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small business secrets small business secrets small business small business secrets small business secrets small business

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small business secrets small business secrets small business small business secrets small business secrets small business

small business secrets small business secrets small business small business secrets small business secrets small business

Mike Reddy caBusiness Development Specialist Com

plete

with

Action P

lan

How to

Slash YourAdvertisingand Increase Your Profits

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 1Copyright 2007 Shape Your Business PTY Ltd

Small Business Secrets - How to Slash YourAdvertising and Increase Your Profits

IF I HAD A DOLLAR 3

CUSTOMER SPENDING CAN REALLY ADD UP 5

ITS EASY TO OVER INVEST IN MARKETING 6

WHAT IS CUSTOMER LIFETIME VALUE? 8

USING CLV TO MAKE MARKETING SPENDING DECISIONS 8

APPLYING THE CLV METRIC 10

MARKETING COSTS AND CLV 10

THE REAL RETURN ON INVESTMENT FROM THE ADVERTISEMENT 11

USING CLV TO EXPERIMENT WITH ‘WHAT IF’ SCENARIOS 11

THERE ARE DIFFERENT WAYS TO MEASURE CLV 13

CHASING VS. RETAINING CUSTOMERS 13

IMPROVE CUSTOMER SERVICE 14

USE YOUR CUSTOMER DATABASE TO TARGET MARKET 15

GET YOUR CUSTOMER’S OPINION 16

INTRODUCE A LOYALTY SCHEME 17

GATHERING CUSTOMER INFORMATION 18

COSTING A LOYALTY MARKETING PROGRAMME 19

USING CLV ANALYSIS TO ASSESS LOYALTY PROGRAMMES 20

MANAGING MARKETING CAMPAIGNS FOR ROI 21

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 2Copyright 2007 Shape Your Business PTY Ltd

USING CLV TO BENCHMARK CUSTOMER ACQUISITION COST 22

SEGMENTING CUSTOMERS 23

PUTTING YOUR MONEY WHERE YOU’LL GET MOST RETURN 24

GROWING CUSTOMERS THROUGH DIFFERENTIAL SERVICE 25

FIRE THE LOW PROFITABILITY CUSTOMERS? 25

NOT SO FAST… 26

KNOW WHAT YOU ARE DOING 27

CONCLUSION 27

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 3Copyright 2007 Shape Your Business PTY Ltd

If I had a Dollar

If I had a dollar for every time a client has asked me how much they should commit toadvertising!

Is it 2%? 3%? 5% of turnover?

Well that depends. It depends on a lot of factors.

But it’s the wrong question anyway. There is a lot more to gain from asking thequestion that any business that has been trading for a couple of years or more should beasking.

Why advertise in the first place? What is the purpose of advertising?

That might seem a silly question. A question that might come from a person that hasnever been in business. How can anything be more obvious?

Yet it’s an answer that could save businesses half of their annual advertising splurge.Half of their annual advertising that could be better spent on growing their business. Oron themselves. The equivalent of 2% or more of their annual turnover available tospend how they wish. Wow.

It’s all about keeping the end in mind. And surely the end game is to grow the businessby increasing sales.

But more importantly by increasing the bottom line.

After all, what would be of greater benefit to a business owner. Increasing sales by, say,$100,000 and increasing the bottom line by $10,000. Or by increasing the annual salesby just $30,000 and increasing the bottom line by $15,000?

A number of owners would suggest the first scenario. For some reason they measuretheir success by turnover. But the value of the business will be determine more by theprofitability and the net cashflow generated from the business rather than the amount ofsales.

And it seems to me that the more money I could make with minimal effort and risk is alot more appealing!

So if the main purpose of advertising is to increase sales in order to increase the bottomline, then shouldn’t that be the purpose of the strategy?

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 4Copyright 2007 Shape Your Business PTY Ltd

Yet time after time I see business owners commit to advertising in a relentless pursuitfor more customers. Any customers will do, as long as they are new to the business.People or other businesses that we have never met before. People we can introduce toour business and hopefully sell something to. And then if we advertise again we can findsome more. And some more. And so on. Until one day our businesses are full with newpeople who want to buy our products.

And I matters not how we spend it. Or when we spend it. The easier the process thebetter still.

It a necessary expense. A bit like paying the electricity bill. Although come to thinkabout it, when we pay the power bill, we know we got the power we paid for. And weknow we are getting a certain cover in return for the insurance payments we make. Andthe accounting fees. And all those other expenses.

But advertising? Are we sure we got the customers we were hoping to get? And if wedon’t, will the advertising medium give us a discount?

Unlikely.

Yet we continue to advertise. We keep making it, month after month, year after year.Never sure if it is worth it. If we are achieving the desired goal. Yet we persevere.

And even when there’s a response, the cost of the advertising could well eat up theprofit that those responses will contribute to the business.

The situation isn’t helped by traditional profit and loss statements showing sales at thetop and advertising cluttered with all the other expenses. There is no match. No way oflinking the expectation that advertising should be resulting in a specific increase in sales.And there should be.

With advertising can take up 3%,5% or even a higher percentage of the sales this canmake a huge impact on the success of the business.

And yet the feeling is that customer acquisition is the sole driver of success. And whatmatters most is to increase revenue by continuously acquiring new one-shot customers.

This is one of the underlying faults with common small business strategy. It's a sadscenario, but it's also the reality.

