Return on Customer: Creating Maximum Value from Your Scarcest Resource by Don Peppers, Martha Rogers

From the Publisher

Internationally acclaimed business gurus and best-selling authors Don Peppers and Martha Rogers kicked off the CRM revolution and changed the landscape of business competition with their classic bestseller, The One to One Future. Now, in Return on Customer, they have written an even more revolutionary book, redefining the very concept of what it means to be “profitable” as a business.

Virtually every manager agrees that a company’s most vital asset is its customer base – the lifetime values of all its current and future customers. Yet when companies track their financial results, they rarely take into account any change in the value of this critical asset. As a result, managers remain blind to one of the most significant factors driving genuine, lasting business success, and instead become preoccupied with achieving short-term financial goals.

Return on Customer is the first book to focus on how firms create value, not just by driving current profits, but by preserving and increasing customer lifetime value. In a powerful blend of theory and practice, Peppers and Rogers demonstrate how to create shareholder value more efficiently by concentrating on Return on Customer(SM), a revolutionary business metric focused on a company’s scarcest resource – customers. By paying close attention to Return on Customer, companies can improve their profits while still conserving and replenishing long-term enterprise value.

Relying on their years of experience working with many of the world’s leading companies, Peppers and Rogers take readers far beyond marketing, sales, and service. Return on Customerwill revolutionize how companies think about their basic competitive strategy, product development efforts, and even the issue of business ethics and corporate governance.

Return on Customer(SM) is a registered service mark of Peppers & Rogers Group, a division of Carlson Marketing Group, Inc.

“To remain competitive, you must figure out how to keep your customers longer, grow them into bigger customers, make them more profitable, and serve them more efficiently. And you want more of them.

Unfortunately, the financial metrics you learned in business school are not easily adapted to account for the value companies generate from this scarce resource, with the right balance between current-period sales and customer lifetime value. But striking that balance is necessary if you want to know whether you’re better off investing in customer acquisition, or in product development, or opening new stores, or plant efficiency, or better qualified personnel, or more service, or cost reduction. While you may believe in your heart that a particular decision creates shareholder value, there’s no financial metric currently available to tell you how much shareholder value you actually created, or even whether you created any at all.

But Return on Customer can help you. Return on Customer is a breakthrough financial metric that can quantify the actual shareholder value you are creating (or, possibly, destroying) with your various business actions and initiatives.”

—from Return on Customer

Soundview Executive Book Summaries

A Revolutionary Way To Measure And Strengthen Your Business
Most managers will say that customers are their company's most important asset, but few have a plan for increasing customer lifetime value. In Return on Customer, management consultants Don Peppers and Martha Rogers explain how companies can improve their basic competitive strategy, product development and corporate governance by focusing on how they create value. According to the authors, "The only value your company will ever create is the value that comes from customers — the ones you have now, and the ones you will have in the future."

To maximize the value a firm creates, the authors write, it must maximize its "Return on Customer" (ROC), which has the same equation as an ROI equation. "ROC equals a firm's current-period cash flow from its customers plus any changes in the underlying customer equity, divided by the total customer equity at the beginning of the period," the authors write. They define customer equity as "the net present value of the future stream of cash flows a company expects to generate from the customer."

The ROC Speedometer
To help readers understand the conflict between current profit and long-term value, the authors describe how they can reach an optimum level of overall value creation by presenting numerous analogies that describe how mistakes can be avoided. One example that they use is the idea that the ROC can be seen as a speedometer that should be pushed to the limit to maximize the value being created by the firm.

The authors explain that an ROC-efficient company conserves and replenishes its stock of customer equity by investing in the development of new products, building relationships, prioritizing customers, creating better customer service, acquiring new customers and retaining current customers.

Customer Trust
With the goal of increasing the overall return generated by a customer, the authors explain that companies must change the customer's behavior. Doing this requires managers to put themselves in the shoes of their customer to better understand the customer's needs, and then building programs around what they find. To do this properly, firms must first earn the customer's trust. As Peppers and Rogers note, "A firm's Return on Customer is maximized at the point that the customer most trusts the firm."

