Adventure of Strategy

If you were able to ask just one question of a client, with the assurance that the answer would give you a good indication of their level of satisfaction with your firm's services, what would that question be? Fred Reichheld's article The Microeconomics of Customer Relationships (subscription or purchase for $6.50 required,) in the Winter 2006 edition of the MIT Sloan Management Review, has the answer. It is:

"One a scale of 1 to 10 where 1 is 'not at all likely' and 10 is 'extremely likely,' how likely is it that you would recommend us to a friend or colleague?"

Depending on the answer, clients would be categorized as promoters (scores of 9 and 10,) passive (7 or 8) and detractors (6 or less.) Note that passives do not straddle the 50% or even the 60% mark. Anything less than 70% is viewed negatively.

General Electric, already the 9th largest company in the world by revenue, is using this model to try to drive its organic growth rate from 5% to 8% pa. According to Reichheld's data, a promoter has a net present value (NPV) to the firm of 1.5 and 2.5 times that of an "average" client (i.e. a passive.) On the other hand, a detractor frequently has a negative NPV. Sometimes, a surprisingly high negative NPV. The article explains how a firm can calculate these figures for themselves and also how to use them. A summary follows:

Unravelling the lifetime value of clients to the firm is an extremely powerful way of understanding, in hard financial terms, what the value of client relationship management is. Moreover, the data is almost always either already available, easily obtainable or at least capable of being estimated with relative accuracy.

The first step is to tally up the fees that have been derived over a "typical" client relationship and to use this, together with an appropriate discount rate, to determine a current value (the NPV.) This is the baseline.

The "typical" client is a very rare animal indeed, however. The different behaviours of promoters and detractors yield dramatically different economic results. These include:

RETENTION RATE

The lifetime value of a client that remains a client for a long time, is obviously greater than one that defects sooner. Also, for every client that does defect, marketing effort needs to be expended to replace that revenue. The lower-than-average retention rate of a detractor therefore represents an actual reduction in value to the firm, in terms of that client's NPV, relative to either passives or promoters.

PROFIT MARGINS

Promoters are less cost-sensitive than detractors, so their profitability to the firm is generally higher. For instance, they value the relationship with the firm more and/or they tend to trust the firm with more valuable work. Detractors are almost always more likely to be price-sensitive, to argue about billing and to demand discounts. The firm needs to examine the "basket" of services purchased by promoters and by detractors over a reasonable period (say, the previous six to twelve months) and determine the actual margin on each basket after taking discounts and other concessions into account. These figures are then added to those needed to adjust promoter NPV up, relative to the "average" or passive, and detractors downwards.

ANNUAL SPEND / SHARE OF WALLET

Promoters tend to use firms that they trust more and more, precisely because of that trust. The share-of-wallet tends to increase over time for this category of client, as opposed to detractors where it is generally decreasing. It is relatively straightforward to gather data for a sample of promoters and a sample of detractors, and then to derive a comparison that can be used to accurately adjust the life-time values and NPVs.

COST EFFICIENCIES

The cost of dealing with complaints, administration of overdue accounts, working capital implications and general frustrations surrounding unhappy clients is often underestimated. Detractors indulge in this kind of behaviour far more frequently than promoters. Debtor defaults are almost always the sole domain of detractors.

WORD OF MOUTH

This component of CRM, Reichheld says, is the one that seems to stump analysts most frequently. It used to be said that detractors were up to ten times more likely to tell people of their "bad experience" than satisfied clients and, furthermore, negative word of mouth usually has more impact than compliments. Now, in this age of emails and blogs, complaints can spread as quickly as computer viruses and a 10:1 ratio may be conservative. Referred clients generally have better economics than those that enter the firm's client register by other means, and also are more likely to become promoters themselves. It's reasonable to assume that all referrals come from promoters, not detractors, and that the opposite applies for negative comment. If one knows the number of referrals that have taken place (data that is there for the asking) and one knows the value of those referrals, it can be inferred what the value of the negative comment from detractors might be, too. On this basis, a 2003 study on Dell Computers (quoted in Reichheld's article) showed that the "average" customer was worth $210 to the corporation; promoters were worth $328 each and detractors were worth an astonishing -$57!

Click on image to enlarge

Figure 1: The Financial Value of Promoters and Detractors

Once one has an acceptable estimate on the value of passives, promoters and detractors, it becomes far easier to have a discussion about how various clients should be handled. The category that deserves the most attention are obviously the profitable promoters. These are the core of your business and they need to be "bulletproofed" against predation by competitors. They are clients that love working with your firm and, chances are, you enjoy working with them too. They generally have extremely high NPVs.

In the next category are currently profitable detractors. Troubleshooting is required here, to convert them to promoters. Sometimes, surprisingly little effort is necessary to achieve this. It may simply be a matter of improving communication. If they cannot be converted, then they need to be carefully monitored and separated if necessary.

The third category in the order of priorities are the promoters that are currently less profitable or unprofitable. Efforts here are focused on improving margins. At the same time, efforts should be directed at moving profitable passive clients into the profitable promoter category.

It should be intuitive that detractors that are also unprofitable should be fired as soon as humanly possible.

Like most models of its kind, this one works best when data is analyzed frequently enough to yield trends. Not only do clients evolve over time, between the three categories, but this also provides valuable management information about whether the firm's overall strategy is on track.

Comments, as always, are most welcome and may be posted below.

Rob

Thanks for drawing the Reichheld article to my attention.

I love that question:

"On a scale of 1 to 10 where 1 is 'not at all likely' and 10 is 'extremely likely,' how likely is it that you would recommend us to a friend or colleague?"

I do wonder how many business developers would have the confidence to use it well. If they did a good follow up question could be:

"Who specifically are the people you would recommend us to?"

This second question is intended to prompt not only a willingness to comment - on the quality of our services - but also a 'mental rehearsal' in the clients mind of actually doing so.

Turning research into action, so to speak!

Warm regards

Clive