Let me tell you something. It will cost you 5 times more to attract a new customer thanit will cost you to bring one of your past customers back to you.

I don't know you personally, but if you're a smart business owner you'll understand thatevery cent you invest in advertising is going towards acquiring new customers. You'llalso realise that once you've acquired the customers, you just can't afford to let themgo.

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 5Copyright 2007 Shape Your Business PTY Ltd

Customer Spending Can Really Add Up

It’s true that we only see some customers, perhaps many, just that once before they

disappear. Never to be seen again.

In business terms their lifetime as a customer is just one transaction.

So their lifetime value to you as a customer is equal to the profit on that one transaction.

But there are others, many others when you produce a good product, that keep coming

back. Time after time.

Think about that.

We use the term “lifetime value” to describe the profit that the customer brings to your

business over the time they elect to regularly deal with you - their effective “lifetime”.

And the lifetime value accumulates with each return to your business.

Let’s look at an example.

A convenience store may have a number of regulars that keep coming back, week after

week, month after month, year after year. The lifetime value of this sort of customer

can be substantial.

Alternatively think about a business who’s team members regularly buy from one

particular coffee shop for an extended period of time. Think about how much that

customer is worth to that coffee shop over a number of years.

Then consider for a moment the cost of initially attracting those customers.

The cost of the advertising, the time taken dealing with the prospects many of who

decided to make a purchase elsewhere, or perhaps not at all.

When you consider that scenario you can see why marketing experts suggest that it

costs between five and eight times more to sell to a new customer than it does to sell to

an existing customer. And that is why it is so important to keep an existing customer

satisfied, in fact more than satisfied. And how this sort of strategy can significantly

improve your profitability.

Frederick Reichfeld points out in his book The Loyalty Effect: “Companies not capitalising

on loyal customers face a dismal future of low growth, weak profits and shortened life

expectancy. A 5% increase in customer retention can produce a 125% increase in

profitability.”

No wonder most businesses struggle to develop their business at a rate any more than

average.

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 6Copyright 2007 Shape Your Business PTY Ltd

They set their entire growth strategy on increasing the number of customers. Week

after week after month after year.

Same strategy, same result. Average.

Its Easy To Over Invest In Marketing

And as was illustrated above, the numbers show that this is a poor strategy.

But without the numbers, how were you to know? And now that you do, what does itmean?

It means that there is a lot of money going down the drain. Too much money.

And it means that the money is being spent on the wrong thing. And therefore resultingin even more money going down the drain.

The Key Performance Indicator that measures the number of new customers coming intothe business is clearly not a good financial performance indicator.

So traditional marketing and advertising expenditure not only takes your focus awayfrom where it should lie, the whole exercise is done without any regard to the true cost,or rather loss, of profitability that could be made.

Yet that is the typical approach by business owners. They believe that business growthcomes from more customers, and that comes from advertising. Consequently theymeasure in some detail the number of new customers coming through the door. It isunfortunate that this takes the focus away from the real solution to improve inprofitability.

From my observation what is even worse is that the advertising is carried out in asporadic manner. There are few aims and objectives, and few measures of successother than a "gut feel" that it must have worked because sales are still being made.There is rarely an objective assessment on the actual return gained from the marketingcost. Perhaps that is because of the panic that will arise if the figures show that theadvertising expense did not achieve a reasonable return on investment. For after all, ifthat doesn't work what chance of the business has of achieving success?

The opportunity that is missed is that previous advertising expenditure has alreadybrought in enough customers to make the business a success if handled correctly.

It is also an easy "out" to the business owner who was skilled in tuning out a quality

product but lacks the critical information that will turn a quality product into a profitable

one.

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 7Copyright 2007 Shape Your Business PTY Ltd

Advertisers have also done a wonderful job in convincing business owners that

advertising is a recurring expense, needing to be frequently repeated, rather than an

investment which should produce a capital asset (ie customers) that can be used to

generate additional profits well into the future.

Because it is regarded as an expense the owner treats it know differently than they

would in measuring the result of paying an electricity bill.

This is a costly mistake.

That is not to say that advertising is an extinct species. But rather a cost that should be

regarded as an investment and therefore monitored like any of your other investments.

One method we use to monitor this is generically known as Customer Lifetime Value.

It could be the closest thing we have to a crystal ball. We can use it to evaluate how

well our advertising is working and even product if a considered campaign is likely to

bring the desired rewards.

Business owners would make better informed decisions if they carried out this sort of

analysis before committing to an advertising campaign. And better informed decisions

are usually more profitable ones.

I would also like to discuss ways in which I believe you can improve the all-important

loyalty factor of your existing client base in order to extend your potential lifetime

relationship with them and therefore significantly enhance your profitability.

This will consist of a range of retention and customer value improvement strategies that

I think will be well worthwhile. I will also advise on how you can segment your customer

base in order to produce even more opportunities to increase your profitability.

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 8Copyright 2007 Shape Your Business PTY Ltd

What Is Customer Lifetime Value?

But first let's begin by having a look at what customer lifetime value is all about.

The concept was apparently brought about by marketing agencies who working to assessthe viability of their marketing strategies. It was therefore brought into existencebecause marketers knew of the importance of providing a return on their clientsinvestment, that is ensuring that profits from additional revenues brought in from thecampaign more than offset the cost of the campaign itself.

But the focus is not on how many customers we bring into the business as a result of thecampaign, nor is it about how much on additional sales we will get from the customerwho visits you shop as a result of the campaign. It is a much more comprehensivecalculation than that.

