Valuation of Customers (Part 1 of 2)

Most businesses recognize the importance of customers. However, few businesses will recognize customers like any other asset, assigning value to customers and categorizing this asset as the main asset for running the business. When you treat customers like an asset, you begin to manage differently. For example, some customers add value to the business while others remove value from the business. For those that add value, more resources are allocated to these types of customers. The net losers are transferred to the competition. Retaining the highest value-creating customers is the primary objective behind assigning values to customers.

The value assigned to customers is based on the future net profits generated by a customer, discounted back at the cost of service rate to a net present value. In some cases, it is necessary to account for additional values contributed by customers. For example, suppose you have a customer that refers new customers to your business or suppose you have a customer that is providing you with valuable feedback for improving your services. These types of customer attributes generate higher values.

When calculating net present values for customers, you will need to estimate the full costs of servicing the customer. This requires a cost allocation system, such as Activity Based Costing with an object layer that captures net profits by customer. Since most cost models will be hard pressed to capture all customer-related costs, you will probably have to apply some probabilities to certain cost categories. Keep in mind that we are trying to calculate a comparison of values between customers so that we can distinguish between customers adding value and customers destroying value. Ranking customers according to value requires an understanding of how customers impact the bottom line. Once we have a ranking by value, we can allocate more marketing and customer service resources to the highest value generators.

Retaining "value-adding" customers is a major challenge for every business. The range of customer values will guide you on how to allocate your limited resources. Some businesses may have a very narrow range of values; i.e. every customer adds more or less the same relative amount of value. For example, a bookstore makes more or less the same amount on each and every customer. Other businesses may find a major divergence between customer groups. For example, airlines tend to make much more money from business travelers that fly first class as opposed to vacation travelers flying coach.

The valuation process is now an integral component of managing customers. And customers are the critical assets behind every business. When we recognize that customers are different, we start to move towards customization. The process of customization is the next phase in properly managing the customer. Part 2 of this article will explore how we leverage customization as a major strategy for retaining and building customer loyalty.