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Customer Life-me  Value   Can  a  Customer  Be  Worthless  to  Your  Brand?  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


A few  years  back,  I  was  living  in   the  UK  when  my  cell  phone   stopped  working.  

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I went  to  the  store  to  get  a   replacement.  

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I got  to  the  store  at  8:55  am  to   find  there  was  already  a  long   line,  and  when  the  store  opened   at  9,  I  told  them  that  I  had  a   flight  to  catch  to  Madrid  and   needed  a  phone.   h"p://emagine-­‐group.com  

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


I was  politely  but  firmly  told  that   I  had  to  wait  my  turn  and  it   would  be  45  minutes  before  I   could  see  a  representa<ve.  

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I tried  to  explain  that  I  really   needed  a  phone  and  had  to  leave   for  a  flight,  but  was  told  -­‐    

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“But sir,  all  of  these  people  are   ahead  of  you;  they  are  just  as   important.”  

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I had  been  a  loyal  customer  for   many  years  and  as  a  result  of  this   interac<on,  when  I  got  back  from   Madrid,  I  canceled  my  cell   service,  data  plan  and  other   services  with  the  same  company.   h"p://emagine-­‐group.com  

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


While the  customer  service  rep   in  the  store  had  given  the  “right”   answer,  the  result  was  the  loss  of   a  high-­‐value  customer  who   defected  to  a  compe<tor.   h"p://emagine-­‐group.com  

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


What went  wrong?  

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Egalitarian –  those  who  believe   every  customer  is  equal  –   marke<ng  &  sales  are  not  limited   to  B2C  companies.  

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We once  consulted  for  a  Fortune   500  B2B  company  with  a  massive   sales  force.  

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The sales  force  had  just  done  an   analysis  that  showed  that  8%  of   the  company’s  B2B  customers   were  93%  of  its  revenues  

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But the  sales  force  treated  every   B2B  customer  equally.  

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What would  happen  if  one  of  the   8%  were  to  defect  to  another   company?  

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A be"er  approach  is  to  realize   that  all  customers  are  not  equal   and  develop  a  marke<ng  and   sales  strategy  grounded  in  this   reality.   h"p://emagine-­‐group.com  

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Customer Profitability   Calcula<ng  the  Value  of  the  Customer  

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Companies look  at  their  performance  in   the  aggregate  –  in  other  words,  past   ac<vity.  

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A common  phrase  within  a  company  is   something  like  “We  had  a  good  year,   and  the  business  units  delivered   $400,000  in  profits.”  

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When customers  are  considered,  it  is   oden  an  average  such  as  “We  made  a   profit  of  $2.50  per  customer.”  

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Although these  can  be  useful  metrics,   they  some<mes  disguise  an  important   fact  that  not  all  customers  are  equal  and   worse  yet,  some  are  unprofitable.  

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Rather than  measuring  the  “average   customer,”  we  can  learn  a  lot  by  finding   out  what  each  customer  contributes  to   our  bo"om  line.  

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Customer Profitability     The  difference  between  the  revenues   earned  from  and  the  costs  associated   with  the  customer  rela<onship  during  a   specified  period  

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The overall  profitability  of  the  company   can  be  improved  by  trea<ng  dissimilar   customers  differently.  

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So when  we  think  about  customers,  we   need  to  think  in  three  different  <ers  

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Tier One  –  Reward     Your  most  valuable  customers  are  the   one  you  most  want  to  retain.  They  get   more  a"en<on.    

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Tier One  –  Reward     Look  for  ways  to  reward  them  in  ways   other  than  simply  lowering  your  price.   These  customers  probably  value  what   you  do  the  most  and  may  not  be  price   sensi<ve.   h"p://emagine-­‐group.com  

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Tier Two  –  Grow     The  customers  is  the  middle  –  with   middle  to  low  profits  associated  with   them  –  might  be  targeted  for  growth.  