It is all about estimating how a customer's spend is likely to change as a result of amarketing initiative (e.g. by introducing some sort of special offer or customer loyaltyscheme).

Using CLV To Make Marketing Spending Decisions

if you accept that advertising in any shape or form is an expensive exercise an obvious

issues arise that need to be addressed including:

how much should be invested

how do you know if the expense can be justified

For all intents and purposes the customer lifetime Value calculation is the perfect means

of answering these particular points.

I think I could best explain with a real-life example.

I once worked with a coffee roasting company which happened to have a mail order

division. They considered an advertising campaign that would cost them $12,000. The

advertisement invited potential customers to accept a free coffeemaker which was

valued at $51.95 provided they bought a sampler selection of fresh roasted coffee blends

for $34 95.

You can see this is not the usual sort of advertising that is entered into by business

owners. It is far more effective than that and is just one example that is covered in my

e-book "if you insist on advertising you may as well make a buck out of it".

Part of the deal was that customers would simply "consider" and "until further notice"

home delivery service. If they decide to request the service they received a monthly

order which will be automatically charged to the credit card. Monthly deliveries continue

until the customer asks that they be stopped.

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 9Copyright 2007 Shape Your Business PTY Ltd

The customers were under no obligation to sign up for the "until further notice"

agreement. They merely had to "consider it" and were entitled to keep the coffee maker

regardless of the decision.

This is the approach to calculating Customer Lifetime Value used in the coffee retailer example. It isbased on the coffee shop knowing the average profit per customer per year and the average numberof years a customer does business with them.

1 Average Profit Per Year Per Customer $245

2 Number Of Years Customer Buys From You (Estimate if necessary or run a‘what if’ scenario)

3

3 Customer Lifetime Value (Line 1 x Line 2) $735

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 10Copyright 2007 Shape Your Business PTY Ltd

Applying The CLV Metric

Because my customers understood the value and profitability that will arise fromextending the average customer lifetime they were not after the usual costly andunprofitable strategy of the quick sale. For that reason we accepted that there was noprofits on the immediate response to this advertisement. In fact the margin on theinitial sale of a sample pack and coffee maker was approximately $1.

Based on a $12,000 advertising campaign a quick calculation would show a break evenin normal terms of 12,000 responses to recover the cost.

But let's remember the customer lifetime Value. That is the key to increasedprofitability.

That company's data base showed that the average customer produced approximately$245 and profit per annum and the average customer stayed with the firm forapproximately three years.

There for the average customer lifetime Value was $735.

They concluded that based on these figures that campaign was worthwhile. Why?

Marketing Costs And CLV

This is how they reached the conclusion.

The average annual gross profit was $245 for every customer who signed up on thisparticular "until further notice" option. There for the break even necessary in order torecoup the advertising cost of $12,000 was just 49!

That is to say that if the advertising campaign attracted just 49 people, their average

spend would be enough to repay the advertising account even though he was only a

margin of $1 being earned on the sale that was actually advertised in the offer.

Quite clearly when you use the lifetime Value of the customer as a means of determining

the value of an advertising campaign you do not need to win much new business in order

to make the campaign worthwhile.

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 11Copyright 2007 Shape Your Business PTY Ltd

The Real Return on Investment From The Advertisement

There is yet another important calculation to be made in order to determine theeffectiveness of an advertising campaign. This is a simple calculation where youmeasure the number of people who have contacted the business as a result of thatadvertising campaign.

A simple means of collecting the data is to ensure you have a script in your system thatidentifies the reason that caused them to make the contact. A simple question could be"Thanks for calling us. Could I just ask how you heard about that company?"

This will enable you to readily keep track of the number of people who have respondedto the campaign.

You may find that potential customers have contacted you with regard to thatadvertisement, but with very different motives.

There may be a group who are not interested in the ongoing coffee order. Others mayindicate that they will be in contact if they would like further supplies. And the rest maydecide that they want the whole shooting box.

Based on the figures calculated above (where the average lifetime Value of our customerwas $735), if 100 people had taken up the full offer that would net us a margin of$73,500.

That wouldn't be a bad return on an investment of $12,000.

Using CLV To Experiment With ‘What If’ Scenarios

These calculations ensure that you make better informed financial decisions.

Not only do they help you to make prudent decisions on where you should place your

marketing investment they also allowed you to more accurately gauge how effective the

campaign was. This information can then be used when determining future marketing

strategies.

Rather than the usual sporadic marketing campaigns which tend to arise when sales

drop off (therefore brought about by desperation rather than cementing a firm strategic

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 12Copyright 2007 Shape Your Business PTY Ltd

direction), you then have the option of programming a marketing campaign with a

purpose.

For instance you may decide that you are going to run that campaign at the beginning of

each quarter. Extrapolating these results means that you could budget on a return of

$220,000 for a marketing investment of $48,000.

While I concede that these are projections and may not necessarily be a guaranteed

outcome there is no doubt that it is based on reality unlike the normal marketing drive

which has little measurement of its effectiveness.

They will be other factors to be considered. The market may not be strong enough to

respond in the same way to a campaign that is repeated a few times a year. Therefore it

may be a better call to program the sort of campaign at a certain time of the year and

consider new campaigns with a different offer at other times of the year if necessary. I

would not be so bold as to suggest that if you ran a campaign such as the one illustrated

above on a monthly basis that it would be a simple matter of multiplying the results by

twelve.

