The evolution of customer based analytics Direct News November 6, 1992

Many hard-headed chief executive officers fear half of all money spent on direct marketing to woo new customers is wasted.

Not anymore, say proponents of direct marketing!

Measurable results are possible as techniques evolve

To tally up the effectiveness of individual campaigns, the value of a long-term relationship with a customer or the overall impact on business is becoming a must do.

The bottom line, say proponents, is calculating what a customer is worth over time which opens the door to a profitable, long-term relationship.

Put aside traditional measurements such as cost per order, or cost per lead jump into sales per customer, or customer valuation.

The importance of segmentation

A new word has emerged in the vocabulary of marketers — segmentation!

Our field has moved on to adopting segmentation as a baseline for understanding customer value.  Marketers segment their database to identify key pockets of customer value  and to evaluate the worth of those segments to their portfolio.   Return on investment analysis, which calculates returns on specific campaigns, has evolved to include better targeting of different customer segments; and measuring lifetime value.

Measurement of direct marketing campaigns is becoming more sophisticated for a host of reasons.

For starters, computer technology, hardware and software, has advanced to a point at which marketers can collect, sort and manipulate customer database information with greater effectiveness and reward.

What is more, hard times means marketers want more from each dollar spent on pampering existing customers and securing new ones – precisely the point of interest from which direct marketers start.

The reasoning is, if you do not know what a customer is worth, you cannot be sure how much money to spend to acquire one.

And you certainly cannot decide which media are best in capturing new customers: the mail, tv or a sales force.

Even so, proponents of direct marketing today battle against ceos who remember doling out money during the go-go 1980s to test or start a program, only to get scant returns.

Smart marketers are today coming round to the importance of establishing life-long relationships with their customers. They must develop the science of building relationships with people.

If you look at customers as worth far more to you over time, you will do more to bring them to your side.

And because the future value of customers determines their current worth, measuring that lifetime value analytically helps marketers decide how much they should spend today to turn one-time buyers into lifetime customers.

Objectives lead the way

Of course, successfully measuring direct marketing campaigns, say proponents, calls for establishing key objectives beforehand.

Virginia Greene, direct marketing manager with Go Direct Marketing in Vancouver, says direct marketing exists precisely to build long-term customer relationships.

For this reason, Greene’s clients aim at developing a business strategy and not simply holding a campaign or two.

‘If you want to do a simple mailing, go somewhere else,’ she says.

Much depends on whether companies are looking for immediate results from direct marketing approaches – in the case of fundraising groups, for example – or whether companies are only looking for leads they can follow up, as with an automaker.

Much also depends on whether marketers are focused on developing a product, a market, choosing media or a host of other variables.  Whatever the objective, measurement tools help establish whether it can be attained at the end of the campaign. Moreover, they help decide how those objectives might be altered to increase profits should the effort be repeated.

For example, a telephone company might see value in looking to secure three-year contracts for cellular phones from new customers during a campaign.

If so, Greene says she can employ tools to measure the return to the client at the end of the campaign, indicating, for example, $10,000 was spent to bring in $100,000 worth of new business.

Do not fail to know your customers

Of course, objectives are only meaningful if marketers know who their customers really are.

Steven Shaw who runs our analytics effort at Salter, de Gruchy is very straightforward in his view of customer metrics.  He starts with Recency and goes from there. ‘So many agencies start with demographic or psychographic segmentation then become lost trying to establish customer value.’

Using segmentation as a customer valuation process to develop a useful and exact customer profile serves this task.

Salter.

Your best customer is in front of you right now!

Marketers, for the most part, know their own customers are their best prospects for future sales, that is, if they know how to take advantage of prospect responses and mapping high value customer behavior.

Despite this fact, most companies have marginal capture rates and limited systems for managing their customer data  – containing names and home addresses, for example – and generally not one they can sort, track and manipulate for greater impact.  They have little idea what their lists contain, what to do with them, or whether they work for the company.

‘If you don’t have the right names on your database, or have rented a bunch of random names, you might as well use broadcast media,’ Shaw says.

Segmentation and the value of the top 20%

Segmentation entails organizing your customers based on their recency of purchase, frequency of sale and monetary value identifying the best value segments to respond to a particular product or offer.

Using this kind of analysis marketers can then buy outside lists, build alliances with strategic partners and optimize results  by picking out only those segments that are predicted to work.

Marketers in packaged goods, faced with declining brand loyalty in hard times, recognize the key to survival may be a matter of focusing on the top 20% of customers who buy 80% of products.  If a company can identify them through segmentation, and succeed in keeping them a customer for only a year or so longer by pampering them, that could well mean increased profits and future sales.

Elsewhere, a specialized financial publication might be mailing to a national weekly magazine’s list and find few responses.

It could then use segmentation to pick out only those names reflecting a preferred set of customer characteristics. Or it could use Statistics Canada data to find only those households with above-average incomes.

Better targeting during mailing opens the way to better response and retention rates around the corner.

But it’s not just about customer retention

Of course, no wise marketer will pamper his/her best customers without going after new ones!  Dave Taylor, Toronto-based chairman of Taylor Tarpay Direct Advertising, put it this way:

‘The danger is you will end up reaching to the converted, and deal with an ever-narrowing market niche because you gradually penetrate that entire market. If so, you won’t be bringing in the heathen.’

At some point, Taylor warns, marketers have to assume the risk of going after new customers that are not as productive as are ‘hot names’ early on.  Establishing which customer value groups are more prone to buy your products through segmentation may also help decide which media to use when choosing advertising channels.

