Value Chains & Value Chain Analysis

A Signature Value Chain Approach to Strengthen Value Chains & Promote Economic Opportunities
ACDI/VOCA uses value chains, specifically value chain analysis, to understand private sector development in emerging economy settings to jumpstart economic growth and poverty reduction. ACDI/VOCA's value chain approach is unique in that it uses a participatory, stakeholder-driven approach to exploit opportunities for investment and growth in industries with high levels of micro and small enterprise (MSE) involvement.

The value chain approach analyzes the firms in a market chainfrom input suppliers to final buyersand the relationships among them. It analyzes the factors influencing industry performance, including access to and the requirements of end markets; the legal, regulatory and policy environment; coordination between firms in the industry; and the level and quality of support services.

Relationships among firms in an industry can facilitate production and marketing efficiencies and enable the flow of information, learning, resources and benefits. ACDI/VOCA works with industry stakeholders to strengthen or restructure relationships and address resource constraints to increase the global competitiveness of the industry and the ability of small firms to contribute to and benefit from this competitiveness.

Working with the U.S. Agency for International Development (USAID), other donors, local governments and industry leaders, ACDI/VOCA promotes MSE access to critical technical, financial and business services to increase efficiency, improve quality and benefit from new markets. ACDI/VOCA provides technical assistance at the firm level to improve capacity to benefit from market opportunities, better inputs and more productive technology. At the market level, ACDI/VOCA alleviates constraints along competitive value chains by supporting suppliers of critical support services and by improving the business enabling environment to increase the contribution of the industry to economic growth and poverty reduction.

World Report: The Value Chain Approach; Strengthening Value Chains to Promote Economic Opportunities

Value Chain Framework | Value Chain Training | Value Chain Publications | Links

Value Chains Versus Supply Chains

by Andrew Feller, Dr. Dan Shunk, and Dr. Tom Callarman
Abstract The concept of a Value Chain has existed for twenty years but we find it still is an unclear concept. It has been suggested that the third generation supply chain is based on customer intimacy and is fully synchronized. In this paper, the authors discuss the need to relate the concepts of the value chain and the supply chain in a more comprehensive and integrative manner. We begin with a discussion of value and the development of the concept of value chain. We then discuss similarities and differences of the value chain and the supply chain, and conclude with suggestions regarding the need for synchronizing value and supply chains to optimize business performance. What is Value? The Value Chain concept was developed and popularized in 1985 by Michael Porter, in Competitive Advantage, (1) a seminal work on the implementation of competitive strategy to achieve superior business performance. Porter defined value as the amount buyers are willing to pay for what a firm provides, and he conceived the value chain as the combination of nine generic value added activities operating within a firm activities that work together to provide value to customers. Porter linked up the value chains between firms to form what he called a Value System; however, in the present era of greater outsourcing and collaboration the linkage between multiple firms value creating processes has more commonly become called the value chain. As this name implies, the primary focus in value chains is on the benefits that accrue to customers, the interdependent processes that generate value, and the resulting demand and funds flows that are created. Effective value chains generate profits. To bring the concept of value into focus, consider for a moment a person walking in the desert, a person who is dying of thirst. As that person walks they have one thing on their mind, and that is water. At that moment there is little consideration for the form of the water, the container, or who will be providing it. Water has a unique value to that person. When they find water, or they are offered some, money would be of little concern. What is the point of this example? First is that value is a subjective experience that is dependent on context. In the context of a busboy clearing a table, a glass of water sitting there has no value, or even negative value its just more work for him. But for the man dying of thirst, that same glass of water is extremely valuable. Second, value occurs when needs are met through the provision of products, resources, or services usually during some form of transaction or exchange. Finally, value is an experience, and it flows from the person (or institution) that is the recipient of resources it flows from the customer. This is a key difference between a value chain and a supply chain they flow in opposite directions. Many views of Value Chains can be created. Examples of Value Chains are One that takes an order from a customer One that fulfills a customer requirement One that defines a product or service And many others We depict the Order Fulfillment Value Chain in Figure 1 as a pictorial of the comparison.
Copyright 2006 Andrew Feller, Dan Shunk, & Tom Callarman. www.bptrends.com

2
Product VALUE CHAIN Customer Reqts Product Reqts SUPPLY CHAIN Customer

Strategic Global Finished Successful Components Assembly Products Customer

Figure 1. A Comparison of a Value Chain with a Supply Chain

From this simple example, we see that value, like beauty, is in the eye of the beholder. Value has meaning in a number of contexts, including trading relationships, consumer purchases, and the interests of company shareholders. In Lean Thinking (2) by Womack and Jones, the first Lean Principle was defining value from the customers perspective. From this come two critical factors that need to be clarified when strategizing the creation of value: 1) Who is the customer?

2) What do they value? Most corporate initiatives are really about developing appreciation and awareness of customer needs and values, and then organizing the firms activities around efficiently providing for those needs quickly, accurately, and at minimum cost. This is because value occurs when customer needs are satisfied through an exchange of products and/or services for some form of payment. The degree to which the needs that are met exceed the price paid in the exchange is one objective way that value can be measured. That is why paying $1,000 for a gallon of water in the desert when dying of thirst might seem reasonable if there were no other alternative. A key distinction in defining value is whether the exchange that generates value is between firms i.e., Business to Business (B2B) or between a firm and a consumer i.e., Business to Consumer (B2C). There are three forms of value that occur in B2B commercial transactions (3). Technical (Resource Value); Organizational (Business Context); and Personal (Career and Idiosyncratic) Technical value is intrinsic to the resource being provided and occurs in virtually all exchanges. For the thirsty man, the water has a technical value regardless of the source or any other consideration. The cup can be used or even dirty, the man providing it a criminal, and the water will still have the same technical value. Organizational value is built upon the context of the exchange, and may derive from a range of factors such as ethical standards, prestige, reliability, and association. Brand image may build organizational value, as well as company reputation. When at a fine dining establishment, the label on the water bottle generates value far in excess of the bottles content. Personal value is derived from the personal experiences and relationships involved in the exchange of resources and the benefits provided. While technical and organizational value accrues to the firms involved in a commercial exchange, personal value accrues to the individual.
Copyright 2006 Andrew Feller, Dan Shunk, & Tom Callarman. www.bptrends.com

Manager motivation, preferences, feelings of comfort and trust create value for individuals that engage in trading relationships on behalf of firms, and can be extremely influential in the determination of successful exchange. For example it is a clich that many corporate IT managers responsible for purchasing computer systems have selected IBM equipment because no one was ever fired for buying IBM, whether the system was the best choice or not. Finally, there are competitive forces affecting the market value of any exchange of resources when comparisons can be made between competing offers. Competing offers can erode value (and margins) by making the lowest price a deciding factor in evaluating an exchange. At the consumer level of exchange, value is layered, and has been described by three concentric rings (4). In the center ring is product value, the technical value derived from providing a source of supply. A second ring of service value is provided by the services that surround the product such as personal care and warranty service. The third ring has been called the new service/quality battleground, and was made popular by business thinkers such as Peters and Waterman (In Search of Excellence) (5). This third level of value is achieved by providing enhanced service, to make your customer successful rather than just satisfied. At this level, the experience surrounding the exchange of resources provides its own unique wow value, and the product itself is secondary. Ronald McDonald, happy-meal toys, and playgrounds have added value to McDonalds burgers for years without any nutritional or flavor change in the basic product. For corporations, the capability of providing value to customers generates revenues in excess of costs creates profit, which in turn generates shareholder value. Thus, the exchange of value (or the value created in exchange) is the basic engine that drives our industrial economy. The upstream (value stream) impact of value creation is shareholder value. This is the value generated for the provider of those financial resources that enable value generation, based on a firms stock price and dividends or a private companys return on investment. Because value is derived from customer needs, activities that do

not contribute to meeting these needs are non-value-added waste, or muda in the parlance of lean thinking (2). Careful consideration of the tasks and functions that occur in many of the industries we serve shows considerable waste still available for process improvement activities to uncover and reduce or eliminate. By streamlining the processes that generate the goods and services that customers value, fewer resources need to be expended, and the margin between customer value and the cost of delivery increases, improving a firms profit margin. This is the essence of corporate strategies that focus on operational excellence. In contrast, innovation and marketing strategies focus on improving customer perceptions of the value of goods and services by innovatively improving the perception of what gets delivered. In either strategy, increasing the margin between delivery cost and perceived value is the foundation for improved business performance. Similarities and Differences Between a Supply Chain and a Value Chain Supply Chain Management (SCM) emerged in the 1980s as a new, integrative philosophy to manage the total flow of goods from suppliers to the ultimate user (4), (5), and evolved to consider a broad integration of business processes along the chain of supply (6). Keith Oliver coined the term supply chain management in 1982 (7), (8). Oliver, a vice president in Booz Allen Hamiltons London office, developed an integrated inventory management process to balance trade-offs between his clients' desired inventory and customer service goals. The original focus was the management of a chain of supply as though it were a single entity, not a group of disparate functions, with the primary objective of fixing the suboptimal deployment of inventory and capacity caused by conflicts between functional groups within the company (8). SCM evolved quickly in the 1990s with the advent of rapid response initiatives in textile and
Product Value Service Value Wow Value
Copyright 2006 Andrew Feller, Dan Shunk, & Tom Callarman. www.bptrends.com

grocery industries, and was refined by large retailer Wal-Mart who used point-of-sale data to enable continuous replenishment (9). Supply chain is a term now commonly used internationally to encompass every effort involved in producing and delivering a final product or service, from the suppliers supplier to the customers customer (6). As the name implies, the primary focus in supply chains is on the costs and efficiencies of supply, and the flow of materials from their various sources to their final destinations. Efficient supply chains reduce costs. In common parlance, a supply chain and a value chain are complementary views of an extended enterprise with integrated business processes enabling the flows of products and services in one direction, and of value as represented by demand and cash flow in the other (3). Both chains overlay the same network of companies. Both are made up of companies that interact to provide goods and services. When we talk about supply chains, however, we usually talk about a downstream flow of goods and supplies from the source to the customer. Value flows the other way. The customer is the source of value, and value flows from the customer, in the form of demand, to the supplier. That flow of demand, sometimes referred to as a demand chain (10), is manifested in the flows of orders and cash that parallel the flow of value, and flow in the opposite direction to the flow of supply. Thus, the primary difference between a supply chain and a value chain is a fundamental shift in focus from the supply base to the customer. Supply chains focus upstream on integrating supplier and producer processes, improving efficiency and reducing waste, while value chains focus downstream, on creating value in the eyes of the customer. This distinction is often lost in the language used in the business and research literature. For example, in 1998, the Global Supply Chain Forum (GSCF) defined supply chain management as the integration of key business processes from end user through original suppliers that provides products, services, and information that add value for customers and other stakeholders (11), thereby adding the notion that supply chain processes must add value and blurring the distinction between a supply chain and a value chain. In a recent conference, Mike Eskew, Chairman and CEO of UPS, described supply chain management that seeks to optimize costs as second generation supply chains (SCM 2.0), and went further to describe the third generation supply chain management as being focused on customer intimacy, and being a

synchronized supply chain where consumers have the power to pull value (21). This description reflects the evolution of supply chains that synchronize the flows of value and supply. A recent survey of the main usages of the term value in the economics, marketing, strategy, and operations fields indicates that the notion of a value chain may actually be a misnomer (3), although a widely used one. According to this analysis, only resources move along the chain of linkages between firms supplies going one way and money going the other, while value is a metaphysical perceived quality associated with the benefits that occur at the various points of exchange along the resource chain. According to this analysis, value surrounds the movement of resources is perceptual and accrues to both parties in a transaction, suppliers and customers. Therefore, value chains can be thought to operate in both directions, with suppliers accruing value from the financial resources, payment terms, stability, and future order cover that their customers provide, while customers derive value from the delivered products and services. Misnomer or not, the value chain concept has become a staple idea in the management and research literature, and is the focus for evolving strategies, enterprise models, and numerous efforts at improving business performance (12), (13), (14). Creating a profitable value chain therefore requires alignment between what the customer wants, i.e., the demand chain, and what is produced via the supply chain. And while supply chains focus primarily on reducing costs and attaining operational excellence, value chains focus more on innovation in product development and marketing.
Copyright 2006 Andrew Feller, Dan Shunk, & Tom Callarman. www.bptrends.com