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Tier Three  –  Fire     The  company  loses  money  on  servicing   these  people.  If  you  cannot  easily   promote  them  to  the  higher  <er  of   profitability,  you  should  consider   charging  them  more  for  the  services   they  currently  consume.   h"p://emagine-­‐group.com  

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Tier Three  –  Fire     If  you  can  recognize  this  group   beforehand,  it  may  be  best  not  to   acquire  them  in  the  first  place.  

h"p://emagine-­‐group.com

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How do  we  calculate  Customer   Profitability?  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


(Revenue from  a  customer)   -­‐  (Cost  to  serve  each  customer)   Profitability  for  the  Customer  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Now doing  this  for  every  customer  may   not  make  sense,  so  you  may  have  to   abandon  the  no<on  of  individual   customers  and  work  with  meaningful   groups  of  customers  instead.  

h"p://emagine-­‐group.com

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Ader you  calculate  the  value,  you  sort   the  customers  based  on  profits.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Once you  have  the  sorted  list,  you  plot   the  percentages  of  total  profits  vs  total   percentage  of  total  customers.  

h"p://emagine-­‐group.com

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Here we  have  a  clear  illustra<on  that  if  they  were  no  longer  to  serve  the  least   profitable  20%  of  customers,  they  would  be  $28  million  be"er  off.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Customer Life-me  Value  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


This metric  is  the  most  advanced  that   we  will  cover  in  this  course  and  value-­‐ based  marke<ng  strategies  oden  require   industrial-­‐strength  infrastructure  to   achieve  the  strategy.  

h"p://emagine-­‐group.com

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


As a  first  step,  most  organiza<ons  oden   start  by  looking  at  plain  sales  revenues   so  that  marke<ng  effort  and  the  sales   force  are  directed  at  the  customers  with   the  most  revenues.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


The problem  is  that  this  does  not  include   the  cost  of  serving  the  customer,  which   might  be  considerable,  and  the   customer’s  revenues  today  do  not   accurately  tell  us  about  the  value  of  the   customer  in  the  future.  

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Customer Life<me  Value  (CLTV)   addresses  both  of  these  issues  and  is   probably  the  most  important  metric  to   learn  in  marke<ng.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Even if  you  don’t  use  CLTV,  everyone  in   marke<ng  should  understand  the   concepts  of  value-­‐based  marke<ng.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


One of  the  biggest  mistakes  marketers   make  is  confusing  customer  profit  with   CLTV.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Customer Profit  measures  the  past  while   CLTV  looks  forward.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


CLTV shapes  managers’  decision  but  is   much  more  difficult  to  quan<fy  than   customer  profit.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Customer profit  is  calculated  through   careful  repor<ng  and  summarizing  the   results  of  past  ac<vity;  CLTV  involves   forecas<ng  future  ac<vity.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


CLTV is  the  present  value  of  the  future   cash  flows  a"ributed  to  the  customer   rela<onship.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


CLTV –  The  Math  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


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AC   Mn     Cn     p     N     (1  –  r)  

=  Acquisi<on  Cost    =  Margin  Produced  by  the  Customer  in  each  <me  period    =  Cost  of  marke<ng  &  serving  the  customer    =  Probability  the  customer  will  not  defect  in  a  year    =  Total  number  of  years  or  <me  periods    =  Discount  rate  (because  money  is  worth  less  in  the  future)  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


To best  understand  this  metric,  think  of   CLTV  as  the  Net  Present  Value  of  a   customer.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


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Time Period  0  

Time Period  1  

Time Period  3  

Time Period  2  

Time Period  4  

   (M  –  C)    =  Margin  –  Cost  in  a  Specific  Time  Period  (Profit)   x  (1  –  c)    =  Probability  that  the  Customer  Will  Stay  (c  =  Churn  Rate)        (1  +  r)    =  Discount  Rate  (Profit  in  the  future  is  worth  less)  

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So how  does  this  work?  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Margin is  easy  to  calculate  –     how  much  profit  do  you  make  on  each   product/service  you  sell?  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Cost, on  the  other  hand,  is  a  bit  more   difficult  

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On the  cost  side,  we  need  to  understand   all  touches  of  the  customer  with  the  call   centers,  web  site,  customer  service,   marke<ng  communica<ons,   maintenance,    and  so  on…  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Time Period  0  