To maximize customer trust, companies must avoid the behaviors that erode that trust. Any actions that a company takes in pursuit of short-term profits can make a company appear ridiculous or even hostile. Customers can see through these actions and can recognize the cynicism of a company that "sees only dollar signs when it is communicating with them," the authors caution. To demonstrate how customers feel about this type of company, the authors point to the popularity in the United States of the "Do Not Call" list as an example of how much customers detest interruptive marketing.

Another example that the authors provide of the detrimental effects of a company's obsession with current-period profits rather than long-term customer value is Citigroup's experience in Japan. In 2004, Japan's Financial Services Agency ordered Citigroup to close four of its private banking offices after it investigated allegations of stock manipulation and misleading investors. The Japan Times reported, "The bank tied salaries closely to sales performance, giving incentive to managers and employees to break rules if it meant large profits." The authors explain that this kind of toxic behavior endangers customer service and destroys value at a company where it remains unchecked.

Anticipation
Taking the customer's perspective not only helps a company understand his or her needs, the authors explain, but also helps it anticipate the customer's wants and needs. This anticipation can improve the efficiency with which the customer is served, which saves a company time, effort and money while saving the customer aggravation.

To illustrate this, the authors describe the way St. George Bank's ATMs "remember" customers individually and prompt them for their usual transactions when they insert their cards. An on-screen message might ask a customer whether he or she would like the usual $100 cash with no receipt, rather than obnoxiously asking the customer once again to "choose a language for this transaction." The authors point out that this type of service makes the bank more relevant, and perhaps essential, to its customers.

Why We Like This Book
The authors have taken the concept of creating firm value to a higher level by dismantling the short-term value equation and reconstructed it using a more accurate financial metric to create long-term value. Filled with timely examples from many industries, Return on Customer describes a better way to grow enterprise value by building better, longer relationships with customers. Copyright © 2006 Soundview Executive Book Summaries

• Table of Contents
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Table of Contents

Read an Excerpt

CHAPTER 1
AN OPEN LETTER TO WALL STREET

Businesses succeed by getting, keeping, and growing customers. Customers are the only reason you build factories, hire employees, schedule meetings, lay fiber-optic lines, dispatch service trucks, stock inventory, file for patents, operate call centers, negotiate contracts, write software, or engage in any other kind of business activity whatsoever.

Without customers, you don’t have a business. You have a hobby.

The problem is that business success is extremely difficult today–probably more difficult than it ever has been. All the easy growth has now occurred. Every household in the industrialized world already has one or two or more cars, a washing machine, television sets in different rooms, and a cell phone (or several). Once an economy matures, customers are no longer so hungry to buy, but businesses are even hungrier to sell.

Yes, we’ve all benefited from the unprecedented improvements in productivity over the last couple of decades, but higher productivity has also put renewed pressure on profit margins. No matter how much streamlining you do today, you’re just keeping up. Everyone in your firm is already doing a job and a half. The cost cutting you thought was a temporary inconvenience has now become a permanent hardship.

And then there’s the impact of globalization. Offshoring and business process outsourcing may help you control your costs, but globalization, too, comes with a price tag. Your products are being reduced to commodities, as more competitors find their own opportunities in your section of the globe,and at least part of the reason you can’t get any pricing traction is that someone in the Far East is already undercutting you.

Even though price increases may be nearly impossible to sustain, the cost of selling and marketing is still going up. The more you spend on marketing, the less you have to show for it. Response rates decline, sales effectiveness erodes, and customers continue to become more demanding. New and improved products may temporarily solve your problem, but knockoffs and competitive innovations now appear in days. And we’ve seen a lot of new and improved products introduced, as companies all try to innovate their own way out of the same problem.

In category after category, in market after market, companies are wrestling with the fact that their products and services are simply in oversupply. Too many personal computers chasing too little demand. Too many airline seats chasing too little traffic. Too many varieties of fresh fruit in the produce section, too many kinds of bottled water, flavored popcorn, and coffee beans. Too many consultants, systems integrators, and executive-recruiting firms. Too much advertising space chasing too few advertisers. Too many frozen foods, breakfast cereals, skin creams, razor blades, cold remedies, and hair rinses. Too many trucking services, wireless minutes, and drums of chemicals.

The only thing in short supply these days? Customers. Customers are difficult to find and hard to keep.

