The fundamentals of customer value

On no topic have we so far been allowed to read more theses in our training courses and seminars than on customer value. And yet, even after all these years, we are repeatedly surprised that this instrument is so rarely found in sales. That’s why this article aims to address the fundamentals of customer value. Fundamentally, a customer-value model is an elementary building block of customer-centric corporate management and thus of Sales Excellence. As already explained several times, in the past revenue and market share were central indicators of corporate steering. Against the backdrop of more and more markets stagnating and more sales channels being deployed, a company’s profit moves more strongly into focus. But why does it not make so much sense to simply stick with revenue and market share?

Customer value describes the present value of a customer’s future profit over the entire duration of their relationship with an organisation. The sum of all individual customer values of an organisation gives the customer base value / customer equity.

Two types of company must be distinguished. Companies that sell chocolate, for example, can assume that most customers eat a similar amount of chocolate. There are certainly moments in life — e.g. the pain of a break-up — when chocolate consumption can rise considerably, but the differences between individual customers’ spending are relatively small. Thus there is a high correlation between revenue and profit. Although e-commerce is already putting cracks in this simple equation, because logistics costs and discounts can lead to a negative contribution for a larger share of customers, despite supposedly high revenue. Here, customer value at the individual-customer level holds less steering potential. In many companies, however, this distribution is markedly different. Often 20% of customers, or even fewer, generate 80% of revenue (the Pareto principle). In addition, customers from this 20% segment often receive large discounts and are looked after intensively by sales. For example, a key account manager is to be budgeted at CHF 150,000 or more per year. As a result, studies show that, roughly from the 2000s, the correlation between customer revenue and customer profit breaks down at these companies. The better the understanding of customers’ value contribution in a company, the greater the potential to increase profit. This is one of the elementary fundamentals of customer value.

Steering by means of customer value pursues two basic objectives: the greatest possible increase in revenue and the greatest possible reduction in costs. Both are not possible with every customer. While revenue data per customer is usually available, cost analysis is apparently a major challenge in everyday business. For profit development, most companies put a great deal of effort in at the product level. Fixed costs and variable costs are determined precisely and continuously optimised — whether in selecting suppliers, buying new machines or adjusting processes. As a starting point, it can be stated that most companies have extensive experience and competencies in, as the saying goes, ‘keeping costs under control’. The situation is quite different with regard to customers. Although most companies can determine revenue per customer precisely, the costs are often hidden. The first reaction we hear from salespeople on this topic is that it is, after all, difficult. OK — is that really so? Is it really easier to determine the exact production costs for a good than the costs for a customer? On closer inspection, it quickly becomes apparent: it is certainly not more difficult, but rather even easier, to determine a customer’s value. The challenge is therefore not to be found in the level of difficulty, but in the existing competencies and experience in the company.

Before addressing the individual methods of determining customer value, a distinction should be made between a purely retrospective view and a retrospective-and-prospective view of determining customer value. If the customer-value model is to be geared towards a purely retrospective view, the following system can be used to determine value. This system is generally referred to as the customer contribution margin. As a first step, the period with which the customer evaluation is carried out needs to be defined. It should be noted that the period is adapted to the average customer’s purchasing cycle. The rule is: purchasing cycle plus one period. If, for example, customers buy the offering on average once a year, then the period should be set to two years. Setting the observation period to the financial year may perhaps meet with great approval in accounting, but it can lead to dangerous results. The calculation is fundamentally carried out with the following system:
Customer’s revenue in period XY –

• Discounts
• Number of customer visits * average visit costs
• Number of calls * average call costs
• Number of emails * average email costs
• Quote-preparation costs
• Training (if not charged)
• Support visits * average visit costs
• Support calls * average call costs
• Support emails * average email costs
• Costs for complaints, special interactions (fax machine)
• Percentage share of costs for digital channels / employees / website / newsletter / social media / trade fairs / events / communication activities
• …

A customer-value calculation should not, however, be based only on the past. This too is part of the fundamentals of customer value. The term customer value also refers to the future and is intended to help support decisions for a company’s future development. This future value involves more than the projection of a customer’s current purchasing behaviour. Customer value comprises two groups of value drivers: the transaction potential, which results from sales transactions, and the relationship potential, whose potential — beyond transactions with the customer — stems from the fact that the customer feels connected to the company. The transaction potential is made up of the following elements:

1. Base volume: the customer contribution margin derived from purchase history and also expected for the future.
2. Intensification potential: the potential that arises from expanding the historical base volume through the purchase of the same product type.
3. Cross-selling potential: the potential that arises from purchasing a further offering from a different product category (e.g. opening a savings account after opening a current account).
4. Up-selling potential: the potential that arises from selling higher-value products or product bundles over time.
5. Potential from declining price elasticity: the potential that arises from customers’ willingness to forgo price advantages.
6. Cost-reduction potential: the potential that arises from costs for marketing and sales — and for satisfying customers’ needs — falling over the course of the customer relationship.

The relationship potential is made up of the following elements:

1. Referral potential: the potential that arises from customers recommending the company to those around them.
2. Information potential: the potential that arises from customer feedback.
3. Cooperation potential: the potential that arises from customers’ willingness to cooperate with the company.

The list shows that a large amount of data can be used to create a customer value, insofar as it is available in the organisation at an individual level. Two approaches can be distinguished for determining a customer value. The organisation ‘estimates’ the future value contributions manually or via a formula/algorithm in CHF, or qualitative weightings are applied. In both approaches, an estimate is made by the respective salesperson. To complement the fundamentals of customer value, a recommendation for the temporal integration of the respective dimension into a customer-value model is shown in the following table. A three-stage approach is recommended, which should be guided, in terms of the concrete time periods, by the company’s capabilities. At least three years should be assumed.

People with a financial perspective will probably prefer the quantitative assessment, because it supports determining the company’s financial development bottom-up. In sales, the financial perspective is certainly valuable too, but at the centre of the customer-value calculation are the support plan and the discount system. Both build on the fundamentals of customer value. Depending on the different value segment, sales needs to invest differently in the respective customers — whether through the type and intensity of support or the discount system.

With this form of customer evaluation, the large C and D customer segment quickly presents itself as a challenge in practice. How should such a forward-looking perspective be taken for a large customer segment? The answer lies in time. In a classic B2B company, customer relationships exist over years. The starting point is the inside-sales team. On the basis of the customer contribution margin, they should make contact with the respective customers (this can also be by email) and systematically make an assessment of the potential. So it is entirely sufficient, for example, to assess all C customers in the first year and all D customers in the following year, and then all C customers again in the following year. Potentials will also be estimated incorrectly, and things can change spontaneously for the respective customer. More important than accuracy for every individual customer in the C and D segment is the systematic cultivation of the entire customer base over time, with the highest possible efficiency. Here, those responsible are called upon to adapt the existing internal resources optimally to the size of the customer base. It can also be expedient not to include the D segment in the consideration at all. The elements presented are part of the fundamentals of customer value and must be observed in order to increase sales efficiency.