Time Period  1  

Time Period  3  

Time Period  2  

Time Period  4  

The Cost  of  the  Customer  to  the  Company  in  Time  Period  0  is  the  Acquisi<on   Cost.  Since  they  are  not  a  customer  yet,  there  are  no  margins  or  service   costs  –  so  no  profits  to  calculate.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Time Period  0  

Time Period  1  

Time Period  3  

Time Period  2  

Time Period  4  

Once the  customer  becomes  a  customer,  we  start  calcula<ng  their  value  to   the  company.  We  take  the  profit  generated  from  the  customer  (M)  and   subtract  it  from  the  cost  of  maintaining/serving  the  customer  (C).  We   mul<ply  it  by  the  probability  of  the  customer  leaving  within  a  year  (1  –  c).  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Time Period  0  

Time Period  1  

Time Period  3  

Time Period  2  

Time Period  4  

Once we  have  the  top  side  of  the  equa<on,  we  take  the  amount  that  money   will  devalue  over  the  life  of  the  customer,  or  discount  rate  –  (1  +  r)  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Looks really  complicated  doesn’t  it?  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Let’s try  an  example  

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An Internet  Service  Provider  (ISP)   charges  $19.95  per  month.  Variable   costs  are  about  $1.50  per  account  per   month.  With  marke<ng  spending  of  $6   per  year,  their  a"ri<on  is  only  0.5%  per   month.  At  a  monthly  discount  rate  of   1%,  what  is  the  CLV  of  a  customer?   h"p://emagine-­‐group.com  

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Margin =  $19.95   Cost  =  $1.50   AC  =  $6/12   Churn  Rate  =  0.995%   Discount  Rate  =  0.01  

h"p://emagine-­‐group.com

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Remember –  we  are  just  taking  the   profit  in  each  <me  period  for  the  value   of  the  money.  

h"p://emagine-­‐group.com

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Now, I  am  sure  you  are  all  asking  1   ques<on  –     “What  is  the  correct  length  of  <me  to   use  for  calcula<ng  CLTV?”  

h"p://emagine-­‐group.com

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


I have  seen  company’s  calculate  CLTV   over  85  years  –  the  natural  “life<me”  of   a  customer,  which  is  wrong.  

h"p://emagine-­‐group.com

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Customer Life<me  Value  is  not  about   the  life  of  the  customer,  but  the  length   of  <me  that  a  customer  will  stay  with   your  brand.  

h"p://emagine-­‐group.com

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


The best  prac<ce  is  3  –  5  years.  

h"p://emagine-­‐group.com

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


While a  customer  may  stay  with  a  brand   much  longer  than  that,  it  is  be"er  to   focus  on  a  shorter  <me  period  for   decision  making  so  that  you  have   reliability,  not  incredibility.  

h"p://emagine-­‐group.com

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Cohort &  Incubate   Which  Customer  is  More  Valuable  –  New  or  Exis<ng?  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


One way  to  project  the  value  of  future   customer  cash  flows  is  to  make  the   assump<on  that  the  customers  acquired   several  periods  ago  are  no  be"er  or   worse  that  new  customers.  

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To prove  that,  we  go  back  and  collect   data  on  a  cohort  of  customers  all   acquired  at  the  same  <me  and  break   down  their  cash  flows  over  specific   periods.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


The next  step  is  to  discount  the  cash   flows  for  each  customer  back  to  the   <me  of  acquisi<on  to  calculate  the  CLTV   and  then  average  the  CLTVs  together  to   produce  an  es<mate  CLTV  of  each  new   customer.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


We call  this  the  “cohort  and  incubate”   approach.  

h"p://emagine-­‐group.com

Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


How do  we  calculate     Cohort  &  Incubate?  

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(Total Cash  Flows  from  the  Cohort)   /  (Number  of  Customers)   Average  CLTV  for  the  Cohort  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


If the  value  of  customer  rela<onships  is   stable  across  <me,  the  average  CLTV  of   the  cohort  sample  is  an  appropriate   es<mator  of  the  CLTV  of  newly  acquired   customers.  

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An Example  

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In 1993,  6,094  customers  of  a  cruise  ship   line  were  tracked  (incubated)  for  a   period  of  5  years.  

