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It's more than a measurement; it's part of overall business design.
CUSTOMER PROFITABILITY IS receiving greater attention than ever before. This concept, critical for understanding and managing customers, has the capability for building customer relationships and capturing the value from customers for the firm. Companies in many industries are applying it, even though it hasn't achieved full acceptance. Three elements needed to appreciate and practically apply customer profitability are:
1. The concept and its measurement.
2. Its link to strategy and buiness design.
3. The implementation issues that accompany it.
The Concept
Customers can be looked at by their behavior, demographics, preferences, or attitudes. Also, customers can be seen as economic units that generate profit for firms. Customer behavior leads to product purchases and use and also generates costs for providers. Individual customers can be characterized by the amount of profit they generate, ranging from highly profitable to unprofitable.
Measurement of customer profitability depends on defining the customer, estimating the revenue and costs associated with each customer, and combining these elements into an estimated profitability for each customer.
First, a customer must be defined and data collected on the relevant revenue-generating behaviors. For retail banks, a customer may be anyone with a deposit, loan, or investment account, and the relevant data to be collected would include balances, payment history, and contacts with the bank through such channels as branches and online.
Second, one must estimate the costs associated with each customer, starting with acquisition. Customers from direct mail solicitations have different costs than those from other media, word of mouth, or referrals. The cost to serve a customer varies according to the resources used by the customer. A branch visit generally costs more than a phone or computer contact.
Third, the revenue-generating and cost-generating behaviors must be combined into an estimated profitability for each customer, calling for translating behavior into dollars and estimating the duration...