CHAPTER 11

Useful Measurement Definitions

Return On Investment (ROI)

Return on Investment (ROI) is a financial metric of profitability that is widely used to measure the return or gain from an investment. It is a simple ratio of the gain from an investment relative to its cost. It is used to evaluate the efficiency and effectiveness of an investment.

In CRM, it can be used to measure the effectiveness of an individual marketing or sales campaign or the payback on customer development.

Individual Campaign

This applies to any individual campaign, deployed against either acquisition or retention objectives, where there is a call to action connected to a measurable response on transaction value.

Customer Development

In this scenario, we are looking at the payback period and associated return from the time a new customer is recruited. This incorporates the acquisition and retention costs where the latter is involved in nurturing an ongoing relationship; for example, loyalty program.

This is best illustrated by reference to a theoretical model based on a bottle of malt whisky. The relevant parameters are:

The payback model per new recruit is illustrated in Table 11.1.

Table 11.1 Payback model for a new recruit

	YEAR 1	YEAR 2	YEAR 3
Acquisition cost	£7	£0	£0
Retention cost	£5	£5	£5
TOTAL COST	£12	£5	£5
Bottles bought per year*	0.75	1.5	1.5
Gross contribution	£7.50	£15	£15
Net contribution per year	(£4.50)	£10	£10
Cumulative net contribution	(£4.50)	£5.50	£15.50

*Incremental number of bottles bought per year

Notes

A. Break-even is passed in year 2 from when a positive contribution to profit is made

B. This simplistic model assumes a 100 percent retention rate. It will need to be adjusted to take account of the actual retention rate.

Customer Lifetime Value (CLV)*

Customer Lifetime Value is the total worth of an individual customer over the lifespan of their relationship with the company/brand—how much revenue to be made from an individual customer. It equates to the revenue an average customer will provide a brand/company before they discontinue their patronage. In this context, the simple formula to apply is to multiply the average annual revenue by the average lifespan of a customer as shown below:

Average annual revenue per customer x average lifetime of customer = Customer Lifetime Value

In reality, there are three factors that have an impact on the value:

As a first step, it is important to evaluate the full potential worth of a customer across the possible lifespan of the customer being active in the product/service category—their total gross worth based on their total spend. This provides the ceiling of revenue opportunity based on 100 percent of the customer’s spending on the category being with the individual brand/company.

This is illustrated below in Table 11.2 using a theoretical model based on the restaurant sector.

Table 11.2 Customer Lifetime Value calculation based on the restaurant sector

	AGE BREAKS: YEARS OLD
	17–34	35–44	45–54	55–64	65–74	75+	TOTAL
Average annual customer value (£)	400	450	500	575	450	400	465
Number of years as a customer	13	10	10	10	10	5	58
Customer value by age break/cum (£)	5,200	4,500	5,000	5,750	4,500	2,000	26,950

Assumptions:

This analysis yields the potential lifetime value of a customer and should act as the reference point for strategic planning. For example, if your current share of wallet is 35 percent, an increase to 50 percent would yield an incremental lifetime value increase of £4,042.50 per customer. This would translate into an incremental revenue stream of £404,250,000 per 100,000 customers!

This demonstrates the strategic importance of using customer lifetime value as a KPI. Increasing customer lifetime value demonstrably increases the total value of the business and therefore the worth of the business.

It also ensures the strategic focus on three important customer dynamics:

*(Bahman, Hajipour, and Molud Esfahani, Delta Model application for developing customer lifetime value, Emerald Insight – Marketing Intelligence and Planning, accessed October 8, 2018), (Baran, Zerres, and Zerres, Customer Relationship Management, Bookboon.co, accessed May 30, 2019), (Pfeifer and Bang 2005)

Customer Churn

This is one of the most important metrics in customer management and development; particularly for a company that is growing. It provides the quantified hard number on the harsh truth about your customer retention status. This was one of the failures of the dot.com boom in the late 1990s. Companies spent a shed load of money on customer acquisition (which made many an agency happy bunnies) but did not measure customer churn. They were managing a “leaky bucket” with customers, at great expense, entering at the top end but falling out at the bottom end.