THE SCARCEST RESOURCE

In today’s business world, customers are even scarcer than capital. If you have a customer for your business, you can almost certainly get the capital you need to serve her. But the market–any market–contains only a finite number of customers, who will each do only so much business in a lifetime, with anybody. Even if there are lots of customers, it’s still a finite number.

To remain competitive, you must figure out how to keep your customers longer, grow them into bigger customers, make them more profitable, and serve them more efficiently. And you want more of them.

Unfortunately, the financial metrics you learned in business school are not easily adapted to account for the value companies generate from this scarce resource, with the right balance between current-period sales and customer lifetime value. But striking that balance is necessary if you want to know whether you’re better off investing in customer acquisition or product development, or opening new stores, or plant efficiency, or better-qualified personnel, or more service, or cost reduction. While you may believe in your heart that a particular decision creates shareholder value, there’s no financial metric currently available to tell you how much shareholder value you actually created, or even whether you created any at all.

But Return on Customer* can help you. Return on Customer is a breakthrough financial metric that can quantify the actual shareholder value you are creating (or, possibly, destroying) with your various business actions and initiatives.

* “Return on Customer”(SM) and ROC(SM) are service marks of Peppers & Rogers Group, a division of Carlson Marketing Group, Inc. Registration pending.

THINKING LONG-TERM

Let’s face it: Businesses gauge their success today almost entirely in terms of current-period revenue and earnings. Wall Street demands that a firm “make its numbers,” or the stock price will likely founder. Certainly, public-company CEOs think this is the case, and they’ll go to great lengths to meet Wall Street’s expectations.

A 2004 survey revealed that meeting short-term Wall Street expectations is such an urgent need at publicly held firms that three out of four senior executives say their company would actually give up economic value in exchange for doing so! More than half of the executives said they would “delay starting a project to avoid missing an earnings target.” Four out of five executives said they “would defer maintenance and research spending to meet earnings targets.”

Quarterly reporting of financial results has certainly created a highly competitive business landscape. But it also drives executives to pursue contradictory business goals. Company managers are expected to strive for long-term value and growth in order to increase true shareholder value, even while they are also pressured to deliver against more and more aggressive short-term goals. Moreover, as financial systems become more sophisticated, we measure performance with continually shortening yardsticks. Some companies now boast about their ability to close a quarter in one day. Stock market analysts focus on short-term results as a proxy for long-term potential.

The problem is that the more short-term a company’s focus becomes, the more likely the firm will be to engage in behavior that actually destroys long-term value. The obsession with current revenue and earnings at many firms has generated a pervasive culture of bad management.

Don’t get us wrong. It’s a good thing for publicly traded firms to respond to investor demands, and it’s good that a free market for a company’s stock can discipline an errant management team. The real problem has to do with the way a firm’s future earnings and cash flow are evaluated by investors and by the stock analysts who interpret the firm’s numbers for them.

Investors are in fact very interested in understanding a company’s long-term value, but at present there is no better or more reliable indicator of long-term value creation than, well, short-term financial performance. The discounted-cash-flow (DCF) method for valuing a business is based on forecasting the firm’s future cash flows, but in the end even the most sophisticated predictions rely mostly on aggregate business trends, projections of market growth, and competitor activity, and in any case all such projections begin with today’s numbers. So, like the butterfly whose wings cause a tornado a continent away, small fluctuations in current earnings or revenues wreak massive changes in projected company valuations and share prices, as their effects are extrapolated and magnified years into a company’s financial future.

TIGHTROPE: BALANCING SHORT-TERM REPORTING WITH LONG-TERM SUCCESS

This creates a difficult problem for managers, because any firm’s current earnings are likely to go up and down frequently, owing to unexpected and unpredictable events. The natural noise of commerce is hard to dampen out of a firm’s “earnings trajectory” from quarter to quarter, but investors’ preoccupation with current numbers requires a firm to try, simply in order to preserve its public-market value.

One symptom of this malaise is the rash of executive scandals and questionable accounting practices that have plagued the investment community in the last few years. Senior managers know they can “game” the price of their own company’s shares by pumping up their current sales, or by smoothing out their short-term results, and then all they have to do is sell their own stock or cash out their personal options sometime before reality catches up with the market.