Why Value Chains Now? The growing interest in value chains began with Porters seminal work, Competitive Advantage, (1) and has increased ever since. Researchers in business and economics have been concerned with the notion of value since the early work of Adam Smith distinguished between use-value and exchange-value (15). At the time of this writing, a Google search on the term value chain produces nearly 4 million hits, while an ABI/Informs search of articles produces a total of 1673 documents including 675 from scholarly journals over the last 20 years and 26 Ph.D. dissertations produced over the 6 years between 1997 and 2003. Clearly, the interest in value chains is not new. In Industrial Engineering, however, the primary focus has been on achieving operational efficiency leading to a focus on production operations and supply chains. There are a number of significant trends that are now driving the need for operations oriented analysis from a value chain perspective. These include Increasing competition and an increasing focus on innovation as an element of strategy Evolving governance models for the extended enterprise The trend towards globalization of supply and production Benefits already wrung out of manufacturing and the supply chain Trends in Management Discourse Increasing Competition and the Primacy of Strategy The value chain is first and foremost a strategic concept, arising from a strategic theory of firm competition (1). As companies struggle to compete in an environment of globalization and intense competition, the focus shifts to alternative means to remain competitive. This creates an increasing interest in Value Chains as a tool to model the extended enterprise and formulate strategies for how to remain competitive (16). Evolving Governance Models for the Extended Enterprise The information era spurred on by the recent focus of capital investment on internet technologies and dot-com business models has increased general business and research interest in alternative value chain and business models. This has been promoted in the research literature by the focus on Core Competencies and the Resource Based View (RBV) of the firm (17). This growth in modular/virtual collaborative enterprise business models has increased interest in the Value Chain as a primary construction for analysis of new models for business governance (18). Globalization of Supply and Production The growth in global sourcing and supply has begun a long-term process of leveling the playing field for adding value world wide (19). This leads to the need to model global value chains as the predominant mode of business in many industries. Many Benefits Already Wrung out of Manufacturing and the Supply Chain The Industrial Engineering and Operations Management disciplines, combined with management and operations improvement initiatives such as lean manufacturing, TQM, and Six Sigma, have been

improving the efficiency of manufacturing and supply chain operations for many years. While there is still considerable work to do in the field, academic theoreticians and practitioners at many of the more advanced firms are beginning to turn to a broader view of the enterprise to continue making a contribution to improving competitive stance (16). Improving the operational capability of other value added activities in the enterprise, such as product development, requires shifting perspective from the supply chain to the value chain (9). Trends in Management Discourse A final reason for the growing interest in Value Chains may simply be the nature of management fashion trends in academic and management discourse. A lifecycle process revealing how management knowledge entrepreneurs participate in the creation of trends in discourse was described in a study of Quality Circles by Abrahamson and Fairchild (1999) (20). This study derived two propositions that are relevant: 1) Management fashions tend to have a lifecycle characterized by a long latency phase followed by a wave-like, often asymmetrical and ephemeral popularity curve.
Copyright 2006 Andrew Feller, Dan Shunk, & Tom Callarman. www.bptrends.com

2) Three conditions occurring in conjunction trigger a management fashion within a niche: (a) a fashion in that niche must collapse; (b) there must be a widespread performance gap that a latency-phase replacement fashion in that niche can believably address; and (c) discourse must have brought this gap to the attention of many management-fashion consumers. The collapsing wave of interest in supply chain management associated with the dot-com era bubble bursting may qualify for condition (a), while the growing global competition in business certainly creates a performance gap condition (b). Value chains have had a long latency period since the mid-1980s, are an accepted terminology in academic discourse, and are believably positioned to address many of the concerns that business practitioners have in industry condition (c). Value chain discourse has come on as a strong contender in the past several years to fill the operations and supply management niche in management fashion, and may be ready for a continuing rise in popularity. Strategically, it is being positioned as a dynamic differentiator (22). Conclusion - The Case for Synchronizing Value and Supply Value is highly conditioned by the larger social and economic environment through which complex and numerous interactions affect the human perception of value-based transactions. Advertising, social trends, and economic conditions all influence consumer and business valuations of products, services, and resources flowing through the value systems in our economy. One of the most watched figures in the marketplace is the consumer confidence index based on a survey of households. This index is an aggregate measure of confidence in the economy and a leading indicator of how consumers will value, and therefore how they will spend money on goods and services. When perceptions of value in a marketplace become exaggerated, market bubbles occur such as the internet technology bubble several years ago. When significant trends take hold in this larger environment it is difficult, if not impossible, for individual companies or households to avoid being swept along in the sudden creation and destruction of value that may result. For supply chains to generate maximum value in this dynamic environment, they must synchronize the flows of supply with the flows of value from customers in the form of rapidly shifting tastes, preferences, and demand. We need to stop thinking of supply chains and value chains as different entities, but, rather, should integrate the two. Third generation supply chains require that the material flow and product delivery be synchronized and lean, and that the information, knowledge, and financial flows be fully integrated and instantaneous. SCM 3.0 requires that product design be fully integrated with production capability, delivery processes, and information about customer demand. This can be achieved by taking a holistic view of the endtoend business process throughout the product life cycle and across geographical borders. To continue to debate the importance of supply chain management versus the value chain concept would be folly. Instead, the next level of business performance will be achieved by companies that learn to integrate fully the concurrent flows of value and supply. Bibliography 1. M. Porter, Competitive Advantage, Creating and Sustaining Superior Performance, The

Free Press, New York, 1985. 2. Womack, James and Daniel Jones, Lean Thinking, The Free Press, New York, 2003. 3. J. Ramsay, "The real meaning of value in trading relationships," International Journal of Operations & Production Management, vol. 25, pp. 549, 2005. 4. Clemmer, Jim, The Three Rings of Perceived Value. The Canadian Manager. 1990 Jun 1;15(2):12-15.
Copyright 2006 Andrew Feller, Dan Shunk, & Tom Callarman. www.bptrends.com

5. Cooper, Martha C., Douglas M. Lambert and Janus D. Pagh, Supply Chain Management: More Than a New Name for Logistics, The International Journal of Logistics Management, Vol. 8, No. 1 (1997), pp. 1-14. 6. Supply-Chain Council (2005), available at: www.supply-chain.org 7. Bacheldor, Beth, (2003), Supply chain management still a work in progress, InformationWeek, May 23. 8. Laseter, T. and Oliver, K. (2003), When will supply chain management grow up?, Strategy + Business, No. 32, pp. 20-5. 9. S.A. Sherer, "From supply-chain management to value network advocacy: implications for e-supply chains," Supply Chain Management, vol. 10, pp. 77, 2005. 10. D. Walters and M. Rainbird, "The demand chain as an integral component of the value chain," The Journal of Consumer Marketing, vol. 21, pp. 465, 2004. 11. Lambert, Douglas M., Martha C. Cooper, and Janus D. Pagh, Supply Chain Management: Implementation Issues and Research Opportunities, The International Journal of Logistics Management, Vol. 9, No. 2 (1998), pp. 1-19. 12. M. Eskew, Sychronized Commerce: The Asia Imperative, Longitudes 05, Shanghai, China, October 20, 2005. 13. The Value Chain: The Original Breakthrough, The Antidote, Vol. 8, 1997. 14. Oswald A Mascarenhas, Ram Kesavan, Michael Bernacchi. Customer value-chain involvement for co-creating customer delight. The Journal of Consumer Marketing. 2004 Nov 10;21(7):486-496. 15. Yuan-Jye Tseng, Yu-Hua Lin. The Grey Relational Evaluation of the Manufacturing Value Chain. Journal of American Academy of Business, Cambridge. 2005 Sep 1;7(1):67-71. 16. Smith, A. (1776) in Cannan, E. (Ed.), The Wealth of Nations (1937), Modern Library, New York, NY. 17. David Walters, Geoff Lancaster. Implementing value strategy through the value chain. Management Decision. 2000 Mar 15;38(3):160-178. 18. C. K. Prahalad, G. Hamel, The Core Competence of the Corporation, Harvard Business Review, vol.68, no. 3, pp. 79-92, 1990. 19. G. Gereffi, J. Humphrey and T. Sturgeon, The Governance of Global Value Chains, Review of International Political Economy, vol. 12, no.1 pp. 78104, 2005. 20. T. L. Friedman, The World is Flat, Farrar, Straus and Giroux, New York, 2005. 21. Eric Abrahamson, Gregory Farichild, Management Fashion: Lifecycles, Triggers, and Collective Learning Processes, Administrative Science Quarterly, Vol. 44, No. 4, 1999. 22. Charles H. Fine, R. Vardan, R. Pethick and J. El-Hout, Rapid-Repsonse Capability in Value-Chain Design, MITSloan Management Review, Vol. 43, No. 2, Winter 2002. _______ Andrew Feller, Ph.D., Student, Arizona State University Dr. Dan Shunk, Professor, ASU and Board Member, Value Chain Group Dr. Tom Callarman, Professor, CEIBS and Executive Director Asia Pacific for Value Chain Group

INTRODUCTION
This paper examines the value creation process as it applies to the management of customer relationships, with the aim of providing practical guidance for enhancing customer value and thus shareholder value. Value creation can be viewed as one of five key cross-functional processes that together constitute the Strategic Framework for Customer Relationship Management (CRM)1 shown in Figure 1. The value creation process is a critical component of CRM as it translates business and customer strategies into specific statements of what value is to be delivered to customers and, consequently, what value is to be delivered to the supplier organisation. Figure 1: Strategic Framework for CRM Creating customer value is increasingly seen as a key source of competitive advantage. Yet, despite growing attention to this aspect of strategic development, there is remarkably little by way of agreement amongst managers and commentators on what constitutes 'customer value'. Further, companies typically do not specify in sufficient detail the value they seek to deliver to clearly identified customer segments and micro-segments, and how they propose to deliver this value. The value creation process consists of three key elements: determining what value the company can provide to its customers (the value customer receives); determining the value the organisation receives from its customers (the value organisation receives); and, by successfully managing this value exchange, maximising the lifetime value of desirable customer segments. The emphasis in many companies is on this second element of value. To these companies, customer value means: yhow much money can we extract from the customer? yhow can we sell them more of the existing products and services they are buying? yhow can we cross-sell them new products and services? However, in todays competitive arena where a growing number of businesses vie for a greater share of a finite customer pool, it has become imperative to consider customer value also in terms of customer benefit: how can we create and deliver value to our customers? how can we ensure the customer proposition is relevant and favourably attractive? how can we ensure the customer experience is consistently positive?
Strategy Development Process: Business Drivers Business vision Competitive characteristics Customer Strategy Customer choice Customer Characteristics Segment Granularity Information Management Process: Back Office Applications Front Office Applications Analysis Tools IT Systems