What is clear in the example is that with these figures the break even point of this

marketing campaign would be a budget of $735 per customer.

I would also suggest that you need to look at your own industry model before blindly

using the sort of calculation. I believe this calculation is an excellent guide in the

decision making process in most industries where customers buy regularly.

The calculation would have to be more complicated if your industry only dealt with the

customer periodically (e.g. once every few years such as a real estate agent or car sales

yards). This is because of what we refer to as the "time value of money". That is to say

that we have assumed that the value of receiving a margin of $235 in three years time is

of the same value as receiving that sum over the next 12 months.

In times of low inflation and "reasonable" interest rates I believe this is quite acceptable.

However in the case of a real estate agent where you may only be dealing with a

customer once every several years I do not believe the calculation should be used

without bringing in a discount factor to account for the fact that some of the revenue is

some time off.

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 13Copyright 2007 Shape Your Business PTY Ltd

There Are Different Ways To Measure CLV

You will see that I have not gone into much detail, nor have I set about creating acomplicated calculation. My aim is to show that you as a business owner can make moreeffective financial decisions without the need to become an accountant.

The approach it is successful because it is so simple and easy to monitor. It also bringsabout a means with which an owner can treat their marketing commitment as aninvestment rather than an expense.

It makes a lot more sense and has a lot more substance than the traditional approach ofspending money on Yellow Pages or any other medium because that is what we havedone in the past, and because that is what our competitors are doing.

The great thing about making smarter business decisions is that you no longer have tofollow your competitors who are only making average returns. It allows you to makemore profitable decisions allowing you to retain more money for yourself or to reinvest inthe business for true profitable growth.

Chasing vs. Retaining Customers

No matter how you approach your business things are never going to the perfect.

Even with the best retention strategies you can still expect to lose customers.

Some may leave the area. Others may believe they can get a better deal elsewhere.

Some may even have a personality clash with you or your team members. For those

and other reasons you can count on the need to attract new customers to your business.

My own experience is that you can expect a churn rate of at least 20%. If you do not

actively engage in effective customer retention strategies your churn rate could double

or even triple this figure.

I do not believe that 20% is an unacceptable figure. But even at this level it means that

you lose the equivalent of your entire customer base once every five years. With a 40%

churn rate it means you are turning your customer base over once every 2.5 years.

What concerns me is that so few business owners bother to actively measure as a key

performance indicator their churn rate. As with all critical success factors it is impossible

to focus on the right things if you do not know what they are. Ignorance is no excuse,

and as my example shows can mean that owners are walking away from a bucket full of

money.

Consequently with effective client retention strategies you could significantly improve

your cash flow by:

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 14Copyright 2007 Shape Your Business PTY Ltd

ensuring your marketing activity will produce a satisfactory return and therefore

reducing your advertising commitment in terms of both money and frequency

extending your customers average lifetime reducing your advertising commitment

in terms of both money and frequency even more

capitalising on their extended relationship with you to market more products and

therefore improve relationships and turnover

Improve Customer Service

When I ask business owners about the reasons I should buy from them a significant

number factor into the list of advantages "customer service".

When I do down deeper it is difficult to establish what customer service is apart from a

smile and a friendly manner.

Yet when I asked that same group what the likely result would be if I phoned the

competitors and asked the same question, most concede that the competitor would also

likely site customer service as an advantage of buying from them.

So how can you as a business owner give the customer better service than your

competitors?

The good news is there are many ways. Enough to write book about. In fact I might

just do that!

Suffice to say that there are some basic low cost things that you can start doing right

now. So small and insignificant as to make you asked the question "how could this

possibly bring me more money?"

the uncanny thing is that it really is this easy.

I agree that there are many complicated psychological practices that can be

implemented as well. But why not start off with a few straightforward easy aspects of

customer care that your competitors are ignoring?

Usually the only time a customer will have contact from a supplier after the sale is when

they haven't paid the bill.

Why not make it a regular part of your business practice that you send them a thank you

card (handwritten) or of the sale justifies it, and instant scratchy lottery ticket. For just

a dollar or two you can make an important statement to the customer that you are

thinking of them after the sale.

Another technique is to follow up the sale a few days later with a telephone call to

ensure the customer is satisfied with the product. As part of a system you can use the

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 15Copyright 2007 Shape Your Business PTY Ltd

time to strengthen your relationship by giving them ideas on how to use the product

more effectively.

I see it as an important way of addressing any customer concerns about the product

which usually stem from the customer's lack of expertise rather than a problem with the

product itself. Without this contact the customer may very well perceived that you have

sold them a "dud" and not return to your business again. Furthermore they may

complain unfairly to their friends and colleagues that your products are sub standard.

While most business owners see a complaint as an affront I believe they really are a

great opportunity to increase your company profits.

Just look to that earlier example where a single transactional profit of one dollar could be

turned into a game of more than $700 to the business.

I would rather welcome the opportunity to address a customers concern and walk away

from $700 any day.

It is this type of logic that ensures your major pizza parlour is all too delighted to replace

the odd pizza in order to appease a disgruntled customer rather than walk away from

the future profits.

Small business owners need to keep their eye on the ball. It's all about relationships

and profitability, it is not personal.

My suggestion to you is to look at every customer contact point. That is every point in

your business where you come into contact with a customer. Always be asking the

question about how you could make a better impression with the customer in that

process.

