & A, Newsletters

Jim answers questions from fellow Drillers
(More questions with answers here, Work Overview here, Index of concepts here)

Q: I have been asked to create a whitepaper on marketing strategy and tactics for a down or recessionary market. In your studies and travels have you come across any literature or have thoughts of your own that I may quote?

A: Well, I suppose someone has written something about it somewhere. The trades write about it for every downturn! But I don’t know of any primary work on the topic – case studies, research, etc.

I do know that when we get into a down / recessionary market my phone rings more and I work a lot harder. The “new client” customer retention business is counter-cyclical; people always wake up during the soft times and say, “Hey, if we can’t drive new customer volume, maybe we can sell more to existing customers!”. You know, the CEO or somebody read that somewhere…

The problem with this kind of thinking is, in most cases, it’s already too late to do anything about customer retention.  That’s not something people generally want to hear. I then say, “The economy is cyclical.  Do you want to be prepared for the next downturn?”

The people who answer yes to that question will often become clients; those looking for the “quick fix” generally won’t become clients – but they call again into the next downturn…

It’s a strategy thing, you know? Long term thinking? But I digress…

The insidious thing about customer defection is that it’s always there, eroding the asset base, wasting away the hard work. But people don’t see it until the flow of new customers shrinks, and then all of a sudden, the defection issue is laid bare.

This is why the retention business is so counter-cyclical; why “discovery” comes in the downturns.

What you normally find is whatever business change / policy / product is causing customer defection, it takes as long to build up the customer asset again as it did to destroy it. Here is a real-world example.

A retailer makes a significant change in the types of products it sells, because it wants to “attract more new customers”. For existing customers, revenue per customer starts to fall. This fact is masked on the revenue side by the attraction of new customers to the new products – for a while. But it ends up these new customers, in terms of revenue per customer, have a value about 30% less than the old customers? So even though new customer adds remain consistent, sales start to drop, and over time drop by 30% as old customers defect and are replaced by the new customers worth 30% less.

Two years into this process, a downturn in the economy causes more attention and analysis of the customer base, and this issue is exposed. Surprise! The newer kind of customers defect at a higher rate and in a shorter time than the old type of customers.

New management is brought in, and they decide to go back to selling more of the “older” product to attract the higher value customer. Once they make the switch, it takes just as long for sales to get back to where they were as it did to create this problem in the first place – 2 (very long) years.

And that’s why it is so tough to deliver a “quick fix” to these kinds of problems. They are systemic in nature and because you are talking about the value of a customer over time, take time to fix.

So, it may well be that your advice should ultimately be “use this downturn to prepare for the next one”, if you know what I mean. Investigate, learn, and understand what happens this time, so you know what to do next time. In terms of action items, a few:

1. Analyze the customer base, to understand the source of customer value. Who are the best customers, where do they come from Which media, sales persons, product lines, services, geographies, etc. create the “best customers” for the business?

2. Analyze these best customers, and understand their behavior. What would be a warning sign that these best customers – who are probably responsible for the lion’s share of your profits – are cracking into the downturn? Slowdown in orders per month, average order size, number of contracts, whatever the relevant metrics are.

3. Track a handful of these customer metrics and see how they change as the economy slows. These metrics will be a map for predicting actual trouble the next time – predicting trouble even before everyone is already talking about “a downturn”. This gives you the extraordinary advantage of lead time over your competition in reacting to the downturn in business.

4. Complete the same 3 steps above for medium value customers and low value customers, if you have the resources.

5. Now, fully understanding what you have to work with (perhaps for the 1st time?), what is the strategy for a downturn?  Generally, it would consist of a reallocation of resources away from lower productivity to higher productivity activity, in order of importance:

a. For best customers, how do we keep them?
b. For mid value customers, how do we grow them?
c. For low value customers, how do we reduce costs to acquire or service them? Note I do not advocate “firing” customers, but you certainly can cut back on acquiring as many low value ones.

For each group, you should have a specific (and probably different) strategy and set of tactics. What a lot of folks don’t understand is there is almost always a truly remarkable difference between these customer groups, and any “one size fits all” edict or direction is bound to screw up the business, just like the example of the “new customer” effort from the retailer above.

For example, we know that marketing spend generally softens in a downturn. Companies cut back on marketing because they feel like they are “pushing on a string”. They cancel or don’t buy advertising, they fire salespeople. This is the wrong move. The old saw about buying more marketing into a downturn to “grab share” can also be the wrong move, though has some “accidental” positive effects.

The company should invest in more marketing, but not across the board. They should buy the right marketing, the marketing that generates the best quality customers.

They should reallocate marketing resources away from generating “c” customers towards generating “a” customers. If you know trade shows generate leads which turn into “a ” customers and online ads generate leads that turn into “c” customers, you take the money you spend online and book more trade shows. You let go of salespeople that generate “c” customers and use that salary to bonus salespeople generating “a” customers.

Of course, this analysis and planning is an exercise that should be done all the time, not just into a downturn. A business should always be trying to understand where customer value comes from and how it is created. But unfortunately, this issue most often comes up going into a downturn.

You’ll have to excuse me now, the phone is ringing again…

Jim

Get the book at Booklocker.com

Find Out Specifically What is in the Book

Learn Customer Marketing Concepts and Metrics (site article list)

Download the first 9 chapters of the Drilling Down book: PDF