Data Repository Multi-Channel Integration Process: Integrated channel management Sales Force Outlets Telephony Electronic Commerce Direct Marketing Mobile Commerce Virtual Physical CRM Performance Assessment Process:
Shareholder Results
Employers value Customer value Shareholder value Cost reduction

Performance Monitoring

Standards Satisfaction measurement Results & K.P.I.s

Value Creation Process:

Value Customer Receives
Value proposition Value assessment

Value Organisation Receives

Acquisition economics Retention economics

Customer Segment Lifetime Value Analysis

THE VALUE THE CUSTOMER RECEIVES

The value the customer receives from the supplier organisation is the total package of benefits derived from the core product and the product surround, or the added values that enhance the basic features such as service and support. As pointed out by Harvard Business School's Theodore Levitt, competition exists not between what companies produce in their factories but between "what they add to their factory output in the form of packaging, services, advertising, customer advice, financing, delivery arrangements, warehousing, and other things that people value". The value the customer attributes to these benefits is in proportion to the perceived ability of the offer to solve whatever customer problem prompted the purchase. This value can be calculated using the value proposition concept and undertaking a value assessment importantly, working from a customer perspective.

The Value Proposition

The aim of all businesses is to create a value proposition for customers, be it implicit or explicit, which is superior to and more profitable than those of competitors. In specific usage, a value proposition is the offer defined in terms of the target customers, the benefits offered to these customers, and the price charged relative to the competition. Value propositions explain the relationship between the performance of the product, the fulfilment of the customers needs and the total cost to the customer over the customer relationship life cycle (from acquisition of the product through to usage and ownership, and eventual disposal). As every customer is different and has changing needs, it is crucial that the value proposition for each customer is clearly and individually articulated, and cognisant of the customers lifetime value. A structured method for developing value propositions, originated by consulting firm McKinsey and Co. and further developed by others2-7 , is comprised of two main parts: formulation of the value proposition and profitable delivery of this value proposition by

means of a value delivery system. Formulating the value proposition Formulating the value proposition involves defining the target customers, the benefits offered to these customers and the price charged relative to the competition, and then expressing this as a formal statement. Some examples of value propositions, based on work by Lanning and Phillips6, are shown in Figure 2. Figure 2: Examples of value propositions for various industries. Company / Product Target Customers Benefits Price Value Proposition Perdue (chicken) Qualityconscious consumers of chicken Tenderness 10 per cent premium More tender, golden chicken at a moderate price premium Volvo (station wagon) Safetyconscious upscale families Durability and safety 20 per cent premium The safest, most durable station wagon your family can travel in at a significant price premium Dominos (pizza) Conveniencemi nded pizza lovers Delivery speed and good quality 15 per cent premium A good pizza, delivered hot to your door within 30 minutes of ordering, at a moderate price premium The recommended approach for defining these elements of the value proposition follows a sequence of three steps. 4 Step 1: Analysing markets based on value This first step involves understanding the price/benefit opportunities that exist within the market and here the value map can prove a useful tool. Value maps provide a graphical presentation of the relative positions of different competitors in terms of the benefits and

price attributes that relate to customer value. Figure 3 shows a value map for the airline industry based on a study undertaken by New York University 7. It depicts a value frontier that incorporates the price/benefit positions of the major carriers. If all competitors shared a similar position on the value map, commoditisation and reduced profitability would likely result. Figure 3: Value map for the airline industry Researchers in this area suggest three generic strategies for developing differentiated value propositions on the value map. 1. Extend the value frontier towards the low end of the value map - the strategy adopted by Southwest Airlines in the USA, and by EasyJet and Go airlines in Europe. 2. Extend the value frontier towards the high end of the value map - the strategy adopted by British Airways and Air France with their Concorde fleets. Pursuit of this strategy is often based on technological innovation. 3. Shift the value frontier - the strategy adopted by Virgin Atlantic with its 'upper class' service, offers first class facilities and a highly distinctive personality based on a business class fare structure. High-performance companies characteristically focus on the development of superior value propositions in order to take advantage of new growth opportunities and identifiable, premier customers.
Cost Performance
Virgin Atlantic

The Value Frontier

British Airways Concorde Air France Concorde Southwest Airlines Easy Jet Go : Braniff Pan Am Shifting the Value Frontier Upward Extension of Value Frontier Major Carriers: American, British Airways, Cathay, KLM, Lufthansa, etc Downward Extension of Value Frontier

5 Step 2: Assessing opportunities in each segment to deliver superior value When a critical review of any market is undertaken it soon becomes obvious that the idea of a single market for a given product or service is highly restrictive. All markets are made up of market segments, or groups of customers with the same or similar needs. Reaching the most profitable and suitable market segments is a matter of evaluating the opportunities (and limitations) in each segment for delivering superior customer value. Even where the offer made to customers is technically identical to competitors offers, efforts to differentiate the total or package offer in terms of customer segment as well as market segment can reap significant rewards. Many companies that have adopted a market aggregation strategy in the past are now actively addressing new ways of appealing to different customer segments. Value maps may also be constructed at the market segment level to enable very specific price/benefit opportunities to be evaluated within segments, and thus highlight the most promising market segments and the most appropriate propositions for them. Assessments of potential opportunities for delivering superlative value should involve a rigorous analysis of cost, competitive offers, and importantly, organisational fit on both strategic and operational levels. Step 3: Explicitly choosing the value proposition Having identified the target market segments, the next priority is to create a value

proposition of winning relevance. The characteristics of the segments that form some markets may vary so radically that different value propositions will be required for different segments. For example, in the automotive industry, the needs and preferences of customers in the luxury segment who buy Rolls Royces are clearly distinct from those of customers in the trendy youth segment that buy Smart cars or VW Beetles. Businesses that justifiably exhibit less marked differences between their product and service offers may benefit from approaching the value proposition issue by developing a generic value proposition for the market as a whole and then developing more specific variants for each specific segment. Once formulated, value propositions should be carefully reviewed to confirm that they are truly distinctive and appropriate. The checklist in Figure 4 can be used to determine whether a superior value proposition has really been developed. Figure 4: A checklist to review your value proposition

1. Is the target customer clearly identified? 2. Are the customer benefits explicit, specific, measurable and distinctive? 3. Is the price, relative to competition, explicitly stated? 4. Is the value proposition clearly superior for the target customer (superior benefits, lower price or both)? 5. Do we have, or can we build, the skills to deliver it? 6. Can we deliver it at a cost that permits an adequate profit? 7. Is it viable and sustainable in the light of competitors and their capabilities? 8. Is it the best of several value propositions we considered? 9. Are there any impending discontinuities (in technology, customer habits, regulation, market growth, etc) that could change our position? 10. Is the value proposition clear and simple?
Source: based on references 4 and 6 6 The value delivery system The means by which the value proposition is delivered represents the other half of the value proposition concept. The importance of having a system, or framework for value delivery stems from the realisation that focusing on the traditional physical sequence of 'make the product/service and sell the product/service is sub-optimal. The value delivery system emphasises that companies need to shift from a traditional view of seeing their business as a set of functional activities to an externally-oriented view that sees their business as a form of value delivery. The value delivery system consists of three parts as portrayed in Figure 5: choose the value, provide the value and communicate the value. Figure 5: The Value Delivery System Source: based on McKinsey & Co 1. Choose the value. Choosing the most appropriate value proposition involves understanding the forces driving demand, customer economics, the buying process and how well the competition serves customer needs, particularly in terms of their products, service and prices charged. 2. Provide the value. Developing a product and service package that provides clear and superior value involves focusing on product quality and performance, service cost and responsiveness, manufacturing cost and flexibility, channel structure and performance, and price structure. 3. Communicate the value. Engaging in promotional activity to persuade customers that the value offered is better than that of competitors not only involves sales promotion, advertising and the sales force, but also the provision of outstanding service in a way that is recognised and remembered by the target audience. Much of the success of a value delivery system depends on the thoroughness and innovation with which value is both generated and reinforced throughout the supplier organisation. "Differentiating the winners is the extent to which this value proposition is echoed in the business system, through changes in branch service delivery, new

products, systems that provide integrated information to customers and those serving them, relationship pricing, etc. Executing these changes is more difficult than choosing the value but also provides formidable obstacles to imitation" 6.

Value Assessment
To determine if the value proposition is likely to result in a superior customer experience, it is necessary to quantify the relative importance that customers place upon the various attributes of a product. A value assessment based on subjective judgments about the attributes and benefits that are important to the customer can fall prey to the assumption that the supplier and customer attach the same importance to the various product attributes rarely do they.
Customer value needs Value positioning Product development Service development Pricing Sourcing, making Distributing, servicing Sales force message Sales promotion Advertising PR, etc. Message & media Choose the value Provide the value Communicate the value

7 Traditional means of customer assessment of value The most common means of discovering the perceived value of product attributes is to ask a representative sample of customers to rank them in terms of importance on a five, seven or ten point scale. However, where a large number of attributes are concerned, this method is impractical and offers little real insight. An alternative approach is to ask respondents to place a weight from 1 to 10 against each attribute while ranking them on a scale of, say, very satisfied to very dissatisfied. This approach also prone to problems, particularly where respondents: do not know the importance of some features; may be unwilling to disclose their opinions; may rate too many attributes as being very high in importance; or, may be influenced by peer pressure, causing some features to be overrated. Improving value assessment using trade-off analysis A more realistic evaluation of customer value can be obtained by asking a representative sample of customers to rank the products attributes and then, using an analytical tool such as conjoint analysis2, or trade-off analysis, applies a weighting system to discover the weight given to different levels of each attribute. Here advanced computer analysis is used to calibrate the importance weights, which can then be aggregated to provide an objective measure of the utility that customers prescribe to each element of customer value. This technique is based on the simple concept of trading off one attribute against another. For example, the purchaser of a new car is likely to trade off a number of specific product attributes in agreeing the purchase price and specifications. Vehicle performance, petrol economy, number of seats, safety features, boot capacity, low price, and so on will have factored in his decision. Trade-off analysis can also be used to identify customers that share common preferences in terms of product attributes, and may reveal substantial market segments with service needs that are not fully catered for by existing offers. Trade-off analysis possesses several advantages over more traditional forms of value

assessment, as it: 1. Employs measures of attribute importance that do not rely on direct rating by respondents; 2. Forces a trade-off among very important attributes to determine which are the most important; and 3. Achieves this for each customer separately. There are two forms of trade-off analysis. The 'full profile' approach presents respondents with a full-profile description of an offer and asks them to rate the offers constituent elements. The 'pairwise' trade-off approach asks respondents to rank combinations of variants of two attributes, from the least preferred to the most preferred, and then repeats this for a series of other pairs of attributes. The 'full profile' form of trade-off analysis is the most commonly used approach, and is often deemed more realistic by researchers as all the products aspects are considered at the same time. However, if the number of attributes is large then the judging process used for each individual profile in the full profile approach can become very complex and demanding. For that reason other researchers prefer the 'pairwise' trade-off approach. While these approaches are typically described in detail only in specialist texts on market research8, numerous company studies have now been undertaken by consultants and market researchers using this form of value analysis. As a result, the commercial acceptance of this approach in businesses has grown greatly. 8

THE VALUE THE ORGANISATION RECEIVES

The value the supplier organisation receives from the customer has the greatest association with the term 'customer value'. Customer value from this perspective is the outcome of providing and delivering superior value to the customer; deploying improved acquisition and retention strategies; and utilising effective channel management. Fundamental to the concept of customer value in this context is understanding the economics of customer acquisition and customer retention. The opportunities for crossselling, up-selling and building customer advocacy are also integral to this view of value creation.

