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Published: 12/04/02
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The Customer Profitability Conundrum: When to Love 'Em or Leave 'Em

Mitch Rosenbleeth, a vice president in Booz Allen’s Dallas office and co-author of a recent report titled “Capturing Value Through Customer Strategy,” says the process of identifying unprofitable customers is challenging for companies to embrace because the value is not obvious and it is painstaking.

“We just finished a project for a client where, when we looked at customer profitability, 30% of the customers created 200% of the client’s profits,” Rosenbleeth says. “About 50% of the customers weren’t very profitable and the remaining 20% destroyed profits. So should the client have cut those 20% loose? That wasn’t the answer.” 

Instead, the solution was to segment customers into what Rosenbleeth calls tailored business streams. “You structurally change the way you serve different customers to make each segment as profitable as possible,” he explains. For example, a company might continue to serve the best 30% of its customers as it always has, but create different business models for the others. For the unprofitable bottom 20% of customers, it could create a model that either makes those customers profitable or encourages them to go elsewhere. For the 50% in the middle, the company could create a model that drives their profitability higher. Too few companies “take the trouble to obtain a true customer profitability picture,” Rosenbleeth says, “and even those that do rarely have a view of the customer’s present profitability, let alone the total lifetime value of a customer.”

If customers are fired, should a company ever try to get them back? “It’s more expensive to acquire a new customer than to retain an existing one,” Kahn says. “It’s even more expensive to bring back a customer that you’ve gotten rid of. It’s costly and it’s a mistake you don’t want to make. That’s why I believe firing customers should be a last resort.”

Love ‘Em or Leave ‘Em
Much is at stake in being able to manage customers effectively. By failing to winnow the good customers from the bad ones and deal with them accordingly, companies that are dominant in an industry expose themselves to withering competitive attacks by new entrants, according to Eric Clemons, professor of operations and information management at Wharton. This can be illustrated by developments in recent years in the financial services industry, specifically credit-card companies, perhaps the most-studied sector when it comes to customer segmentation.

“It's a scarier notion to turn clients away than it is to hope against hope that you can make profitable the 500 clients you should get rid of," says Booz Allen's Chris Dallas Feeney
Clemons is co-author, with Matt Thatcher of the University of Arizona, of a case study analyzing how a small, relatively unknown institution called Capital One became one of the world’s largest — and most profitable — credit-card issuers in a few short years during the late 1980s and 1990s. The company, a pioneer in customer segmentation, achieved its robust growth by exploiting an innovative approach to targeted marketing, based on customer profitability analysis.

Capital One attributes its success to efforts in applying information technology tools to customer acquisition and retention. Specifically, the company has relied on what it calls its Information-Based Strategy (IBS), a proprietary set of analytical tools, to tailor its products to the appropriate customers and ensure that each customer is serviced efficiently.

In the case study, Clemons and Thatcher coined colorful terms for two groups of customers — love ‘ems (the customers who are profitable) and kill yous (the unprofitable customers). Most retail banks in 1988 charged uniform prices to all consumers for banking services despite major differences in costs in serving the love ‘ems and the kill yous. That situation provided an opportunity for a new entrant, like Capital One, to go after the love ‘ems of entrenched banks that were failing to segment customers. The new entrant’s strategy: offer fees that were lower than the love ‘ems were charged by their current bank, but high enough to generate profits for the new entrant.

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