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No Profitable Customer Left Behind

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Posted September 2, 2004 By Heidi Cohen     Feedback

Not all customers are created equal.

Watching the Republican National Convention, I realized online marketers could learn a lot from politicians. Like voters, customers fall into distinct categories. There are core supporters, who are the solid base as your most loyal customers. There are swing customers, with the potential to become better customers. There are the great silent majority who occasionally buy from you, particularly sale items. There are former customers who no longer shop at your Web site. Then, there are nonvoters who have never bought from you.

You can create a winning campaign strategy by understanding how your customer base breaks down across these categories. The rule of thumb is the best 20 percent of customers generate 80 percent of revenue. In my experience, actual results tend to be even more skewed.

The most extreme case I've seen was in a business unit targeted at wealthy individuals. In one geographic region, less than 5 percent of the customers accounted for over 95 percent of revenue. Despite strong sales, the market was at risk. A change in market conditions or a few key customer defections would have had a disastrous effect.

Analyze an Online Customer Base Like a Politician

  • Stratify your customer base by purchasing level. To determine the influence of your top-, average-, and lowest-performing customers, rank customers by total sales over the past year. Divide the list of customers into deciles (tenths). Create a cumulative total sales column, starting with the highest-revenue customer. Develop a cumulative total sales percentage by dividing the cumulative total sales by total sales for the year. You can now easily identify which tier customers generated what percentage of total sales.

  • Calculate the top tier's turnover rate. Over time, companies tend to maintain the same percentage of top customers. Customers making up this top tier vary to some extent from year to year. To ascertain the turnover rate, rank these customers by sales for two consecutive years. Compare the names of the top customers. Determine the number of customers who were in the top tier in both years. Divide by the total number of top-tier customers from the first year. This is your retention rate. Subtract it from one to get your turnover rate.

    Turnover rate = 1 - [number of top-tier customers in years 1 and 2/number of top-tier customers in year 1]

  • Determine whether customers are profitable. Short term, customer revenue must cover total variable costs (i.e., product, fulfillment, and bad debt) and hopefully contribute to marketing and overhead expenses. Don't spend lots of money romancing these customers until they cover their fully loaded costs.

    Positive contribution customer = [customer revenue — total variable costs] > 0

    A customer is truly profitable when the revenue he generates exceeds his fully loaded costs (i.e., total variable costs, marketing, and overhead associated with servicing this customer). These customers are worth continuing to market to at the current level.

    Truly profitable customer = [customer revenue — total variable costs — applicable marketing costs — allocated overhead] > 0

    As this analysis shows, all customers aren't created equal. To win, you must target your marketing to those segments with the greatest profit potential.

Adapt Online Marketing to Maximize Revenue

  • Enhance your relationship with core supporters.. At a minimum, acknowledge the importance of your best customers, who comprise up to 20 percent of your customer base. These customers tend to refer other good customers. Use special touches to delight these customers and humanize the relationship. gives its best customers incentives to join its loyalty program. Customers pay $25 annually to join Readers' Advantage, a membership program. With the loyalty card, customers receive discounts on all online and in-store purchases, as well as special offers. can track cross-channel sales in a way that would otherwise be impossible.

    Consider creating a special by-invitation-only offer for your very best customers, for which an incremental fee may be charged. It can enhance the cachet of being a preferred customer.

  • Improve marketing to swing customers. Many of these second-tier customers, the next 10 to 20 percent of your base, have the potential to become best customers. Develop programs to make them feel special without sizably shrinking your margins. At a minimum, different messaging or service may be in order. Send an e-mail just to thank these customers. You may need a differentiated offering.

  • Maintain promotion to the great silent majority. Constituting about half your list, these customers will continue to purchase for the same reasons they did before, barring any change in either your offering or their circumstances.

  • Manage bottom-tier customers proactively. The bottom 10 to 20 percent of your customer base probably hasn't recently purchased. You need feedback to understand why. Did they only purchase a gift? Did they have a bad experience with your company? Develop a plan to market to or drop these customers by segment.

    For customers who are still profitable, implement or extend a customer win-back program. Based on customer feedback, test different offers to restart purchasing. I've successfully tested welcome-back offers with incentives (purchases may take time to return to previous levels). You already have their contact information and they already know your brand, so acquisition costs tend to be less than for a totally new customer. Every win-back creates a second customer lifetime value.

    For low-end customers who are unprofitable, drop them. They aren't worth the additional marketing dollars. Depending on your business, you may need to notify customers if you intend to stop servicing them.

Ensure no profitable customer is left behind. Like a good politician, tailor your message to meet customers' needs and potential. It may not be PC to say so, but all customers aren't created equal. Understanding the dynamics of your customer base is critical, especially as online retailing matures and growth rates slow. Finding ways to maximize the value of each profitable customer relationship is even more critical to maintaining business momentum.

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