It is an ongoing process and something that should be reviewed at least once a quarter.

Use Your Customer Database To Target Market

We often talk about customer relationship management systems. Every business hasone. It's just that some are used as business tools to create opportunities for moreprofit while others are simply ignored. There is no middle ground. They are eitherutilised or they are not.

Even the most basic computer systems such as MYOB have the ability to collect some

useful information about your customers.

There are also some sophisticated dedicated CRM systems as well.

Segmenting your market allows for greater effectiveness in your advertising campaigns.

Too often businesses use what I call a "shot gun" approach where their money is poured

into one generic advertisement designed to appeal to everyone but in effect appeals to

no one.

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 16Copyright 2007 Shape Your Business PTY Ltd

American Express were one of the forerunners with the realisation that they could

profitably segment their credit card market.

That is why they implemented a coloured credit card system segmenting their market

into such categories as gold credit card, black credit card, platinum credit card and basic

(green) credit card.

This allowed them to target specific offers based on their knowledge of what each

market segments found attractive or important.

The result was a significantly improved return on their marketing investment, and

stronger relationships with each of their market segments.

McDonald's have also accomplished this with their core market being children but they

have added another dimension attracting a very different customer segment with their

MCCafe concept which is aimed at upwardly mobile generation Y consumers with a high

disposable income.

The marketing strategy for this market is very different from that used to appeal to their

core market.

Get Your Customer’s Opinion

business owners often tell me about the strong relationships they have with their

customers.

Most seem to be based on anecdotal evidence rather than anything substantial.

I often suggest meeting with a clients top five or six customers in what we call a focus

group. The benefit of that is that often those customers will tell me things that they

wouldn't tell the business owner. It is always constructive but they feel they owner

might get defensive or it might in some way be seen as being critical which may impact

on the special relationship they have.

Even if you choose not to go along the sort of route it is imperative to ensure you have a

system in place to actively solicit your customers views.

I often see customer feedback forms which are all about measuring customer service

(whatever that may mean in the mind of the customer), the quality of the product and

other such items.

The sort of survey does little more than stroking the ego of the business owner.

It is unlikely that a customer will use this medium in order to discuss an unsatisfactory

experience, and there is little room or incentive for the customer to constructively

criticise the business.

Small Business Secrets - How to Slash Your Advertising and Increase Your Profits

Page 17Copyright 2007 Shape Your Business PTY Ltd

I would rather see surveys which ask for valuable input such as "how could we improve

our product?", or at the question is designed principally to gather information with which

to make changes to the business.

Asking questions that merely right from unsatisfactory upwards is no measurements at

all unless you also have equivalent marks from them on their experience with your

number one competitor. After all getting 4 out of 5 on product quality is of little use if

they would have scored your competitor 5 out of 5!

And thrusting a questionnaire as a customer and standing over them while they

complete its is not the best way of getting the customer is true reflection on their

experience.

We find online surveys and effective and inexpensive way of anonymously collecting

results which allow us to improve our overall performance.

Any system should be sure to encourage a client to report any problems or issues

ensuring they are a where that you rely on this information in order to improve your

business practice.

Introduce A Loyalty Scheme

Another way to improve customer retention is by way of a loyalty scheme.

There is no doubt that the most understood and successful examples have been the ones

that relate to frequent-flier miles. And to this end there has been a exponential increase

in the number of schemes trying to emulate the success.

I remember purchasing a birthday cake a couple of years ago and given a loyalty card

which showed me that my 10th birthday cake would be free!

Even if I had a large family it would still take a few years to claim my benefit. And even

then there would be great disappointment as the value of the "free" cake was

significantly less than my usual spend.

My wallet is overflowing with all sorts of loyalty cards and many of them never see the

light of day.

The benefit of them is that research shows us that where the prize is worthwhile you can

expect a greater loyalty from your customers than you would otherwise receive. That is

to say that some will expect a lesser standard because of the benefits that are accruing

to them by way of the loyalty scheme.

That is not to say that I am advocating reducing the customer service or any part of your

customer delivery because you can rely on the loyalty scheme.

But it is somewhat reassuring that customers may give you a second chance.

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When designing a loyalty scheme you need to accept that competition is strong for that

place in your customers wallet. It is both rare and valuable real estate. So you should

fully recognise the average lifetime value of your customer when deciding on the

investment you are willing to make in both designing your scheme, and in the rewards

you are willing to give.

If you are designing a loyalty scheme for the sake of having one, and the rewards of the

customer is not perceived to be of a high enough value, then you are probably engaging

in an unnecessary expense which will not earn enough to recover your costs.

Once you have designed and implemented a scheme you must make in your business to

ensure all customers and prospective customers that you come into contact with aware

of the scheme and the benefits and are encouraged to enroll. The enrolment process

must be as simple as you can make it. Expecting the customer to complete an

application form for the sake of a cup of coffee is doomed to fail.

Gathering Customer Information

I once worked with a massage practice which I noticed had little knowledge of its

customers buying practices because they largely paid in cash. This made it difficult to

recognise the customers likes, dislikes and preferences.

This was not a satisfactory position to be in where the owner wanted to increase the

business' profitability.

I encouraged the owner to introduce a plastic card which had their name and customer

number on it. It entitled the customer to a 5% discount on purchases.

But loyalty scheme was promoted by the team and buy in store merchandising.