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The total  net  present  value  of  the  cash   flows  from  these  customers  was     $  27,916,614.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


These flows  included  revenues  from  the   cruises  taken  (6,094  customers  took   8,660  cruises  over  5  years),  variable  cost   of  the  cruises  and  promo<onal  costs.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


The total  5-­‐year  net  present  value  of  the   cohort  on  a  per  customer  basis  was   $4,581  per  customer.     $27,916,614/6,094  =  $4,581  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Cohort and  Incubate  works  best  when   customers  are  sta<onary  –  changing   slowly  over  <me.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


When the  value  of  rela<onships  changes   slowly,  we  can  use  the  value  of   incubated  past  rela<onships  as  the   predic<ve  value  of  new  rela<onships.  

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Value Based  Marke-ng   Marke<ng  Based  on  the  Value  of  the  Customer  

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Value-­‐Based Marke<ng  drives  significant   performance  gains  and  firms  that  bridge   the  marke<ng  divide  focus  on  customer   value  in  all  marke<ng  ac<vi<es.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


An Example  of  Direct  Mail  Offers   Low  to  Medium  CLTV  +   Low  to  Medium  Response   Rates  are  not  sent  a   mailing     From  a  ROMI  point  of   view,  these  customers  are   slow  on  the  take  rate,  so   why  waste  marke<ng   dollars  here?  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


An Example  of  Direct  Mail  Offers   High  CLTV  +  Low  Response   Rates  are  also  not  sent  a   mailing     The  cost  of  the  mailing  is   not  jus<fied     Our  focus,  as  marketers,   must  be  on  the  medium  to   high  CLTV  +  Medium  to   High  Response  Rate   customers  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


An Example  of  Direct  Mail  Offers   No-ce     Highest  Expected   Response  Rate  +  the   Highest  CLTV  get  the  2nd   most  expensive  offer     Highest  Expected   Response  Rate  +  Medium   CLTV  get  the  3rd  most   expensive  offer     While  the  Lowest  CLTV   don’t  get  an  offer  at  all  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Why do  you  think  that  is?  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Those that  have  the  lowest  CLTV  are   coming  anyway  so  they  get  the  lowest,   most  cost  effec<ve  offer.  They  are   coming  because  they  value  your  product   but  don’t  respond  to  the  “offers”;  so  it   would  be  a  waste  targe<ng  them.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


By focusing  this  single  strategy  on  a   value-­‐basis,  we  cut  our  marke<ng  costs   in  half  –  since  we  now  focus  on  less  than   50%  of  the  poten<al  customer  base,  but   the  impact  is  significantly  higher   because  we  are  focusing  on  profitability.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


What Makes  a  High-­‐Value  Customer?  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


This is  one  of  the  most  important   ques<ons  to  ask  your  business  and  you   may  need  focus  groups,  surveys  and   analysis  to  answer  it.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


In banking,  a  high-­‐value  customer  has  a   poruolio  of  services  –  cash  deposits,   credit  cards,  auto  loans,  and  perhaps  a   mortgage.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


To best  manage  this  customer,  you  have   to  ensure  –  first  and  foremost  –  that   they  don’t  leave  

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Secondly, up-­‐sell  and  cross-­‐sell   addi<onal  products  and  services.  Sell   deep  to  high-­‐value  customers.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Selling bundles  of  services  to  high-­‐value   customers  has  the  advantage  of  crea<ng   lock-­‐in  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


What is  lock-­‐in?  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Lock in  means  that  there  is  a  significant   switching  cost  to  the  customer  if  they   want  to  change  to  a  compe<tor.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


But you  need  to  be  careful  of  customer   lock  in  backlash  –  poor  service  can  result   in  nega<ve  customer  sa<sfac<on  (CSAT)   that  results  in  mass  defec<ons  when  a   compe<tor  enters  with  a  low-­‐switching   cost  alterna<ve.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  


Customer Service  and  Service  Recovery   are  extremely  important  to  retain  high-­‐ value  customers.  

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Brand Focused,  Socially  Ac<ve,  Digitally  Enabled  

Customer Lifetime Value  

Understanding how to calculate profitability of a customer

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