Customer acquisition and its economics

The importance of customer acquisition varies considerably according to a companys specific situation. For example, a new market entrant to the fast-paced world of ebusiness will be primarily focused on customer acquisition, while an established manufacturing company operating in a mature market may be more concerned with customer retention. The customer acquisition process is typically concerned with: yacquiring customers at a lower cost, yacquiring more customers, and yacquiring more attractive customers. The starting point in understanding customer value from the perspective of the supplier organisation is to determine the existing customer acquisition costs within the utilised channels, and also how these costs vary across different segments or microsegments. Customer acquisition at Electro plc To illustrate the economics of both customer acquisition and customer retention we will use an example from Electro plc, a large UK electricity supplier. From the late 1990s, the residential sector of the market was going through substantial changes as electricity companies, for the first time, could now sell electricity outside their traditional geographic boundaries. Electro faced competition within their own territory from other electricity providers, but also could now market their services outside their traditional geography. Segmentation of Electros customer base identified four key market segments, each of which displayed different characteristics in terms of socio-economic grouping, expected switching behaviour and customer profiles. The data needed to undertake an analysis of customer acquisition and customer retention economics at Electro, at the segment level, was collected. This included: the

number of existing customers within each segment; annual customer acquisition targets with reference to the total UK customer base; the cost of acquisition (per customer); and estimates of profit per customer per annum for each segment. The likely annual retention rates in the new competitive environment were considered. Different levels of retention for each segment were estimated, and one scenario of the broad characteristics of these segments is shown in Figure 6. Some of the figures stated have been adjusted to protect proprietary information. 9 Figure 6- Customer Segment Data Template for Electro plc As shown in the table above, the acquisition costs per customer at the segment level were estimated to be: Segment 1 - 'struggling empty nest super-loyals' - 110; Segment 2 - 'older settled marrieds' - 70; Segment 3 - 'switchable middles' - 55; and Segment 4 - 'promiscuous' - 30. To give meaning to a comparison of acquisition costs, the expected profitability of the average customer in each segment and the overall profit potential of each segment overall was also considered. The profit per customer per annum in Segment 1 (the 'struggling empty nest super-loyals') was 6, making a break-even of 18.3 years. As this segment comprises elderly people, many of the customers will die before they break even! In the case of Segment 4 (the 'promiscuous averages'), the profit per customer per annum was 22, making a breakeven of 1.36 years. This segment is highly attractive in terms of acquisition economics, especially if CRM strategies to successfully retain customers are put in place. Unfortunately, many organisations operating in consumer markets still do not differentiate their CRM activities at the segment level. They contact each prospect with the same frequency (as Electro had done since their establishment) instead of applying a level of effort consistent with the cost of acquisition and profit potential. Their unrefined use of resources not only leads to wasted investment but can cause annoyance among customers who are either being oversupplied or undersupplied with attention. This situation highlights the importance of understanding acquisition economics at the segment level.
Segment Name No. Existing Customers Acquisition Target for year Cost of Acquisition Annual Retention Rate Profit per Customer per Year Segment 1 Segment 2 Segment 3 Segment 4 Struggling empty nest super-loyals Older settled marrieds Switchable middles Promiscuous

averages 421,300 618,000 497,900 459,600 500 66,000 110,000 220,000 110 70 55 30 96% 94% 90% 80% 6 9 18 22 Segment Number

10 Acquisition across different channels Having determined the acquisition costs for different segments, the next step is to consider how acquisition costs may vary across different channels. The advent of web sites and electronic communication channels has enabled companies to acquire customers at a fraction of the cost of using more traditional channels such as direct mail. RS Components, a leading international supplier of electrical components and other products understands extremely well the cost and customer service benefits of employing the internet in conjunction with more conventional channels. The company deals with its customers through physical branches, a call centre and, more recently, a highly sophisticated and personalised web site. It should be stressed, however, that the choice of channel(s) must be appropriate to the type of business and customer base concerned. Improving acquisition Equipped with a sound understanding of how acquisition costs vary at both the segment and channel levels, companies can then seek to acquire more attractive customers at lower cost. In many instances customer acquisition can be improved through acting on insights drawn from the value proposition and the value assessment. More refined promotional campaigns and the encouragement of customer referrals can also attract customers who meet the target criteria. First Direct, the leading UK bank, boasts the highest levels of advocacy in the retail banking sector. Approximately one-third of all its customers join as a direct result of customer referral with the added bonus of reducing its average customer acquisition cost.

Customer retention and its economics

Writers and researchers have suggested that it costs around five times more to get a new customer than it does to keep an existing one. Despite this finding, many companies have traditionally focused their marketing activity on acquiring new customers, rather than retaining existing customers. This may be due to the historical convention in many companies that rewards customer acquisition to a much greater extent than customer retention, or it may be caused by a lack of understanding of why customer retention can be such a boon to commercial profitability. The profit impact of customer retention improvement While most companies recognise that customer retention is important, relatively few understand the economics of customer retention within their own firm. Until fairly recently, there was little research that critically evaluated the relative financial benefits of customer acquisition versus customer retention. In 1990, a partner at consulting firm Bain & Co and a professor at the Harvard Business School, Fred Reichheld and Earl Sasser, published

some revealing research, which demonstrated the financial impact of customer retention 9. They found even a small increase in customer retention produced a dramatic and positive effect on profitability: a five percentage points increase in customer retention yielded a very high improvement in profitability in net present value (NPV) terms. Increasing the customer retention rate from, say, 85% to 90% represented a net present value profit increase from 35 per cent to 95 per cent among the businesses they examined, as shown in Figure 7. 11
Figure 7: Profit Impact of a 5 % Increase in Customer Retention for Selected Businesses

Source: Bain & Company These findings have been very influential in drawing attention to the critical role customer retention has to play within CRM strategy. Customer retention at Electro plc Returning to the Electro plc example above, we considered the realistic potential improvement that can be made in customer retention through a CRM strategy based on improved service, given the relative attractiveness of the four segments and used the views of several executives experienced in this area to come up with the following improvement targets: Segment 1 - 1%, Segment 2 - 2%, Segment 3 - 5%, and Segment 4 - 9%, based on a segmented service strategy. Using these increases in retention rates for each segment we then modelled the increase in 'gross' profit in five and ten years with a segmented service strategy and compared it with the base case. This modelling shows a significant increase in overall gross profit, before costs of improved service, of 48% at year 5 (from 21.7 m to 32.2 m) and 71% at year 10 (from 23.8 m to 40.6 m. The results within each of the four different segments varied significantly because of differences in improvement in retention rates and other inputs to the model. Although few organisations undertake advanced evaluation of segment profitability, the broad approach is straightforward - understand the profit potential in each segment (gross profit less costs) of a segmented service approach and selectively manage the segments to maximise profits. In considering CRM initiatives, it should be emphasised that the costs are not always substantial. The most attractive CRM initiatives are those that are of high value to the customer but are of low cost to the supplier. Organisations should first consider a 0 20 40 60
Profit increase % per customer
28% 35% 125% 25% 50% 45% 55% 40% 35% 20% 26% Auto Service Chain Business Banking Credit Card Credit

Insurance Insurance Brokerage Industrial Distribution Industrial Laundry Office Building Manage -ment Software Mail Order Transportation

12 reallocation of the existing expenditure such that greater emphasis is placed on those segments which have the greatest potential for increasing net present profitability. This involves no significant increase in costs. The organisation can then identify where additional incremental expenditure should selectively be placed on the most relevant market segments. The objective is to ensure the overall cost-benefit of increased expenditure is significantly enhanced lifetime profitability. The impact of retention on profitability Why should retention have such a great effect on profitability? Reichheld and Sasser suggested a number of reasons to explain their findings: yAcquiring new customers involves costs that can be significant and it may take some years to turn a new customer into a profitable customer. yAs customers become more satisfied and confident in their relationship with a supplier, they are more likely to give the supplier a larger proportion of their business, or share of wallet. yAs the relationship with a customer develops, there is greater mutual understanding and collaboration, which produces efficiencies that lower operating costs. Sometimes customers are willing to integrate their IT systems, including planning, ordering and scheduling, with those of their suppliers, and this further reduces costs. ySatisfied customers are more likely to refer others, which promotes profit generation as the cost of acquisition of these new customers is dramatically reduced. In some industries, customer advocacy can play a very important role in acquiring new customers, particularly when there is a high risk involved in choosing a supplier. yLoyal customers can be less price-sensitive and may be less likely to defect due to price increases. This is especially true in business-to-business markets where the relationship with the supplier becomes more valued and switching costs increase. Despite these findings, recent research by the author suggests that managers have been slow to implement changes in marketing activities to emphasise customer retention. A survey of the marketing practices in 225 UK organisations revealed that the greatest proportion of marketing budget - 41 per cent - was spent on customer acquisition, while only 23 per cent was spent on customer retention. Given that the majority of firms surveyed in this sample were in mature industries, the research raises grave concerns that the economics of customer retention (and customer acquisition) are poorly understood and hugely under exploited. The study also investigated which measures managers consider to be important and which they use to evaluate their relationship marketing activities. The findings suggest that, although many organisations say they understand the importance of customer retention and its links with profitability, very few measure the economic value of their customer retention strategies. Customer acquisition and customer satisfaction are much more frequently measured than are customer retention and profit per customer. The author's research identified that many organisations are not placing the optimal amount of effort on acquisition and retention activities in terms of their marketing expenditure. Another study of 200 large UK organisations showed there is a significant misallocation in the amount of money spent on customer acquisition and customer

