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Wednesday, May 08, 2002

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Na tum jaano na hum

Varad G. Varadarajan

If this is the response to a query on how well your company services your customer, isn't it time for a relook at your CRM strategies? Here's a hypothetical case-study.

Companies are closely looking at customer relationship management (CRM) to see how it can improve their businesses. In abstract terms, the benefits are easy to understand — improved customer focus across all areas of the company such as marketing, sales and service increases revenue, reduces operating expenses and reduces customer churn. Loyal, happy customers bring repeat business. The net result is improved profitability.

However, this analysis does not go far enough to explain the tangible benefits of CRM, leaving many companies unsure of exactly how a CRM package will improve their business. Hence they are unable to compute the return on investment (ROI) from CRM.

Investments in CRM usually run into a million dollars or more in hardware, software and consulting service costs, and are spread over six months to a year. Such investments require a closer look at how CRM actually improves the top line of the company.

Here is an analysis of a CRM initiative at a hypothetical company, Late Adopter Inc. Although simplistic, this analysis will illustrate some important points that will help companies measure their CRM initiatives in concrete terms, and match them against their investments.

Before implementing CRM, Late Adopter had about Rs 50 million in profit and 5 million customers, at an average profit of Rs 10 from a customer. The company discovered that if it did not take any special initiative over the next year, it would grow its customer base by about 5 per cent. Assuming that the profits are uniformly distributed across all customers (i.e., every customer is equally profitable), Late Adopter Inc. calculates an increase in profit of 5 per cent. This would put the final state of the company as follows:

Fiinal state without CRM

Profit: Rs 52.5 million

Number of customers: 5.25 million

Late Adopter's management considers this unacceptable. They believe that their products are good, the market demand is high, and peers in the industry are having much better growth rates. So Late Adopter goes back to its drawing room to look for ways to improve profits. Generally speaking, a company can try to increase profits by reducing expenses or increasing sales. In the CRM domain, some ways in which a company can reduce expenses are by:

  • Reducing marketing expenses through targeted marketing.

  • Using less costly distribution channels to deliver its products.

  • Reducing the cost of service by providing customer self-service.

  • Reducing customer churn by retaining more profitable customers.

    On the sales side, some ways in which a company implementing CRM can increase revenue are by:

  • Acquiring newer, more profitable customers and fewer loss-making customers.

  • Selling more products to the more profitable customers.

    These translate to the following CRM initiatives:

  • Targeted Customer Acquisition

  • Customer Management

  • Customer Retention

    Before going in for a CRM package, Late Adopter decides to do a customer segmentation analysis to better understand its customers. It splits its base of 5 million customers into 5 equal segments of 1 million each. It then collects the information about what each segment's share of profit is of the total. It finds that the profit is not uniformly distributed among all customers. In fact, the top 20 per cent of the customers accounted for 80 per cent of the profits. The top 3 customer segments (Platinum, Gold and Silver — 60 per cent of the total) were profitable while the bottom 2 segments (Copper and Wood — 40 per cent of the total) were a drag on the profits! Such an 80-20 distribution is commonly observed in many industries. (The original, assumed profit per cent is shown in both tables.)

    Targeted Customer Acquisition

    Late Adopter could try to improve the profits by applying some of the basic principles of CRM. Let us see what results it would get by applying the first CRM initiative — Targeted Customer Acquisition. It should focus its marketing efforts on acquiring more customers in the Platinum, Gold and Silver segments. A good place to start will be to look at its customers' purchasing patterns, their characteristics such as age, gender, demographics, likes and dislikes and so on.

    Let us assume that Late Adopter can increase the first two segments by 30 per cent each, and the third segment by 20 per cent through targeted marketing. If it does not do anything to the Copper and Wood segments, it is expected they will have a natural growth rate of 5 per cent.

    This leads to a growth in net profits by Rs 20.25 million (40 per cent) as can be seen from the table.

    Customer Management

    Independently, we can see the benefits of the second initiative, Customer Management. Because only the Platinum, Gold and Silver segments are profitable, Late Adopter can market more to these customers. It can do this by cross selling and up-selling its products. After doing some market research, Late Adopter's marketing department determines that it can increase the profits in the Platinum segment by Rs 8 per customer (20 per cent), the Gold segment by Rs 6 per customer (25 per cent) and the Silver segment by Rs 4 per customer (40 per cent).

    Next, the company analyses the loss-making segments and discovers that the Copper and Wood customers are buying some of its old products that are costly for the company to produce and service. They could be moved to the newer products that offer better functionality at comparable prices, where the company's margins are better. This can bring the Copper segment to the black by increasing the profit here by Rs 8 per customer, and reduce the loss in the Wood Segment by Rs 10 per customer (50 per cent). This leads to a growth in net profits by Rs 36 Million (72 per cent), as can be seen from the table.

    To be continued

    The author heads the eCRM Practice at Digital GlobalSoft, Bangalore, India. He can be reached at varad.varadarajan@digital.com

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