The customer churn rate is the percentage of customers that stop using a company’s product or service during a defined time frame.

It can simply be calculated by dividing the number of customers lost during the defined time period by the customer universe that was in place at the beginning of the time period.

For example:

*5000−4750 = 250/5000 × 100 = 5%

Alternatively, revenue churn can be calculated over a defined time (say one year) period by:

Revenue churn reveals how much recurring revenue was lost in a given period of time. This is particularly important for a subscription business.

The churn rate and its management underpins a company’s profitability on the proven premise that it costs more to acquire new customers than it does to retain the existing customers. There are many ratios quoted but, as a rule of thumb, a 5 percent increase in retention rate can increase profit by 25 percent because returning customers have a greater propensity to spend more on a company’s products and services. This, in turn, gives the option for a company to spend less on acquiring new customers and saving related marketing cost.

Some observations:

Customer Acquisition Cost (CAC)

Customer acquisition cost is the amount of money spent on an individual recruitment campaign or across sales and marketing to close a transaction deal to recruit a new customer over a defined time period; for example, a company’s trading year.

It is calculated by summing all the individual campaign costs, including any incentives offered, and dividing it by the number of new customers. Alternatively, summing a company’s total sales and marketing spend against new customer acquisition and dividing it by the number of new customers recruited.

Net Promoter Score (NPS)

NPS is a metric that can be used in measuring customer responses to any attribute where a quantified scale is used by grouping responses into three categories. Based on, for example, a 10 point scale:

The NPS score is derived by subtracting the percentage of “Detractors” from the percentage of “Promoters.” This is simply illustrated below:

Anything above zero is good while anything below zero suggests action is required to address the issue being investigated.

The raw data is normally obtained by sending out a survey to the existing customers asking them, for example, how likely they would be to recommend your product or service to a friend, relative, or colleague? In this context, a negative score will suggest you need to improve the customer experience with the survey indicating the areas you need to focus on for such improvements.

This methodology can also be used to gauge a “CUSTOMER SATISFACTION SCORE (CSA)” where the question in the survey is crafted to specifically address this.

Formula to Predict Response Rate Required to Break Even

Marketing costs are high and, as such, a scientific approach should be employed to build a response model to determine the response required to breakeven for a marketing activity in which a measurable transaction value is the object of the activity. The actual result can then be evaluated against the target required.

A very simplified model is outlined below based on a theoretical online consumer product as an example to illustrate the type of approach.

Formula

The breakeven point is where the communication cost equates to the gross contribution.

That is, cost of communications (comms) = gross contribution = net revenue × % profit margin.

Or net revenue = cost of comms/% profit margin

Net revenue = average order value (AOV) × number of orders (responses)

Therefore, for a predicted AOV, it is possible to derive the response required to breakeven.

Response rate required = Net revenue/AOV

For example, a model based on the following parameters:

The formula works as follows:

Application of Formula

Table 11.3 shows how the formula is applied to the 3 levels of AOV and 3 levels of communication cost per contact; all based on a contact universe of 1,000:

Table 11.3 Application of formula to show response rate required to breakeven

COMMUNICATION COST		BREAK-EVEN REVENUE	AOV: RESPONSE RATE REQUIRED
Per Contact	Total		£25	£50	£75
£1.00	£1,000	£2,222	8.9%	4.4%	3%
£2.00	£2,000	£4,444	17.8%	8.9%	5.9%
£3.00	£3,000	£6,666	26.7%	13.3%	8.9%

Some Key Thoughts to Reflect on if You Are Considering/Reviewing CRM

One of the major strengths of CRM is its focus on the commercial performance using quantified analysis to measure key metrics. This chapter features some formulae commonly used within the CRM fraternity; many of which are founded in Direct Marketing.

Readers should consider and incorporate them into their own analysis toolkit.