retention. The study identified three categories of organisation - "acquirers", "retainers" and "profit maximisers through CRM". "Acquirers" spent too much on customer acquisition activities at the expense of customer retention activities. The majority of firms, 80% of them, were in this category. "Retainers", by contrast, spent too much on customer retention activities at the expense of customer acquisition - this group represented 10% of firms. The "profit maximisers through CRM" represented only 10 per cent of firms in their survey. This last category considered they have identified the appropriate balance in spend between acquisition and retention activities. 13 We are not suggesting that new customers are unimportant; indeed, they are essential for sustained success. However, a balance is needed between the marketing efforts directed towards existing and new customers. Also, customers vary in their attractiveness for retention. Some customers are likely to yield greater long-term profitability than others and marketing strategies should reflect this fact. A framework for customer retention improvement Given the dramatic impact that improved customer retention can have on business profitability and the fact that many organisations continue to place too much emphasis on customer acquisition at the expense of customer retention, there is a strong need for a structured approach which organisations can follow to enhance their retention and profitability levels. Three major steps are involved in such an approach: the measurement of customer retention; the identification of root causes of defection and key service issues; and the development of corrective action to improve retention. Step 1: Measurement of Customer Retention The measurement of retention rates for existing customers is the first step in improving customer loyalty and profitability. It involves two major tasks - measurement of customer retention rates and profitability analysis by segment. To measure customer retention, a number of dimensions need to be analysed in detail. These include the measurement of customer retention rates over time, by market segment, and in terms of the product/service offered. If customers buy from a number of suppliers, share of wallet should also be identified. The outcome of this first step should be a clear definition of customer retention, a measurement of present customer retention rates, and an understanding of the existing and future profit potential for each market segment. Step 2: Identification of Causes of Defection and Key Service Issues This step involves the identification of the underlying causes of customer defection. Traditional marketing research into customer satisfaction does not always provide accurate answers as to why customers abandon one supplier for another. All too often customer satisfaction questionnaires are poorly designed, superficial and fail to address the key issues - forcing respondents to tick pre-determined response choices. The root causes of customer defections should be clearly identified, for it is only by understanding them that the company can begin to implement a successful customer retention programme. Often this research task needs to be undertaken by very experienced market researchers. Step 3: Corrective Action to Improve Retention The final step in the process of enhancing customer retention involves taking remedial action. At this point, plans to improve retention become highly specific to the organisation concerned and any actions taken will be particular to the given context. Some key elements include: marshalling top management commitment; ensuring employee satisfaction and dedication to building long-term customer relationships; utilising best practice techniques to improve performance; and developing a plan to implement customer retention strategy. 14 Increasingly, organisations are recognising that enhanced customer satisfaction leads to better customer retention and profitability. Many organisations are now reviewing their customer service strategies to find ways to boost retention rates as a means of improving their business performance. This often entails a fundamental shift in business emphasis

from customer acquisition to customer retention. Achieving the benefits of long-term customer relationships requires a firm commitment from senior management and all staff - to understanding and serving the needs of customers.

CUSTOMER SEGMENT LIFETIME VALUE ANALYSIS

The discussion above suggests that a balance is needed between the marketing efforts directed towards existing and new customers. This balance will vary greatly depending on whether the business is a startup such as a 'dotcom' or a mature 'bricks and mortar' company. However, in general, marketing expenditure is unbalanced with too much attention being directed at customer acquisition and too little at customer retention. To enable a decision on the relative amount of emphasis that needs to be placed on them, an understanding of both acquisition and retention economics at the segment level is critical. To calculate a customers real value a company must look at the projected profit over the life of the account. This represents the expected profit flow over a customers lifetime. The key metric used here is customer lifetime value (CLV), which is defined as the net present value of the future profit flow over a customers lifetime. It should not be assumed that companies will wish to retain all their customers. Some customers may cost too much money to service, or have such high acquisition costs in relation to their profitability, that they will never prove to be worthwhile and profitable. Clearly, it would be inadvisable to invest further in such customer segments. It is likely that within a given portfolio of customers, there may be some segments that are profitable, some that are at break-even point and some that are unprofitable. Thus, increasing customer retention does not always yield increases in customer profitability. In some instances, increasing the retention of such unprofitable customers will decrease profitability. It should be recognised, however, that unprofitable customers may be valuable in their contribution towards fixed costs and considerable caution needs to be placed in the allocation of fixed and variable costs to ensure that customers who make a contribution are not simple discarded. Modelling customer lifetime value Research has highlighted the need for managers to adopt a stronger focus on customer retention and measuring CLV. However, there is currently a lack of available analytical tools to help identify CLV for customer segments in a specific business. Some companies are now starting to build comprehensive frameworks and models that enable them to measure CLV at the segment level. We have developed one framework, the 'Retentiongram Model' 10 to undertake such modelling. This model, which derives its name from a unique graphical representation method, is used to visually depict the trade-off between acquisition and retention strategies in specific businesses. It enables the profit impact of changes in customer retention, customer acquisition and other variables to be measured at the aggregate, segment, micro-segment and individual customer levels. The model allows a trade-off to be made in the allocation of scarce organisational resources between strategies concerned with retaining existing customers and strategies concerned with attracting new customers for a specific organisation. Choices can also be made about the relative emphasis to be placed on strategies for different customer segments. Modelling future profit potential Such models are important in helping organisations determine customer value in terms of CLV. However, few organisations have reached the stage of understanding their existing acquisition economics and retention economics, let alone gone beyond it. Those that have can move on to modelling future profit potential for each market segment. Modelling of future profit potential takes into account that individual consumers may be persuaded to buy other products, or more of an existing product over time. Corporate customers, for 15 example, tend to buy from a range of suppliers. By enhancing its predictive modelling capability the supplier organisation may be able to increase 'share of wallet' as well as market share, especially through more creative exploitation of alternative channel structures such as the internet. Building profit improvement In seeking to further increase profitability, companies need to develop integrated

programmes that address customer acquisition, customer retention and other related activities that can improve customer lifetime value. One framework for reviewing such profit opportunities is the ACURA model shown in Figure 8. Figure 8: The ACURA framework ACURA Is an acronym for: acquisition, cross-sell, up-sell, retention and advocacy. Rarely do companies systematically build CRM strategies that focus on all elements within the ACURA framework. Whilst companies seek to improve customer acquisition and customer retention, they also need to exploit cross-selling and up-selling and advocacy opportunities. Companies such as McDonalds and American Express are excellent at cross-selling and up-selling; and Virgin and First Direct excel at creating advocacy within their customer bases.

CONCLUSION
Understanding and undertaking the value creation process is crucial in transforming the outputs of the strategy development process in CRM into programmes that both extract and deliver value. An insufficient focus on the value provided to key customers, as opposed to the income derived from them, can seriously diminish the impact of the offer in terms of its perceived value. Only a balanced value exchange will ensure that both parties enjoy a good return on investment, leading to a good (long-term and profitable) relationship.

Acqu ire Up- sell Advoc acy Cross-sell Retain

Professor Adrian Payne 2000

16 Achieving the ideal equilibrium between giving value to customers and getting value from customers is a critical component of CRM and requires competence in managing the perception and projection of value within the reality of acquisition and retention economics. To anticipate and satisfy the needs of current and potential customers, the supplier organisation must be able to target specific customers, and to demonstrate added value through differentiated propositions and service delivery. This means adopting an analytical approach to value creation, supported a dynamic, detailed knowledge of customers, competitors, opportunities, and the companys own performance capabilities. Increasingly sophisticated technologies provide essential aids in developing and deploying intelligence for competitive advantage. Many companies have achieved greater organisational efficiency and market place effectiveness through automating the business processes that deliver value to their customers (as well as suppliers and employees). However, such innovations do not negate the vital role fulfilled by employees. Indeed, excellent customer care remains the key determinant of winning and keeping customers. 17 REFERENCES The reader wishing to explore issues within this paper further may wish to consult some of the following. 1. For a more detailed description of this framework see: BT CRM White Paper "A Strategic Framework for CRM", 2001. (Published earlier on Insight Interactive) 2. Bower, M. and Garda, R. A., "The Role of Marketing in Management", McKinsey Quarterly, Autumn 1985, pp 34-46. 3. Bower, M. and Garda, R. A., "The Role of Marketing in Management", in Buell, V.P. (ed.), Handbook of Modern Marketing, 1998,1-3 to 1-10. 4. Lanning, M. and Michaels, E., A Business is a Value Delivery System, McKinsey Staff Paper, 1988. 5. Lanning, M. and Phillips, L., How Market-Focused Are You?", Marketing , October 1990, pp. 7 - 11.

6. Lanning, M. and Phillips, L., Building Market-Focused Organisations, Gemini Consulting White Paper, 1991. 7. Kambil, A., Ginsberg, A. and Bloch, M., "Re-inventing Value Propositions", NYU Centre for Research on Information Systems Working Paper IS - 96 - 21, New York University, 1996. 8. For example see: Aaker, D. A., Kumar, V. and Day, G. S., Marketing Research, sixth edition, John Wiley & Sons, New York, 1998. 9. Reichheld, F. F. and Sasser, W. E. Jr. "Zero Defections: Quality Comes to Services", Harvard Business Review, September-October, 1990, pp. 105-111. 10. For an example of the use of this model see: Payne, A F T and Frow, P, Treating Customers Appropriate to Value How Segmentation Can Boost Profitability, Customer, Vol. 4, 1999, pp. 4-7. INTRODUCTION This paper examines the value creation process as it applies to the management of customer relationships, with the aim of providing practical guidance for enhancing customer value and thus shareholder value. Value creation can be viewed as one of five key cross-functional processes that together constitute the Strategic Framework for Customer Relationship Management (CRM)1 shown in Figure 1. The value creation process is a critical component of CRM as it translates business and customer strategies into specific statements of what value is to be delivered to customers and, consequently, what value is to be delivered to the supplier organisation. Figure 1: Strategic Framework for CRM Creating customer value is increasingly seen as a key source of competitive advantage. Yet, despite growing attention to this aspect of strategic development, there is remarkably little by way of agreement amongst managers and commentators on what constitutes 'customer value'. Further, companies typically do not specify in sufficient detail the value they seek to deliver to clearly identified customer segments and micro-segments, and how they propose to deliver this value. The value creation process consists of three key elements: determining what value the company can provide to its customers (the value customer receives); determining the value the organisation receives from its customers (the value organisation receives); and, by successfully managing this value exchange, maximising the lifetime value of desirable customer segments. The emphasis in many companies is on this second element of value. To these companies, customer value means: yhow much money can we extract from the customer? yhow can we sell them more of the existing products and services they are buying? yhow can we cross-sell them new products and services? However, in todays competitive arena where a growing number of businesses vie for a greater share of a finite customer pool, it has become imperative to consider customer value also in terms of customer benefit: how can we create and deliver value to our customers? how can we ensure the customer proposition is relevant and favourably attractive? how can we ensure the customer experience is consistently positive?
Strategy Development Process: Business Drivers Business vision Competitive characteristics Customer Strategy Customer choice Customer Characteristics Segment Granularity Information Management Process: Back Office

Applications Front Office Applications Analysis Tools IT Systems Data Repository Multi-Channel Integration Process: Integrated channel management Sales Force Outlets Telephony Electronic Commerce Direct Marketing Mobile Commerce Virtual Physical CRM Performance Assessment Process:
Shareholder Results
Employers value Customer value Shareholder value Cost reduction

Performance Monitoring
Standards Satisfaction measurement Results & K.P.I.s

Value Creation Process:

Value Customer Receives

Value proposition Value assessment

Value Organisation Receives

Acquisition economics Retention economics

Customer Segment Lifetime Value Analysis

THE VALUE THE CUSTOMER RECEIVES

The value the customer receives from the supplier organisation is the total package of benefits derived from the core product and the product surround, or the added values that enhance the basic features such as service and support. As pointed out by Harvard Business School's Theodore Levitt, competition exists not between what companies produce in their factories but between "what they add to their factory output in the form of packaging, services, advertising, customer advice, financing, delivery arrangements, warehousing, and other things that people value". The value the customer attributes to these benefits is in proportion to the perceived ability of the offer to solve whatever customer problem prompted the purchase. This value can be calculated using the value proposition concept and undertaking a value assessment importantly, working from a customer perspective.