Dave asks, ‘Why not use in the future what has made your products profitable in the past?’

And, there is value in the middle of the file

As managing partner of Salter de Gruchy Direct, I am consistently making a single point to our clients that, ‘short-sighted marketers are missing cross-selling and up-selling opportunities’ every day in their customer file.’

I strongly believe that while ‘It’s fine to be well-positioned,’ if you ignore deciding how to retain customers, then you might well go out of business in time.’ Direct marketers are indeed throwing away money if they profit from a new customer and then let them slip away.

The fact is, loyal customers deliver a useful income and profit stream that far exceeds the value of their original purchase. There is much to be gained from retaining a customer and selling to them for years to come.  But these customers are created.  They don’t just walk in the door!

Record and book club marketers know this lesson well. One of the ways they woo new customers is by offering six books for one dollar. Initial responses may well lose them money. But profit will come on purchases club members make down the road.

So Where’s This All Going?

Direct marketers everywhere act in a similar way. Scarce resources are used to get customers in the first place. The profit comes from future relationships with customers they have successfully brought on board.

Once marketing objectives are set, and customer lists are productive, companies are increasingly using return on investment analysis to project paybacks from specific campaigns.  They do this by taking the total dollars spent, and total revenue received, and figure the total return on the program.

This is key because, for all the hoopla surrounding direct marketing, bottom line CEOs want to know whether the job can be done, within budget, and when they can expect a payback.

John Wright, director of direct marketing at Toronto-based Promanad Communications, argues companies are also measuring marginal returns on investment, or the profits possible from pursuing different audiences.

As Wright puts it: ‘Let’s say you ask whether to send 100,000 pieces of mail or 75,000 pieces during a campaign.

‘Traditional return on investment analysis calls for costing both efforts and calculating the likely response rate overall to figure out the return,’ he says.

Wright says in a profitability analysis, what is considered is how much profit is wanted from each person approached, adding what is then determined is how many people will be marketed to based on that calculation.

‘You can decide between sending mail to 45,000 people and 45,001 people because you know the incremental profit possible from each person you approach.’

Greene says she can tell a fundraising client how much money the company will bring in at the beginning of a fiscal year, within a 5% margin of error.

The fundraiser will know the cost of bringing in new donors, and of getting past donors to repeat their generosity.

‘With that type of data, you can say if you mail to 1,000 people, 18% of them will respond by each giving you $37.50 on average,’ Greene says. ‘And if you mail yet again later on, you will receive so much from them.’

Likewise with credit cards for department stores.

Greene says an in-depth study of customer relationships can identify how much existing cardholders spend annually, and how many years they have held cards.

Using various calculations, the department store can then estimate how much each new cardholder recruit will spend on average over how many years.

What’s this Lifetime Value thing?

Shaw notes that an ‘analytical tool gaining in popularity is measuring lifetime value of customers.’ This allows marketers to measure how many responses they might gain from a campaign, how many they might retain over time, and how they might estimate the current worth of future profits.

Ted McGregor, the Toronto-based direct response manager at Radio Shack, says the electronics retail chain has a mainframe computer in Barrie, Ont. capable of tracking responses and calculating the lifetime value of customers.

But why is measuring lifetime value specifically useful? Most marketers rely on using profit or loss per response to decide which mailing will solicit the most prospects.

But this approach overlooks future profits from repeat customers. Nor, unless you measure marginal returns on investment, does profit or loss per response employ scarce marketing dollars to best effect.

In the insurance business, calculating the lifetime value of a policyholder is crucial to drumming up new business.  The exercise calls for defining the present value of a future stream of net contributions to overhead and profit expected from the new policyholder.  The lifetime value model focuses on the future, that is, spending behavior and the cost of retaining customers, and reselling to them over their entire projected lifetime.

Keeping in mind that future dollars are worth less than what they are today, the future value of a customer must be discounted to arrive at an equivalent present value owing to inflation and the cost of capital.  Of course, proponents of direct marketing caution that lifetime value calculations are not for everyone.

A case in point: the Lexus division of Toyota Canada runs an upscale direct mail campaign to lure prospects for its luxury car models.

Wayne Jefferey, general manager at Lexus, says developing and refining the car maker’s customer database is key to the success of the campaign in finding exclusive car buyers.

‘Most people send out direct mail and hope for the best,’ Jeffery says. ‘You can’t do that.’  He says the car maker spent a lot for software to measure the effectiveness of the direct mail campaign, but found response rates did not climb as a result.

Jefferey puts this down to the small size of Canada’s luxury car market. Only 45,000 luxury cars were sold in the country last year, and 3,900 were sold by Lexus.

‘We get to know our customers by name,’ he says.

I argue only larger, established companies are looking to lifetime value calculations with seriousness.

I’ve often asked who ‘In the real world, who is doing lifetime value?’  ‘Not many. Most companies are not even to the point of operating an electronic database let alone implementing a standardized customer valuation tool like CLTV’

And in the end?

Measuring the effectiveness of direct marketing is made easier by thinking of one’s long-term relationship with a customer as a brick wall.

Each effort to make that relationship is a brick. And the foundation of that relationship is the product on offer – that attracts customers in the first place.

As more and more companies come to lay the foundations for future relationships with their customers, the worth of measuring progress along the way grows.

Companies are coming slowly but surely to see the worth of measurement tools. And as their popularity grows, so, too, do the efforts of direct marketing practioners to make those tools ever more sophisticated and accessible.

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