Over the following 12 months we gathered a large amount of customer data about the

customer, what they purchased, and we also started getting information on the length of

time that the customer stayed loyal.

This information was used to create segmented loyalty schemes aimed at different types

of customers.

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Costing A Loyalty Marketing Programme

Think for a moment about that bakery and the ill-fated birthday cake giveawaypromotion.

Imagine what could have been achieved if they had systemised a process that capturedbasic customer information.

For instance think of the value to the business if they had recorded the name of the

person that I was buying a birthday cake for. Think of the opportunity they would have

had exactly one year after. And one year after that. And so on.

Think of the value to me as a customer if they had offered to e-mail me a reminder the

following year with a special offer. Rather than have me wait several years for my

bonus, they could have demonstrated a high standard of customer care if they had

contacted me by phone or e-mail a week or so before the birthday to confirm

arrangements.

If they had really been on the ball they could also have offered birthday balloons and an

age and gender appropriate birthday card and wrapped everything into a special deal.

In all likelihood I would have put the whole family in the register as I was the official

birthday cake provider. And rather than have two runaround to various cake shops

during the year I could have left this task to the one bakery that cared.

Perhaps they may have factored in an anniversary, my preferred hot cross buns, my

Christmas order and any other special occasion they may have been interested in.

But instead they decided to spend money on a pile of loyalty cards.

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Using CLV Analysis To Assess Loyalty Programmes

But I am getting ahead of myself. I am setting about implementing a marketingcampaign without practising what I preach.

The bakery marketing strategy I was talking about would require systems, monitoring(to ensure special occasions weren't missed), and increasing our inventory in balloonsand party goodies.

In all likelihood it would become our single most important marketing initiative.

So let's utilise the customer lifetime value to determine the viability.

Remember what I was saying earlier about the time value of money? Or perhaps it's agood opportunity to explore that formula in more detail so that we can ensure we areconfident before entering into this long-term marketing initiative.

Accordingly we will enter a discounting factor to account for the fact that the customerlifetime value will in all likelihood extend not only over a few months but over a numberof years. Entering into a marketing campaign now is going to commit us to spendingdollars in the short-term while the revenue streams will continue over a longer term.

It would not make sense to enter into an advertising campaign costing us $1000 now ifwe were expecting to wait three years or more for the revenue to start coming in.

Although we are hoping for revenues to start coming and immediately we have toappreciate that the bulk of the income will be derived over time.

It might also be appropriate to factor in that this point of differentiation may result in acustomer speaking to friends and colleagues who may also decide to take advantage ofthe unique customer care service provided by this bakery. And we know the strongestrecommendation is always that it comes from friends, colleagues and other people thatwe respect.

I would have fully expected that this approach would increase the amount of time thatthe average customer continues to purchase from us. After all, that was the keyadvantage of making the change.

The only other information we need is the cost of the marketing campaign.

This would include the cost of implementing a system, the costs of running a report sothat we can contact our customer the month before to remind them that the occasion iscoming up, and the costs of stocking up with the birthday cards and other goodies.

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Ensure that you have included the costs in the relevant months in your spreadsheets sothat you arrive at a monthly "surplus".

We could certainly debate an appropriate discounting factor. But in the interests ofkeeping things simple I would suggest you could use your average overdraft or creditcard interest rate.

Excel spreadsheets allow you to complete this calculation. Refer to the net present valuefunction. Don't get too carried away with all of the options available under this function.Where you have budgeted on a monthly basis just use the monthly interest rate Idescribed above and highlight your revenue totals.

To make it easier, I have included my own version of a spreadsheet that I hope you finduseful.

Managing Marketing Campaigns For ROI

So what about the final result?

Well, if the projected customer lifetime value based on the expected increase andretention rate and increased sales volume is better than the existing customer lifetimevalue then you should be comfortable knowing that the campaign could provide agreater return than the costs you are going to incur to run the campaign.

Conversely, if the costs had worked out greater than the possible return (this would havebeen indicated by a result of n improvement in the customer lifetime value, then it wouldbe quite clear to you that pursuing the campaign would be fruitless and the correctdecision would be to reject that campaign.

But in saying that I need to make an essential point.

I am not suggesting for one moment that this calculation is in some form a crystal ball.

It is not guaranteeing in any shape or form that the campaign will work.

It is imperative for you to get out there and make it happen.

What the calculation is showing is that if your estimates on expected retention and thevalue of the increased spend are a close approximation to reality, then you can becomfortable that it would be a good business decision to pursue the opportunity.

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This is a great opportunity to compare this approach to that which is usually undertakenby business owners.

The usual situation is that a business owner will come up with the idea, commitexpenditure to carrying out the idea in some form without having any idea on what thescheme will contribute to the bottom line.

In fact it could never be regarded as a failure as unless there are specific systems inplace to monitor the effectiveness the usual result is that the scheme will drain moneyout of the business without the owner having any idea.

That’s right, unless the systems are in place it is no difference in my mind than havingan employee take money a lawfully or a customer shoplifting. The financial effect islikely to be the same.

This as a result of their being no specific targets nor expectations as are essential if youare going to use the method I explained to calculate the customer lifetime value.

It is a tragedy that really does a business owner think long-term when committing tosomething as fraught with risk, and as expensive as an advertising campaign.

The other tragedy is when a business owner drops what is otherwise an excellentcampaign in terms of a positive customer lifetime value over the longer term justbecause there is no immediate payback.