The Value Proposition

The aim of all businesses is to create a value proposition for customers, be it implicit or explicit, which is superior to and more profitable than those of competitors. In specific usage, a value proposition is the offer defined in terms of the target customers, the benefits offered to these customers, and the price charged relative to the competition. Value propositions explain the relationship between the performance of the product, the fulfilment of the customers needs and the total cost to the customer over the customer relationship life cycle (from acquisition of the product through to usage and ownership, and eventual disposal). As every customer is different and has changing needs, it is crucial that the value proposition for each customer is clearly and individually articulated,

and cognisant of the customers lifetime value. A structured method for developing value propositions, originated by consulting firm McKinsey and Co. and further developed by others2-7 , is comprised of two main parts: formulation of the value proposition and profitable delivery of this value proposition by means of a value delivery system. Formulating the value proposition Formulating the value proposition involves defining the target customers, the benefits offered to these customers and the price charged relative to the competition, and then expressing this as a formal statement. Some examples of value propositions, based on work by Lanning and Phillips6, are shown in Figure 2. Figure 2: Examples of value propositions for various industries. Company / Product Target Customers Benefits Price Value Proposition Perdue (chicken) Qualityconscious consumers of chicken Tenderness 10 per cent premium More tender, golden chicken at a moderate price premium Volvo (station wagon) Safetyconscious upscale families Durability and safety 20 per cent premium The safest, most durable station wagon your family can travel in at a significant price premium Dominos (pizza) Conveniencemi nded pizza lovers Delivery speed and good quality 15 per cent premium A good pizza, delivered hot to your door within 30 minutes of ordering, at a moderate price premium The recommended approach for defining these elements of the value proposition follows a sequence of three steps. 4

Step 1: Analysing markets based on value This first step involves understanding the price/benefit opportunities that exist within the market and here the value map can prove a useful tool. Value maps provide a graphical presentation of the relative positions of different competitors in terms of the benefits and price attributes that relate to customer value. Figure 3 shows a value map for the airline industry based on a study undertaken by New York University 7. It depicts a value frontier that incorporates the price/benefit positions of the major carriers. If all competitors shared a similar position on the value map, commoditisation and reduced profitability would likely result. Figure 3: Value map for the airline industry Researchers in this area suggest three generic strategies for developing differentiated value propositions on the value map. 1. Extend the value frontier towards the low end of the value map - the strategy adopted by Southwest Airlines in the USA, and by EasyJet and Go airlines in Europe. 2. Extend the value frontier towards the high end of the value map - the strategy adopted by British Airways and Air France with their Concorde fleets. Pursuit of this strategy is often based on technological innovation. 3. Shift the value frontier - the strategy adopted by Virgin Atlantic with its 'upper class' service, offers first class facilities and a highly distinctive personality based on a business class fare structure. High-performance companies characteristically focus on the development of superior value propositions in order to take advantage of new growth opportunities and identifiable, premier customers.
Cost Performance
Virgin Atlantic

The Value Frontier

British Airways Concorde Air France Concorde Southwest Airlines Easy Jet Go : Braniff Pan Am Shifting the Value Frontier Upward Extension of Value Frontier Major Carriers: American, British Airways, Cathay, KLM, Lufthansa, etc Downward Extension of Value Frontier

5 Step 2: Assessing opportunities in each segment to deliver superior value When a critical review of any market is undertaken it soon becomes obvious that the idea of a single market for a given product or service is highly restrictive. All markets are made up of market segments, or groups of customers with the same or similar needs. Reaching the most profitable and suitable market segments is a matter of evaluating the opportunities (and limitations) in each segment for delivering superior customer value. Even where the offer made to customers is technically identical to competitors offers, efforts to differentiate the total or package offer in terms of customer segment as well as market segment can reap significant rewards. Many companies that have adopted a market aggregation strategy in the past are now actively addressing new ways of appealing to different customer segments. Value maps may also be constructed at the market segment level to enable very specific price/benefit opportunities to be evaluated within segments, and thus highlight the most promising market segments and the most appropriate propositions for them. Assessments of potential opportunities for delivering superlative value should involve a rigorous

analysis of cost, competitive offers, and importantly, organisational fit on both strategic and operational levels. Step 3: Explicitly choosing the value proposition Having identified the target market segments, the next priority is to create a value proposition of winning relevance. The characteristics of the segments that form some markets may vary so radically that different value propositions will be required for different segments. For example, in the automotive industry, the needs and preferences of customers in the luxury segment who buy Rolls Royces are clearly distinct from those of customers in the trendy youth segment that buy Smart cars or VW Beetles. Businesses that justifiably exhibit less marked differences between their product and service offers may benefit from approaching the value proposition issue by developing a generic value proposition for the market as a whole and then developing more specific variants for each specific segment. Once formulated, value propositions should be carefully reviewed to confirm that they are truly distinctive and appropriate. The checklist in Figure 4 can be used to determine whether a superior value proposition has really been developed. Figure 4: A checklist to review your value proposition

1. Is the target customer clearly identified? 2. Are the customer benefits explicit, specific, measurable and distinctive? 3. Is the price, relative to competition, explicitly stated? 4. Is the value proposition clearly superior for the target customer (superior benefits, lower price or both)? 5. Do we have, or can we build, the skills to deliver it? 6. Can we deliver it at a cost that permits an adequate profit? 7. Is it viable and sustainable in the light of competitors and their capabilities? 8. Is it the best of several value propositions we considered? 9. Are there any impending discontinuities (in technology, customer habits, regulation, market growth, etc) that could change our position? 10. Is the value proposition clear and simple?
Source: based on references 4 and 6 6 The value delivery system The means by which the value proposition is delivered represents the other half of the value proposition concept. The importance of having a system, or framework for value delivery stems from the realisation that focusing on the traditional physical sequence of 'make the product/service and sell the product/service is sub-optimal. The value delivery system emphasises that companies need to shift from a traditional view of seeing their business as a set of functional activities to an externally-oriented view that sees their business as a form of value delivery. The value delivery system consists of three parts as portrayed in Figure 5: choose the value, provide the value and communicate the value. Figure 5: The Value Delivery System Source: based on McKinsey & Co 1. Choose the value. Choosing the most appropriate value proposition involves understanding the forces driving demand, customer economics, the buying process and how well the competition serves customer needs, particularly in terms of their products, service and prices charged. 2. Provide the value. Developing a product and service package that provides clear and superior value involves focusing on product quality and performance, service cost and responsiveness, manufacturing cost and flexibility, channel structure and performance, and price structure. 3. Communicate the value. Engaging in promotional activity to persuade customers that the value offered is better than that of competitors not only involves sales promotion, advertising and the sales force, but also the provision of outstanding service in a way that is recognised and remembered by the target audience.

Much of the success of a value delivery system depends on the thoroughness and innovation with which value is both generated and reinforced throughout the supplier organisation. "Differentiating the winners is the extent to which this value proposition is echoed in the business system, through changes in branch service delivery, new products, systems that provide integrated information to customers and those serving them, relationship pricing, etc. Executing these changes is more difficult than choosing the value but also provides formidable obstacles to imitation" 6.

Value Assessment
To determine if the value proposition is likely to result in a superior customer experience, it is necessary to quantify the relative importance that customers place upon the various attributes of a product. A value assessment based on subjective judgments about the attributes and benefits that are important to the customer can fall prey to the assumption that the supplier and customer attach the same importance to the various product attributes rarely do they.
Customer value needs Value positioning Product development Service development Pricing Sourcing, making Distributing, servicing Sales force message Sales promotion Advertising PR, etc. Message & media Choose the value Provide the value Communicate the value

7 Traditional means of customer assessment of value The most common means of discovering the perceived value of product attributes is to ask a representative sample of customers to rank them in terms of importance on a five, seven or ten point scale. However, where a large number of attributes are concerned, this method is impractical and offers little real insight. An alternative approach is to ask respondents to place a weight from 1 to 10 against each attribute while ranking them on a scale of, say, very satisfied to very dissatisfied. This approach also prone to problems, particularly where respondents: do not know the importance of some features; may be unwilling to disclose their opinions; may rate too many attributes as being very high in importance; or, may be influenced by peer pressure, causing some features to be overrated. Improving value assessment using trade-off analysis A more realistic evaluation of customer value can be obtained by asking a representative sample of customers to rank the products attributes and then, using an analytical tool such as conjoint analysis2, or trade-off analysis, applies a weighting system to discover the weight given to different levels of each attribute. Here advanced computer analysis is used to calibrate the importance weights, which can then be aggregated to provide an objective measure of the utility that customers prescribe to each element of customer value. This technique is based on the simple concept of trading off one attribute against another. For example, the purchaser of a new car is likely to trade off a number of specific product attributes in agreeing the purchase price and specifications. Vehicle performance, petrol economy, number of seats, safety features, boot capacity, low price, and so on will

have factored in his decision. Trade-off analysis can also be used to identify customers that share common preferences in terms of product attributes, and may reveal substantial market segments with service needs that are not fully catered for by existing offers. Trade-off analysis possesses several advantages over more traditional forms of value assessment, as it: 1. Employs measures of attribute importance that do not rely on direct rating by respondents; 2. Forces a trade-off among very important attributes to determine which are the most important; and 3. Achieves this for each customer separately. There are two forms of trade-off analysis. The 'full profile' approach presents respondents with a full-profile description of an offer and asks them to rate the offers constituent elements. The 'pairwise' trade-off approach asks respondents to rank combinations of variants of two attributes, from the least preferred to the most preferred, and then repeats this for a series of other pairs of attributes. The 'full profile' form of trade-off analysis is the most commonly used approach, and is often deemed more realistic by researchers as all the products aspects are considered at the same time. However, if the number of attributes is large then the judging process used for each individual profile in the full profile approach can become very complex and demanding. For that reason other researchers prefer the 'pairwise' trade-off approach. While these approaches are typically described in detail only in specialist texts on market research8, numerous company studies have now been undertaken by consultants and market researchers using this form of value analysis. As a result, the commercial acceptance of this approach in businesses has grown greatly. 8

THE VALUE THE ORGANISATION RECEIVES

The value the supplier organisation receives from the customer has the greatest association with the term 'customer value'. Customer value from this perspective is the outcome of providing and delivering superior value to the customer; deploying improved acquisition and retention strategies; and utilising effective channel management. Fundamental to the concept of customer value in this context is understanding the economics of customer acquisition and customer retention. The opportunities for crossselling, up-selling and building customer advocacy are also integral to this view of value creation.

