That Elusive Customer Loyalty: How to Build It, Learn From It and Profit From It (page 1 of 4)

Banks have traditionally treated retail customers identically: "Deposit your money and you get a check book." Yet when banks began to collect data that allowed them to compute profitability for each customer, there were marked differences. Some kept a lot of money in their checking accounts and rarely accessed it, or if they did, withdrew the cash through ATMs. These customers were very profitable. Others kept low balances and made frequent withdrawals, often through contact with tellers. Such customers ended up costing the bank more, and were not profitable. Identifying profitability helped banks devise strategies to suit different types of customers.

Customer Portfolio Management
The analysis banks used to track profitability was customer portfolio management. It is a technique that has proved useful for many businesses, those dealing with both consumer and business markets. To determine which customers were most valuable, banks had to allocate revenues and costs at the customer level. Although revenues had traditionally been allocated at the customer level (banks always knew who had the most money in their accounts), it was not typical to treat costs in this way. In banks, as in most companies, costs were handled at the product or operations level.

By allocating costs to each customer, banks were able to find out which customers were most profitable. It then became easier to devote resources and time to the most profitable customers. While revenues were known to follow an 80/20 law, so that 80% of revenues were generated by 20% of customers, costs can follow a 90/10 law, so 90% of costs are generated by 10% of "whiny" customers. If you reduce the costs of serving customers whose business does not warrant additional attention, and spend more time serving customers whose business does, the overall customer portfolio can become more profitable.

The trick is to figure out how to allocate costs to each customer. Costs can vary by units (such as inventory, physical handling, cost of goods sold). They can vary at the transaction level (order processing, shipping, order frequency costs); or at the relationship level (maintaining an account, contact time, service costs). There are also selling and maintenance costs (promotional mailings, free samples) and enterprise level costs (warehousing). These costs need to be assigned as appropriate to each customer. When costs are broken down and compared with revenues from each customer, profitability can be computed.
This profitability determines the asset value of the customer relationship, or the customer equity. One way to think about customer equity is to create a grid with revenues (high/low) on the vertical axis and customer costs (low/medium/high) on the horizontal. Customers can be designated to one of the boxes on the grid and profitability assessed.

When customers are designated in a portfolio system, management goals become clear. With unprofitable customers, managers need to do three things. First, reduce the costs of dealing with them, for example by encouraging electronic banking. Second, increase the revenues generated, perhaps through fees for services or price increases. Finally, consider ending the relationship, although this is frequently an undesirable or unethical solution.

The problem with profitable customers is retaining them, because they will attract the attention of your competitors.