A great opportunity gone begging.

Another fantastic advantage of using customer lifetime value is that the figures willhighlight the areas that need to be monitored in order to ensure the scheme is asuccess. The key performance indicators literally jump out at you.

Using CLV To Benchmark Customer Acquisition Cost

At the risk of repeating myself I need to reiterate an important point.

A lifetime value of a customer measures the value of the customer to your business. Ithas the potential contribution of the customer to your business over a period of time.That period of time as the likely amount of time they will be expected to deal with youon a regular or continuous basis.

It is when you know, or at least reasonably estimate the value of your customer, youhave a benchmark for how much you can invest to acquire a new customer at a profit.

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My observation is that desperation causes businesses to acquire customers at a loss.That is the profit from selling to that customer is eaten up by the cost of acquiring themin the first place.

For a significant number of small businesses my calculations show that a significantnumber of the customers, sometimes as high as 60%, were acquired at a loss.

That is why I maintain (unlike most advertising agencies I will add) that theeffectiveness of any marketing campaign should concentrate on the expected financialreturn rather than the number of prospective customers that respond to that campaign.

That effectiveness as measured by the number of customers multiplied by the averagelifetime value discounted by the value of time and then completed to the advertising,system implementation costs and other related outlays.

Rather than restricting the amount you will feel comfortable investing in a marketingcampaign you’ll be able to justify a greater investment when you look at your returns inthis way. The result as that you can achieve significantly greater business growth.

Another fantastic advantage is that, chances are, your competitors will not be looking attheir marketing campaigns in this light and will be under investing in good opportunitiesand over-investing in poor selection choices.

I say this because it is obvious one should invest more in a good choice and less in a badchoice, but unless you have the systems and knowledge that you now have, you areplaying Russian roulette with only one empty chamber.

Segmenting Customers

The opportunity doesn’t end there.

I would now like to explain how a knowledge of customer profitability (that is what

customers have spent with you up to now) can also be used in business.

Imagine for a moment if you analysed your customers in such a way as to be able to

segment being into distinct profitability bands. For instance, you might be able to

segment the into five distinct of groups according to the amount of profit they

contributed to your business.

You may have heard of the Pareto principle. This principle was named after the Italian

economist Vilfredo Pareto. He observed that approximately 80% of income in Italy was

received by 20% of the population. Therefore the principle assumes that most of the

results in any situation are determined by a small number of causes.

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This observation has also been made in the business environment. It is likely that

something like 20% of your customers are probably contributing about 80% of your

revenue.

The obvious question that stems from this probability is what to do with that 80%, or at

least the low as contributors in that 80% group, who are between them contributing

minimal profitability guts to whom you still committed to managing accounts for,

providing after sales service to answering enquiries from and sending out marketing

information to?

It certainly makes sense from a business perspective to start considering the merits of

reallocating your marketing budget and your service offering to each of these groups in

order to improve your overall profitability.

Putting Your Money Where You’ll Get Most Return

I can assure you that having an appreciation of how valuable your customers are to you

(all could be to you) can actually change the way you do things.

As an example I would suggest that many businesses that sell to other businesses serve

their major customers (that is the customers they sell the most to) and provide them

with a greater level of service and support than they do their other customers.

This is a most unprofitable practice.

The reason I suggest that is that these customers tend to recognise their importance to

your business (how can and must with that special service and special pricing) and make

the most of that. They will tend to be the slowest players, require a lot of caressing and

get the biggest discounts.

However until you segment your customers according to profitability (and note I’m

talking about bottom line profitability, not sales volume) it is impossible to say whether

these big customers are really the most profitable and deserving of these special

benefits.

You also have smaller customers who pay full price, pay by cash or credit card and

receive minimal service. However because of their relatively low sales volumes they

may not be worthy of having a significant amount spent in order to pursue their

business, or other customers like them.

I would suggest that most businesses should form a strategy aimed at their midsize

customers.

This is a group that is usually not quite so demanding in terms of service or discounts

and with reasonable transaction costs they have the potential to be grown into more

profitable customers by extending their customer lifetime value.

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Growing Customers Through Differential Service

One very effective way of “paying attention” to the customers you want to grow into

high-value customers is to provide them with a special level of service.

I was never one to suggest that the customer is always right, and that all customers are

equal.

Businesses that follow this mantra are the ones that continue to fall behind in

profitability.

There are now many examples of companies who have bothered to segment the

customers into profitability bands and are defining specific tiered level strategies to

accommodate each band.

For example, some businesses allow their high-value customers to set the time for a

service call to their own convenience. For everyone else it’s a matter of being told the

day they will have to be home on.

A concern brought up by business owners is that the result could be a higher number of

complaints from the less favoured. My observation is that most people understand that

you generally “get what you pay for” and that this is a valid approach to doing business.

For example most airlines offer segmented travel. There is an option of at least business

class and economy class.

There is an expectation by business class passengers that after they enjoy the benefits

of their special airline lounge they should feel free to board the aircraft’s before the

masses or after they are all seated and the queues have gone. There is also an

expectation of more spacious surroundings and more service.

Clearly these passengers are more profitable to the airline because of the significant

premium they pay on their fares.

Credit card companies have taken the same approach by segmenting their customers

into categories such as Platinum, Gold, Standard, etc. The cost to the customer of

electing their favourite colour entitles them to a greater level of service and enables the

credit card company to target specific marketing opportunities to each particular

segment as a significantly better profit.