Customer acquisition and its economics

The importance of customer acquisition varies considerably according to a companys specific situation. For example, a new market entrant to the fast-paced world of ebusiness will be primarily focused on customer acquisition, while an established manufacturing company operating in a mature market may be more concerned with customer retention. The customer acquisition process is typically concerned with: yacquiring customers at a lower cost, yacquiring more customers, and yacquiring more attractive customers. The starting point in understanding customer value from the perspective of the supplier organisation is to determine the existing customer acquisition costs within the utilised channels, and also how these costs vary across different segments or microsegments. Customer acquisition at Electro plc To illustrate the economics of both customer acquisition and customer retention we will use an example from Electro plc, a large UK electricity supplier. From the late 1990s, the residential sector of the market was going through substantial changes as electricity companies, for the first time, could now sell electricity outside their traditional geographic boundaries. Electro faced competition within their own territory from other electricity providers, but also could now market their services outside their traditional geography. Segmentation of Electros customer base identified four key market segments, each of

which displayed different characteristics in terms of socio-economic grouping, expected switching behaviour and customer profiles. The data needed to undertake an analysis of customer acquisition and customer retention economics at Electro, at the segment level, was collected. This included: the number of existing customers within each segment; annual customer acquisition targets with reference to the total UK customer base; the cost of acquisition (per customer); and estimates of profit per customer per annum for each segment. The likely annual retention rates in the new competitive environment were considered. Different levels of retention for each segment were estimated, and one scenario of the broad characteristics of these segments is shown in Figure 6. Some of the figures stated have been adjusted to protect proprietary information. 9 Figure 6- Customer Segment Data Template for Electro plc As shown in the table above, the acquisition costs per customer at the segment level were estimated to be: Segment 1 - 'struggling empty nest super-loyals' - 110; Segment 2 - 'older settled marrieds' - 70; Segment 3 - 'switchable middles' - 55; and Segment 4 - 'promiscuous' - 30. To give meaning to a comparison of acquisition costs, the expected profitability of the average customer in each segment and the overall profit potential of each segment overall was also considered. The profit per customer per annum in Segment 1 (the 'struggling empty nest super-loyals') was 6, making a break-even of 18.3 years. As this segment comprises elderly people, many of the customers will die before they break even! In the case of Segment 4 (the 'promiscuous averages'), the profit per customer per annum was 22, making a breakeven of 1.36 years. This segment is highly attractive in terms of acquisition economics, especially if CRM strategies to successfully retain customers are put in place. Unfortunately, many organisations operating in consumer markets still do not differentiate their CRM activities at the segment level. They contact each prospect with the same frequency (as Electro had done since their establishment) instead of applying a level of effort consistent with the cost of acquisition and profit potential. Their unrefined use of resources not only leads to wasted investment but can cause annoyance among customers who are either being oversupplied or undersupplied with attention. This situation highlights the importance of understanding acquisition economics at the segment level.
Segment Name No. Existing Customers Acquisition Target for year Cost of Acquisition Annual Retention Rate Profit per Customer per Year Segment 1 Segment 2 Segment 3 Segment 4 Struggling empty nest super-loyals

Older settled marrieds Switchable middles Promiscuous averages 421,300 618,000 497,900 459,600 500 66,000 110,000 220,000 110 70 55 30 96% 94% 90% 80% 6 9 18 22 Segment Number

10 Acquisition across different channels Having determined the acquisition costs for different segments, the next step is to consider how acquisition costs may vary across different channels. The advent of web sites and electronic communication channels has enabled companies to acquire customers at a fraction of the cost of using more traditional channels such as direct mail. RS Components, a leading international supplier of electrical components and other products understands extremely well the cost and customer service benefits of employing the internet in conjunction with more conventional channels. The company deals with its customers through physical branches, a call centre and, more recently, a highly sophisticated and personalised web site. It should be stressed, however, that the choice of channel(s) must be appropriate to the type of business and customer base concerned. Improving acquisition Equipped with a sound understanding of how acquisition costs vary at both the segment and channel levels, companies can then seek to acquire more attractive customers at lower cost. In many instances customer acquisition can be improved through acting on insights drawn from the value proposition and the value assessment. More refined promotional campaigns and the encouragement of customer referrals can also attract customers who meet the target criteria. First Direct, the leading UK bank, boasts the highest levels of advocacy in the retail banking sector. Approximately one-third of all its customers join as a direct result of customer referral with the added bonus of reducing its average customer acquisition cost.

Customer retention and its economics

Writers and researchers have suggested that it costs around five times more to get a new customer than it does to keep an existing one. Despite this finding, many companies have traditionally focused their marketing activity on acquiring new customers, rather than retaining existing customers. This may be due to the historical convention in many companies that rewards customer acquisition to a much greater extent than customer retention, or it may be caused by a lack of understanding of why customer retention can be such a boon to commercial profitability. The profit impact of customer retention improvement While most companies recognise that customer retention is important, relatively few

understand the economics of customer retention within their own firm. Until fairly recently, there was little research that critically evaluated the relative financial benefits of customer acquisition versus customer retention. In 1990, a partner at consulting firm Bain & Co and a professor at the Harvard Business School, Fred Reichheld and Earl Sasser, published some revealing research, which demonstrated the financial impact of customer retention 9. They found even a small increase in customer retention produced a dramatic and positive effect on profitability: a five percentage points increase in customer retention yielded a very high improvement in profitability in net present value (NPV) terms. Increasing the customer retention rate from, say, 85% to 90% represented a net present value profit increase from 35 per cent to 95 per cent among the businesses they examined, as shown in Figure 7. 11
Figure 7: Profit Impact of a 5 % Increase in Customer Retention for Selected Businesses

Source: Bain & Company These findings have been very influential in drawing attention to the critical role customer retention has to play within CRM strategy. Customer retention at Electro plc Returning to the Electro plc example above, we considered the realistic potential improvement that can be made in customer retention through a CRM strategy based on improved service, given the relative attractiveness of the four segments and used the views of several executives experienced in this area to come up with the following improvement targets: Segment 1 - 1%, Segment 2 - 2%, Segment 3 - 5%, and Segment 4 - 9%, based on a segmented service strategy. Using these increases in retention rates for each segment we then modelled the increase in 'gross' profit in five and ten years with a segmented service strategy and compared it with the base case. This modelling shows a significant increase in overall gross profit, before costs of improved service, of 48% at year 5 (from 21.7 m to 32.2 m) and 71% at year 10 (from 23.8 m to 40.6 m. The results within each of the four different segments varied significantly because of differences in improvement in retention rates and other inputs to the model. Although few organisations undertake advanced evaluation of segment profitability, the broad approach is straightforward - understand the profit potential in each segment (gross profit less costs) of a segmented service approach and selectively manage the segments to maximise profits. In considering CRM initiatives, it should be emphasised that the costs are not always substantial. The most attractive CRM initiatives are those that are of high value to the customer but are of low cost to the supplier. Organisations should first consider a 0 20 40 60
Profit increase % per customer
28% 35% 125% 25% 50% 45% 55% 40% 35% 20% 26% Auto Service Chain

Business Banking Credit Card Credit Insurance Insurance Brokerage Industrial Distribution Industrial Laundry Office Building Manage -ment Software Mail Order Transportation

12 reallocation of the existing expenditure such that greater emphasis is placed on those segments which have the greatest potential for increasing net present profitability. This involves no significant increase in costs. The organisation can then identify where additional incremental expenditure should selectively be placed on the most relevant market segments. The objective is to ensure the overall cost-benefit of increased expenditure is significantly enhanced lifetime profitability. The impact of retention on profitability Why should retention have such a great effect on profitability? Reichheld and Sasser suggested a number of reasons to explain their findings: yAcquiring new customers involves costs that can be significant and it may take some years to turn a new customer into a profitable customer. yAs customers become more satisfied and confident in their relationship with a supplier, they are more likely to give the supplier a larger proportion of their business, or share of wallet. yAs the relationship with a customer develops, there is greater mutual understanding and collaboration, which produces efficiencies that lower operating costs. Sometimes customers are willing to integrate their IT systems, including planning, ordering and scheduling, with those of their suppliers, and this further reduces costs. ySatisfied customers are more likely to refer others, which promotes profit generation as the cost of acquisition of these new customers is dramatically reduced. In some industries, customer advocacy can play a very important role in acquiring new customers, particularly when there is a high risk involved in choosing a supplier. yLoyal customers can be less price-sensitive and may be less likely to defect due to price increases. This is especially true in business-to-business markets where the relationship with the supplier becomes more valued and switching costs increase. Despite these findings, recent research by the author suggests that managers have been slow to implement changes in marketing activities to emphasise customer retention. A survey of the marketing practices in 225 UK organisations revealed that the greatest proportion of marketing budget - 41 per cent - was spent on customer acquisition, while only 23 per cent was spent on customer retention. Given that the majority of firms surveyed in this sample were in mature industries, the research raises grave concerns that the economics of customer retention (and customer acquisition) are poorly understood and hugely under exploited. The study also investigated which measures managers consider to be important and which they use to evaluate their relationship marketing activities. The findings suggest that, although many organisations say they understand the importance of customer retention and its links with profitability, very few measure the economic value of their customer retention strategies. Customer acquisition and customer satisfaction are much more frequently measured than are customer retention and profit per customer.

The author's research identified that many organisations are not placing the optimal amount of effort on acquisition and retention activities in terms of their marketing expenditure. Another study of 200 large UK organisations showed there is a significant misallocation in the amount of money spent on customer acquisition and customer retention. The study identified three categories of organisation - "acquirers", "retainers" and "profit maximisers through CRM". "Acquirers" spent too much on customer acquisition activities at the expense of customer retention activities. The majority of firms, 80% of them, were in this category. "Retainers", by contrast, spent too much on customer retention activities at the expense of customer acquisition - this group represented 10% of firms. The "profit maximisers through CRM" represented only 10 per cent of firms in their survey. This last category considered they have identified the appropriate balance in spend between acquisition and retention activities. 13 We are not suggesting that new customers are unimportant; indeed, they are essential for sustained success. However, a balance is needed between the marketing efforts directed towards existing and new customers. Also, customers vary in their attractiveness for retention. Some customers are likely to yield greater long-term profitability than others and marketing strategies should reflect this fact. A framework for customer retention improvement Given the dramatic impact that improved customer retention can have on business profitability and the fact that many organisations continue to place too much emphasis on customer acquisition at the expense of customer retention, there is a strong need for a structured approach which organisations can follow to enhance their retention and profitability levels. Three major steps are involved in such an approach: the measurement of customer retention; the identification of root causes of defection and key service issues; and the development of corrective action to improve retention. Step 1: Measurement of Customer Retention The measurement of retention rates for existing customers is the first step in improving customer loyalty and profitability. It involves two major tasks - measurement of customer retention rates and profitability analysis by segment. To measure customer retention, a number of dimensions need to be analysed in detail. These include the measurement of customer retention rates over time, by market segment, and in terms of the product/service offered. If customers buy from a number of suppliers, share of wallet should also be identified. The outcome of this first step should be a clear definition of customer retention, a measurement of present customer retention rates, and an understanding of the existing and future profit potential for each market segment. Step 2: Identification of Causes of Defection and Key Service Issues This step involves the identification of the underlying causes of customer defection. Traditional marketing research into customer satisfaction does not always provide accurate answers as to why customers abandon one supplier for another. All too often customer satisfaction questionnaires are poorly designed, superficial and fail to address the key issues - forcing respondents to tick pre-determined response choices. The root causes of customer defections should be clearly identified, for it is only by understanding them that the company can begin to implement a successful customer retention programme. Often this research task needs to be undertaken by very experienced market researchers. Step 3: Corrective Action to Improve Retention The final step in the process of enhancing customer retention involves taking remedial action. At this point, plans to improve retention become highly specific to the organisation concerned and any actions taken will be particular to the given context. Some key elements include: marshalling top management commitment; ensuring employee satisfaction and dedication to building long-term customer relationships; utilising best practice techniques to improve performance; and developing a plan to implement customer retention strategy. 14

Increasingly, organisations are recognising that enhanced customer satisfaction leads to better customer retention and profitability. Many organisations are now reviewing their customer service strategies to find ways to boost retention rates as a means of improving their business performance. This often entails a fundamental shift in business emphasis from customer acquisition to customer retention. Achieving the benefits of long-term customer relationships requires a firm commitment from senior management and all staff - to understanding and serving the needs of customers.

