This time of year, most marketers are busy developing annual marketing plans. These plans outline the specifics of consumer and salesforce communications and incentives that impact metrics such as sales, gross margin, share of market, traffic, brand awareness, etc. by changing consumer behavior. The marketing plan not only provides the framework for these activities but, more importantly, describes the connection between individual activities and overall brand and business strategies.
This year, in response to tightening budgets and increased marketing accountability, I have been asked repeated about "variable marketing spending." Simply put, variable marketing spending (VMS) adjusts the investment (read: marketing budget) for each customer based on current and future company value. The benefits of this approach are many, but in this economy, the promise of VMS is to increase financial resources despite tightening marketing budgets.
To say that this approach assumes consistent lifetime customer value measurement is like saying that the economist stuck in a pit assumes there is a ladder. For this article, assume that some measurement of historical customer value has been established. A predictive model for complete customer value is a substantial undertaking and is not assumed to have been completed. I will discuss the differing approaches to customer value estimation in a forthcoming article.
The first question that should be raised in development of a VMS approach is: who are we targeting and what are the desired behaviors? Measuring the change in a customer’s behavior (vs. baseline) following a marketing effort is the first step toward making marketing measurable, which is key to maintaining budgets in these cost-cutting times.
A hierarchy for marketing spending usually follows priorities such as these:
Best Customer Management the highest priority usually involves best customers (BCs), some subsegment of the 20 percent that contribute 80+ percent of a company’s revenue. The desired behaviors for this group include retention, simply a maintenance of the current strong behavior over time, and relationship expansion, usually through cross-sell of new categories that best customers may not consider to be part of the company’s offerings.
While relationship maintenance among BCs is not a high excitement opportunity, such an activity is critical to the enterprise’s success. Strong, consistent performance of the customers in this segment, if lost, require many non-BC customers to compensate, and you could argue that you never compensate for the strength of a BC relationship, since newer customers require additional expense, such as service and returns. BC attrition, if left unchecked, is a key indicator of a company’s decline, since it is difficult (and expensive) to replace BCs’ consistent sales volume and positive impact on other customers (through word of mouth, referrals, etc.).
Expansion of Best Customer Relationships Since research shows that best customers are often the competition’s best customers as well, the battle here is for a metric called "share of wallet." Share of wallet indicates the percent of the customer’s total category requirements that are filled by your company. Since that percentage, even for best customers, is usually 50 percent or less, substantial opportunities exist to increase depth of relationship, either through increased frequency or through cross-sales into categories that the customer does not currently purchase.
This particular effort is usually the most profitable, since it is easier and less expensive to motivate a customer who purchases frequently to make one more purchase than it is to motivate a one-time customer to repeat. In addition, the frequency of contact for best customers provides multiple, low-cost opportunities for education and cross-selling.
"Opportunity" Customers After shoring up the best customer relationship and mining them for additional revenue, the next opportunity is to grow that best customer base. The most common strategy is to target the customers who are just below the best customers in sales volume and deliver promotional offers or a loyalty program to increase revenue. While this approach may drive some behavior change, it leaves out two critical considerations share of wallet and market basket. Share of wallet measurement is critical, since an individual customer may be spending all they can with the company and cannot significantly alter that spending, despite incentives. Whatever additional communication expense and special treatments would essentially be wasted.
From an upside perspective, market basket analysis provides the most substantial opportunities for increased profitability. This analysis assumes that a strong indicator of the likelihood to become a best customer is the mix of products a customer has already purchased. If the purchase mix of best customers is examined, patterns emerge, from both their current purchases and the products that best customers purchased early in their relationship. Relationships evolve over time; and as relationships mature and customers learn more about the company, their purchases tend to evolve, both in amount and in product type. If that pattern is identified, it can be "overlaid" on the purchases of non-best customers. Such analysis identifies customers who appear on the path toward best customer status but have not reached it yet. Such prospective best customers usually have the highest profitability per dollar invested, since they are already "on the road" toward becoming best customers.
The Rest of the Pack The natural tendency would be to eliminate spending on the rest of the customer base to maximize savings from the VMS effort. However, the elimination of all communication to lower-tiered customers often yields suboptimal results. The main reason is data incompleteness or inaccuracy. Since it is not possible to understand everything about a customer’s situation and since that information can change unpredictably, customers who were not considered potential best customers can suddenly increase their transactions beyond expectations. Lifecycle changes can alter income, shopping patterns, etc., in ways that a marketing manager cannot predict. In addition, it is often difficult to determine the relationships between customers. A low-value customer may be related to a best customer, and poor treatment of the low- value customers could therefore backfire in unpredictable manners. Given this lack of information, caution is best exercised in managing these low-profit customers.
The opportunity does exist, however, to change contact frequency and to adjust contact cost, without significantly reducing the chance that a customer could surprise you and increase their spending. Use of the Web, e-mail and lower-cost direct mail represent significant cost savings, since this segment often encompasses 40+ percent of the total customer count. If this base currently is contacted monthly, communication frequency could be cut back to every six weeks or even two months without diminishing their upside potential unreasonably. The reduction of communication cost and frequency can free up marketing dollars for reallocation against best customers and opportunity customers.
Figure 1: Hierarchy for Market Spending
This approach does not work solely for direct marketing industries. In a sales force-based model, the goal would be to free up precious time that a salesperson spends with clients and focus them on contacts with the highest potential to convert and expand relationships. Lower-value customers could receive direct mail and a quarterly call vs. several visits for the highest profit and opportunity customers.
A word of warning about variable marketing spending. This approach is based primarily on a financial customer value metric. Remember that loyalty is created not by finances, but by relationships. It is possible that, given a framework of customer-value-based analysis, a marketing manager may choose to increase investments in customers with the highest share of wallet and the longest retention, in recognition of their continued support. In addition, since this approach cannot adequately measure referral value, it is assumed that customers with the largest share of wallet and loyalty also spread positive word of mouth, which drives additional company value.
Variable marketing spending holds the potential to change the way marketing plans are developed and executed. By varying the investment according to customer value (both current and potential) managers can reallocate funds and increase ROI and marketing accountability. While lifetime customer value is a difficult measurement to develop, VMS provides a modified approach based on historical performance and some basic analysis of best customer behavior.
By promoting accountability and measurement in the marketing plan, VMS moves marketing from a cost center to a revenue generator, which is critical to maintaining the budget in these challenging cost-conscious times.
Now, this article did not address how to invest the money that is available in a variable marketing spend approach. Obviously, the manner in which the money is invested plays heavily on the success of a VMS marketing plan. Pure incentives, at higher and higher levels, will begin over time to cheapen the brand and will erode the best customer relationship the segment such an effort is designed to serve. Instead, some mix of reward, recognition and access, combined with superior customer service can solidify best customer relationships and provide a platform for growth. Varying the spending provides the fuel; smart customer management will steer the train onto the right tracks for profitability and growth.
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