As bad as the most recent round of corporate scandals has been, however, this obsession with current numbers has had a far more corrosive effect on overall management decision making. Focusing on the short term to the exclusion of other concerns allows managers to shirk their primary responsibility altogether–which is to preserve and increase the value of the enterprise.

Think about it: Almost every senior manager at any public company has had the experience of attending a meeting called for the express purpose of hitting the year-end numbers, or even quarter-end numbers. Perhaps at this meeting they decided to put off some valuable R&D work, or maybe they trimmed a costly but important service improvement. Chances are, the attendees knew full well that taking these actions would do more actual harm to the company than good, but they went ahead anyway–because they weren’t being held accountable for creating enterprise value. They were being held accountable for short-term results. Wall Street results. Bonuses depended on it. Jobs depended on it. Many of these managers probably also figured they’d be long gone before the company tabulated the actual bill.

And why is it that in business magazines and surveys, lists of the most admired and successful companies seem to include a disproportionate number of privately held firms? Obviously, the market for private companies’ equity is less liquid, so private companies have some disadvantages relative to publicly traded firms when it comes to raising capital. But their equity values are also considerably less volatile, with the result that private firms do not have to dance the Wall Street Quickstep. At private firms, cynicism does not trump economics.

Surely there is a message here. Surely this has some significance. Is there anything Wall Street analysts could do to address the difficulty public companies have in paying serious attention to the long term? Well–yes, actually. And that’s why we’re addressing this open letter to the investment community.

THE DESPERATE PUSH FOR ORGANIC GROWTH

Investors today want executives to demonstrate that their companies can actually make money and grow, the old-fashioned way–by earning it from the value proposition they offer customers. They want a firm’s customers to buy more, to buy more often, and to stay loyal longer. They want a firm to show it can go out and get more customers. They want organic growth.

Managers read this message loud and clear. As one CEO put it, “I believe that you don’t get better by being bigger, you get bigger by being better. And so [we want] organic growth.” According to another, “We don’t create shareholder value by getting larger through acquisitions, but rather through organic growth.” Of course, sometimes an acquisition does create shareholder wealth, but it has to be the right kind of acquisition–a business combination that increases the power of the customer value proposition, allowing the combined entity to achieve genuine, organic growth.

Managers push for growth because it is essential to protecting and improving shareholder value. All management’s thoughts and actions, from strategizing with respect to competitive positioning, to cutting costs and streamlining operations, to creating an attractive and productive environment for employees–everything, in the end, is designed to preserve and increase the value of the firm they are managing, and organic growth is the key.

Growth fuels innovation and creativity, generating new ideas and initiatives, and stimulating managers in all areas to “think outside the box.” Growth keeps a company vibrant and alive, making it a good place to work–a place that provides employees with economic benefits and opportunities for advancement. Organic growth is, in the words of one human resources executive, “the Fountain of Youth” for a company.

Most business executives would agree, intellectually, that customers represent the surest route to business growth–getting more customers, keeping them longer, and making them more profitable. Most understand that the customer base itself is a revenue-producing asset for their company– and that the value it throws off ultimately drives the company’s economic worth. Nevertheless, when companies measure their financial results, they rarely if ever take into account any changes in the value of this underlying asset, with the result that they are blind–and financial analysts are blind– to one of the most significant factors driving business success.

Think about your personal investments. Imagine you asked your broker to calculate your return on investment for your portfolio of stocks and bonds. She would tally the dividend and interest payments you received during the year, and then note the increases or decreases in the value of the various stocks and bonds in the portfolio. Current income plus underlying value changes. The result, when compared to the amount you began the year with, would give you this year’s ROI. But suppose she chose to ignore any changes in the underlying value of your securities, limiting her analysis solely to dividends and interest. Would you accept this as a legitimate picture of your financial results? No?

Well, this is how most investors assess the financial performance of the companies they invest in, because this is how companies report their results. More ambitious analysts can examine comparable firms, they can try to estimate growth prospects, and they can even try to evaluate the benefits of loyal customers. In the final analysis, however, they are still just counting the “dividends” from these customer assets, while ignoring any increase (or decrease) in the value of the underlying assets themselves. But just as a portfolio of securities is made up of individual stocks and bonds that not only produce dividends and interest but also go up and down in value during the course of the year, a company is, at its roots, a portfolio of customers, who not only buy things from the firm in the current period but also go up and down in value.