CUSTOMER SEGMENT LIFETIME VALUE ANALYSIS

The discussion above suggests that a balance is needed between the marketing efforts directed towards existing and new customers. This balance will vary greatly depending on whether the business is a startup such as a 'dotcom' or a mature 'bricks and mortar' company. However, in general, marketing expenditure is unbalanced with too much attention being directed at customer acquisition and too little at customer retention. To enable a decision on the relative amount of emphasis that needs to be placed on them, an understanding of both acquisition and retention economics at the segment level is critical. To calculate a customers real value a company must look at the projected profit over the life of the account. This represents the expected profit flow over a customers lifetime. The key metric used here is customer lifetime value (CLV), which is defined as the net present value of the future profit flow over a customers lifetime. It should not be assumed that companies will wish to retain all their customers. Some customers may cost too much money to service, or have such high acquisition costs in relation to their profitability, that they will never prove to be worthwhile and profitable. Clearly, it would be inadvisable to invest further in such customer segments. It is likely that within a given portfolio of customers, there may be some segments that are profitable, some that are at break-even point and some that are unprofitable. Thus, increasing customer retention does not always yield increases in customer profitability. In some instances, increasing the retention of such unprofitable customers will decrease profitability. It should be recognised, however, that unprofitable customers may be valuable in their contribution towards fixed costs and considerable caution needs to be placed in the allocation of fixed and variable costs to ensure that customers who make a contribution are not simple discarded. Modelling customer lifetime value Research has highlighted the need for managers to adopt a stronger focus on customer retention and measuring CLV. However, there is currently a lack of available analytical tools to help identify CLV for customer segments in a specific business. Some companies are now starting to build comprehensive frameworks and models that enable them to measure CLV at the segment level. We have developed one framework, the 'Retentiongram Model' 10 to undertake such modelling. This model, which derives its name from a unique graphical representation method, is used to visually depict the trade-off between acquisition and retention strategies in specific businesses. It enables the profit impact of changes in customer retention, customer acquisition and other variables to be measured at the aggregate, segment, micro-segment and individual customer levels. The model allows a trade-off to be made in the allocation of scarce organisational resources between strategies concerned with retaining existing customers and strategies concerned with attracting new customers for a specific organisation. Choices can also be made about the relative emphasis to be placed on strategies for different customer segments. Modelling future profit potential Such models are important in helping organisations determine customer value in terms of CLV. However, few organisations have reached the stage of understanding their existing acquisition economics and retention economics, let alone gone beyond it. Those that have can move on to modelling future profit potential for each market segment. Modelling of future profit potential takes into account that individual consumers may be persuaded to buy other products, or more of an existing product over time. Corporate customers, for 15 example, tend to buy from a range of suppliers. By enhancing its predictive modelling capability the supplier organisation may be able to increase 'share of wallet' as well as

market share, especially through more creative exploitation of alternative channel structures such as the internet. Building profit improvement In seeking to further increase profitability, companies need to develop integrated programmes that address customer acquisition, customer retention and other related activities that can improve customer lifetime value. One framework for reviewing such profit opportunities is the ACURA model shown in Figure 8. Figure 8: The ACURA framework ACURA Is an acronym for: acquisition, cross-sell, up-sell, retention and advocacy. Rarely do companies systematically build CRM strategies that focus on all elements within the ACURA framework. Whilst companies seek to improve customer acquisition and customer retention, they also need to exploit cross-selling and up-selling and advocacy opportunities. Companies such as McDonalds and American Express are excellent at cross-selling and up-selling; and Virgin and First Direct excel at creating advocacy within their customer bases.

CONCLUSION
Understanding and undertaking the value creation process is crucial in transforming the outputs of the strategy development process in CRM into programmes that both extract and deliver value. An insufficient focus on the value provided to key customers, as opposed to the income derived from them, can seriously diminish the impact of the offer in terms of its perceived value. Only a balanced value exchange will ensure that both parties enjoy a good return on investment, leading to a good (long-term and profitable) relationship.

Acqu ire Up- sell Advoc acy Cross-sell Retain

Professor Adrian Payne 2000

16 Achieving the ideal equilibrium between giving value to customers and getting value from customers is a critical component of CRM and requires competence in managing the perception and projection of value within the reality of acquisition and retention economics. To anticipate and satisfy the needs of current and potential customers, the supplier organisation must be able to target specific customers, and to demonstrate added value through differentiated propositions and service delivery. This means adopting an analytical approach to value creation, supported a dynamic, detailed knowledge of customers, competitors, opportunities, and the companys own performance capabilities. Increasingly sophisticated technologies provide essential aids in developing and deploying intelligence for competitive advantage. Many companies have achieved greater organisational efficiency and market place effectiveness through automating the business processes that deliver value to their customers (as well as suppliers and employees). However, such innovations do not negate the vital role fulfilled by employees. Indeed, excellent customer care remains the key determinant of winning and keeping customers. 17 REFERENCES The reader wishing to explore issues within this paper further may wish to consult some of the following. 1. For a more detailed description of this framework see: BT CRM White Paper "A Strategic Framework for CRM", 2001. (Published earlier on Insight Interactive) 2. Bower, M. and Garda, R. A., "The Role of Marketing in Management", McKinsey Quarterly, Autumn 1985, pp 34-46. 3. Bower, M. and Garda, R. A., "The Role of Marketing in Management", in Buell, V.P. (ed.), Handbook of Modern Marketing, 1998,1-3 to 1-10.

4. Lanning, M. and Michaels, E., A Business is a Value Delivery System, McKinsey Staff Paper, 1988. 5. Lanning, M. and Phillips, L., How Market-Focused Are You?", Marketing , October 1990, pp. 7 - 11. 6. Lanning, M. and Phillips, L., Building Market-Focused Organisations, Gemini Consulting White Paper, 1991. 7. Kambil, A., Ginsberg, A. and Bloch, M., "Re-inventing Value Propositions", NYU Centre for Research on Information Systems Working Paper IS - 96 - 21, New York University, 1996. 8. For example see: Aaker, D. A., Kumar, V. and Day, G. S., Marketing Research, sixth edition, John Wiley & Sons, New York, 1998. 9. Reichheld, F. F. and Sasser, W. E. Jr. "Zero Defections: Quality Comes to Services", Harvard Business Review, September-October, 1990, pp. 105-111. 10. For an example of the use of this model see: Payne, A F T and Frow, P, Treating Customers Appropriate to Value How Segmentation Can Boost Profitability, Customer, Vol. 4, 1999, pp. 4-7.

Tata motor

TCS Vision & Mission

...Purpose

To continually strive to achieve excellence - both on and off the job.

...Vision Statement

"TCS will be recognized and respected as professional, innovative, profitable information, and knowledge based logistics/services enterprise. TCS embeds internet based technologies into its internal operating structures and as business solutions for customers; with customer, employee and shareholder interests at the core of its operations; demonstrating a clear concern for ethical conduct and good corporate citizenship; with the objective of growing into a regional and global player, with emphasis on the Middle East, Europe and North America".

...Mission Statement

"To direct all our organizational efforts at building upon the existing organizational strengths and brand recognition to achieve enhanced levels of profitable growth in the core business, and diversify into new areas that compliment and supplement the core business, with the diversification aimed at achieving excellence and industry leader status in the new areas. The TCS People will however be encouraged to be open to unconventional ideas and services and recognize new trends at very early stages".

Commercial Vehicle Business Unit (CVBU) Our Vision To be a world class corporate constantly furthering the interest of all its stakeholders. Our Mission Shareholders: To consistently create shareholder value by generating returns in excess of Weighted Average Cost of Capital (WACC) during the upturn and at least equal to Weighted Average Cost of Capital (WACC) during the downturn of the business cycle. Customers: To strengthen the Tata brand and create lasting relationships with the customers by working closely with business partners to provide superior value for money over the life cycle.

Employees: To create a seamless organization that incubates and promotes innovation, excellence and the Tata core values. Vendor and Channel Partners: To foster a long-term relationship so as to introduce a broad range of innovative products and services, that would benefit our customers and other stakeholders. Community: To proactively participate in reshaping the countrys economic growth. To take a holistic approach towards environmental protection Passenger Car Business Unit (PCBU) Vision To develop TATA into a world class Indian car brand for innovative and superior value vehicles. World class in:-

Superior value in offering:-

Mission To,

Commercial Vehicle Business Unit (CVBU) Our Vision To be a world class corporate constantly furthering the interest of all its stakeholders. Our Mission Shareholders: To consistently create shareholder value by generating returns in excess of Weighted Average Cost of Capital (WACC) during the upturn and at least equal to Weighted Average Cost of Capital (WACC) during the downturn of the business cycle. Customers: To strengthen the Tata brand and create lasting relationships with the customers by working closely with business partners to provide superior value for money over the life cycle. Employees: To create a seamless organization that incubates and promotes innovation, excellence and the Tata core values. Vendor and Channel Partners: To foster a long-term relationship so as to introduce a broad range of innovative products and services, that would benefit our customers and other stakeholders. Community: To proactively participate in reshaping the countrys economic growth. To take a holistic approach towards environmental protection Passenger Car Business Unit (PCBU) Vision To develop TATA into a world class Indian car brand for innovative and superior value vehicles. World class in:-

Superior value in offering:-

Mission To,

Commercial Vehicle Business Unit (CVBU) Our Vision To be a world class corporate constantly furthering the interest of all its stakeholders. Our Mission Shareholders: To consistently create shareholder value by generating returns in excess of Weighted Average Cost of Capital (WACC) during the upturn and at least equal to Weighted Average Cost of Capital (WACC) during the downturn of the business cycle. Customers: To strengthen the Tata brand and create lasting relationships with the customers by working closely with business partners to provide superior value for money over the life cycle. Employees: To create a seamless organization that incubates and promotes innovation, excellence and the Tata core values. Vendor and Channel Partners: To foster a long-term relationship so as to introduce a broad range of innovative products and services, that would benefit our customers and other stakeholders. Community: To proactively participate in reshaping the countrys economic growth. To take a holistic approach towards environmental protection Passenger Car Business Unit (PCBU) Vision To develop TATA into a world class Indian car brand for innovative and superior value vehicles. World class in:-

Superior value in offering:-

Mission To,