Fire The Low Profitability Customers?

As I just suggested, customer focused is not suggest that a company should cater to the

needs of every single customer. At least not the same degree.

The cost to generate revenue and growth varies dramatically across customers and that

all to be reflected in what you spend servicing them.

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Sometimes a business owners are advised on how to treat the very low profitability

groups in a simple, “well, let’s not do business with them any more”. That is, they

literally fire the customer.

I’m certainly not suggesting that this is necessarily the way to go.

It’s important to use what you know about customers to make the best decision. It is

absolutely fine to set up low level service arrangements to push away low value

customers if they happen to have been that way for years. But without that knowledge

you could be firing someone who was relatively new and has a lot of potential to grow.

Some businesses are creating sophisticated processes that match service levels to

customer value. In the case I mentioned earlier of credit card companies each segment

of credit card holders will have a unique phone number to call if they have an enquiry.

The higher up the chain, the better the service staff to cardholder ratio.

There is an interesting example when it comes to the United States telephone company,

AT&T.

They have a technique which can serve to “push away” low profit customers or limit the

costs to serve those customers.

If you phoned them with a question about your long-distance service the company uses

a caller ID system to identify your number. Your number is used to match to your

monthly bill. If its high, you get what the company calls “hot towel service”. A human

operator will stay on the phone with you. If you spend at minimal amount you get no

such handholding. Instead you are connected with automated voices.

So what if this lower service drives off those low value customers?

The company loses $500 million a year on its 15 million to 20 million “occasional

communicators” who rarely make long-distance calls yet cost plenty to acquire, bill and

service. So they are prepared to live with that.

Without segmentation, or recognising the different values of different customers, they

would not have been in a position to maximise the chances of retaining a profitable

customer while minimising the costs of dealing with a low value customer.

Not So Fast…

There are a number of cases where a customers or lack of profitability could well be a

short-term situation. My whole thrust in this book has been to demonstrate that

customer relationship should be a long-term investment.

If you are going to fire a customer as soon as they aren’t profitable for you, you can

really hurt your credibility and reputation.

Because of the amount of travel I was required to do in assisting clients and presenting

seminars I used to be a regular visitor with the Starwood hotels (they operate Westins,

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Sheratons and the like). It just so happens that in one year I had a significant reduction

in my travelling obligations and spent less time staying with them. In fact the number of

nights would hardly have qualified me for their Gold status not to mention Platinum. So

I was impressed that when my membership card came the following year it was still at

the Platinum level. As a result they are continuing to enjoy my patronage, and I’m

continuing to enjoy the benefits.

Contrast that with the rental car firm that downgraded me to Gold level. The response

was that there was no need to favour their business as I would be getting that level from

their competitors in no time at all with my frequent use of those services. Therefore my

bruised ego sought comfort from their main competitor and we both continue to this day

to benefit from our mutual relationship.

If a business is too severe on “firing” or “demoting” their customers the result will be an

inevitable increase in customer lifetime value from the remaining customers, but at the

same time, a steadily decreasing pool of customers and declining overall profits.

Know What You Are Doing

However in saying that I need to reiterate that the bottom line is your business cannotafford to keep losing money on a customer.

Some customers simply become a drain on resources. Examples include customers whohave proven to be a poor credit risk, or whose costs to serve a greater than the profitsthey contribute.

In businesses such as banks and telcos it is not unusual to find that a majority ofcustomers switch back and forth between being profitable and unprofitable. Howeverabout 14% of the customers never turn profitable- suggesting possible targets to “pushaway”.

It’s important that your business identifies any customers you have pushed away andensure that they are not included in future marketing activities. There is cost and timein getting rid of them so the last thing you wanted to is to encourage them back into thefold again.

I hope you’ll appreciate what I consider it so important for your business to spend timeaccumulating information on your customers. All of the types of decisions I’ve discussedin this book need to be based on good customer knowledge.

Conclusion

My analysis in working with businesses show that it is a much more profitable strategy toretain your existing customers (that is the profitable ones) and to use your marketing

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budget to increase sales to them rather than constantly spending money chasing newcustomers.

That is why thinking about your customers in terms of their lifetime profitability is soimportant.

However not all of your customers are currently, or ever will be, equally profitable.

Segmentation of customers into profitability bands is a very useful way of looking at justwhich ones are providing what percentage of your profits and with that knowledge youcan start considering which ones to market to and the sorts of marketing that would bestretain their loyalty to you.

You might even decide the very bottom group is not worth pursuing nor retaining at all.

Finally, when you are considering developing loyalty schemes, or for that matteradvertisements or any promotions of any sort, you need a tool to allow you to test thevalidity of the strategy and monitor the actual results against your expectations.

This is the role of customer lifetime value analysis.

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Your action plan

Action Outcome

Establish the customer turnover, or churn rate, of

your business

You’ll become aware of your customer turnover

Set up a brainstorming session to discuss ways in

which you could improve customer service

A set of polices and procedures to improve customer

retention rate

Set up a brainstorming session to discuss ways in

which you could make your marketing more

targeted and personal

More cost effective and targeted marketing to

improve sales and customer lifetime profitability

Set up a brainstorming session to consider if a

loyalty scheme would be useful with your customers

and if so, what sort

Improved customer retention and profitability

Check your management information systems to see

if you collect the data on customers and costs that

would allow you to build a lifetime value score