By Timothy Keiningham and Lerzan Aksoy
Ask yourself a question: “What is the purpose of any business"? “Easy,” you reply. “To make a profit.” But that’s the wrong answer. Profits are an outcome. They only tell us whether our business strategy and execution are viable.
Peter Drucker, the father of modern management, argued that the common belief that creating profits was the purpose of a business was not only wrong but harmful. He maintained that the profit-driven mindset causes us to make bad business decisions and lose sight of the things that delight customers. He summed up the actual purpose of business this way: “There is only one valid definition of business purpose: to create a customer.”
The mark of success for a firm, and therefore the ultimate objective of its strategy, is to satisfy customer needs and wants at a sustainable profit. Whatever strategy and tactics we employ to gain competitive advantage must ultimately be based upon our profitably providing a better solution for customers.
Managing Customers as Assets
Customers are the ultimate asset for all profit-making organizations and they provide all of a company’s real value. Paradoxically, customers are one of the few aspects of a business that are not managed as an investment. This oversight negatively impacts profits by creating:
- Inefficient resource allocation (via suboptimal company-customer interactions)
- Product design and launch failures (via poor fit with customer needs)
- Unstable cash flows (via increased customer defections and price sensitivity)
If customers are the primary asset, the ultimate aim of any business strategy should therefore be to maximize customers’ net present value (NPV) to the firm. While this statement may seem academic, it is much more than a theoretical maxim. Research shows that firms that adopt a customer lifetime value framework for customer selection and resource allocation significantly outperform their competitors in profits and shareholder value.
But this doesn’t just happen. It requires the implementation of an integrated strategy across each business area—accounting, finance, marketing, operations, and human resources. Here are some ways to begin:
- Accounting. Analyze the profitability of your customers. Research conducted by the Harvard Business School finds that most customers do not produce an acceptable rate of return (i.e., they are not profitable). In fact, for most companies, the top 20% of customers in terms of profitability produce all of a company’s profits; the middle 60% break even; and the bottom 20% cause the company to lose money. Paradoxically, revenue is a terrible predictor of customer profitability. The highest revenue customers tend to be the most profitable or the least profitable. Managers need this information to effectively run their businesses. They need to know who their profitable customers are and what behaviors are associated with profitability.
- Finance. Incorporate customer metrics into your financial models. When prioritizing investment decisions, pay attention to the projected impact on the future value of customers to the business. Analysts cannot consistently beat (or even meet) the market; in the language of finance, they don’t add alpha. Research finds that this is because they don’t include intangibles that reflect the strength of the company-customer relationship.
For example, analysts are generally skeptical of the impact that customer satisfaction has on a company's market value. They tend to view customer satisfaction information as “soft” data because they don’t understand how satisfaction data links to a company’s bottom line. Because it is intangible, they frequently regard it as a money drain.
Our own research found that incorporating customer satisfaction into standard models used in investment finance significantly improved the ability to pick winners versus losers. And the winners dramatically outperformed the market by 2 to 1.
- Marketing. Move the focus to current customers. Marketing activity has largely focused on persuasion—the ability of the company to change someone’s attitudes or behavior. And while that is a critical role of marketing, it often gets translated into simply persuading someone to try something for the first time. An old saying goes, “A good salesman can sell anything once. The trick is getting someone to buy again.”
But it is not as simple as focusing on customer retention either (i.e., getting them to come back). Today, customers buy competing products from multiple companies with seemingly no real loyalty. They divide their wallets among competitors.
Consequently, one of the most important elements in improving financial performance is getting customers to allocate a larger share of their wallets to the firm. A McKinsey study found that focusing on share of wallet had a 10 times greater impact than focusing on retention alone. Research demonstrates that the strongest driver of share of wallet is customer loyalty.
Therefore, the primary goal of marketing must be the transformation of first-time or occasional buyers into loyal, long-term customers. This requires a clear understanding of what makes customers want to be loyal. Gathering and understanding customer needs is the job of marketing.
- Operations. Make certain that company-defined quality and customer-perceived quality are aligned. Because operations are often focused on the creation and distribution of products and services, there is a natural tendency for managers to focus on meeting technical specifications.
While the quality movement of the 1980s did a great deal to establish standards of technical excellence, we have a long way to go to achieve user-defined excellence. It matters little if a firm meets its internal guidelines if these are disconnected from the customer.
We must always remember that the customer did not design the process, and he doesn’t care that the system we have designed makes our lives easier. His only concern is whether it makes his life easier. So when designing and implementing any process, we need to understand the customer experience (i.e., shop our own stores).
- Human Resources. Establish a climate for service in the organization: support and reward the procedures and behaviors that lead to customer service excellence. Research consistently demonstrates that service climate is positively linked with lower turnover, higher customer satisfaction, and improved financial performance.
While we all pay lip service to the importance of employees in serving customers, too often we manage in terms of operational productivity at the exclusion of all else. How many employee evaluations actually include customer metrics as part of the formal criteria? The reality is that most employees are rewarded for completing tasks. Few are rewarded for making customers happy.
A Holistic Strategy
Too often managers think about strategy in terms of our own functional area: marketing strategy, operations strategy, finance, and so forth; but each of these departments should contribute to an overall holistic company strategy—one where everyone in the organization is allied in one common cause: to profitably create and keep a customer.
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