The customer is an intangible asset long overlooked in valuing the worth of a business. The customer asset has qualities similar to inventory. The inventory line on the balance sheet represents the summation of the estimated values for raw material, work-in-progress material, and finished goods (unless they are broken out separately). The customer asset also takes on different values depending upon the state of the relationship between the company and the customer. By viewing the customer as an asset, managers can target new customers more accurately, gather customer intelligence more effectively, and manage the customer relationship much more profitably.
The way in which a company adds value to raw materials by transforming them to finished products is strikingly similar to the way in which the value of the customer asset can be enhanced by addressing the changing needs of customers at each stage of development. The analogy begins by considering the importance of choosing the right raw materials, and continues through the handling and eventual recycling or disposal of scrap materials.
|Developmental Stages of Raw Materials and Customer Assets|
|Characteristic||Real Inventory||Customer Inventory|
|Unused Material||Raw Material||Potential Customers|
|Material with Value Added||Work-in-progress||New Customers|
|Complete Product||Finished Goods||Loyal Customers|
|Diminished Value Product||Scrap||Low Margin/Vulnerable Customers|
View Potential Customers as Raw Materials
Raw material, in the realm of customer inventory, is the potential customer waiting to be attracted to the firm. Raw material, in terms of customers, is the pool of potential customers that the company can economically attempt to reach. Distribution channels act analogously to warehouses of raw material in that each contains a finite amount of customers or goods. Companies spend advertising, promotion, sales, and support dollars to maintain distribution channels for customers much the same as they spend expense dollars on space, heat, light, insurance, taxes, and labor to maintain warehouses for raw material.
Customer Service Can Add Value to the Customer Asset
A company adds value to raw material through the manufacturing process. Potential customers gain in value in a similar fashion as the company initiates sales. A customer who has made an initial purchase is no longer “raw material.” The customer’s revenue potential is converted through the selling process into a revenue-generating customer. The customer then is considered equivalent to “material with value added” since the cost and energy expended to attract the customer has returned revenue to the firm. A customer who has just purchased a copier from Xerox is an example of a potential customer (raw material) being transformed into one with value added (the company received the price of the copier). The salesperson has taken a potential customer as a raw material and added value in a manner similar to taking an empty circuit board and populating it with computer chips.
The next step is to increase the revenue from the customer. The current expression for this process is “share of pocket.” Customer value increases as a company obtains a greater share of the customer’s spending. Computer software companies have learned this lesson well. They make special offers of complementary products to the new owner of their software as soon as they receive the warranty registration card that indicates a product acquisition. Another technique used to increase the share of pocket is the software upgrade process. For example, owners of programs such as Microsoft Excel are usually sent notices of the opportunity to purchase upgrades for a discount as new versions are released.
The cost of selling to existing customers is significantly less than marketing to new customers and, since most companies have more than one product or service to sell, an initial sale often carries the potential for further revenues. Some firms have one sales staff to prospect and sell to new customers and a different staff to service and up-sell existing customers. This allows more specialization since those who are good at “cold calling” or opening up new accounts utilize different skills, and are motivated differently, than those who excel at maintaining existing accounts and relationships.
The disadvantage of maintaining two separate sales staffs is the challenge of communicating effectively and maintaining a collaborative environment that best serves customers. Customers may fall between the cracks, and relationships may suffer, when a disconnect exists between the two sales staffs. Using a single sales organization keeps the customer with a single individual who provides relationship continuity, but reduces the time available for that person to pursue new sales opportunities.
The process of increasing a firm’s share of a customer’s pocket adds value to the organization in the same manner that additional raw materials and labor applied during the manufacturing process increase the value of the product. Maximum share of pocket means acquiring a customer’s full purchasing potential. For example, a Xerox copier customer would be considered a full-service customer when he or she purchased their entire copying capability, paper, supplies and ancillary services from Xerox.
A Full-Service Customer is Like a Finished Product
A customer who reaches his or her full potential in terms of maximum possible revenue per period is equivalent to the finished product of the assembly line. Some companies hold up such customers for admiration. Full-service customers may appear in advertisements for the company by offering product endorsements or giving testimonials to prospective customers. Both the company and the customer usually benefit from customer-featured advertisements and promotions because of their substantial investment of time, energy, and revenue resources.
Unlike finished goods in a warehouse, the complete customer is not available for sale. The complete customer generally provides the greatest long-term revenue and profit margin to the company, and a company will fight hard to keep them unless it is being sold. But companies sometimes spend more money and energy saving a customer than the customer is really worth. Spending excessive amounts of money and energy to maintain low margin customers is equivalent to spending $5,000 to repair a twenty-year-old car with a replacement value of $500.
The Pareto argument, which says that 80% of the business comes from 20% of the customers, gives a simple measure of the value of full-service customers as well as an indication of the percentage of the customer base that represents complete customers. This means that most of an organization’s business (about 80%) is derived from a few customers whereas only a small portion of the business (about 20%) comes from the majority of the customers. That is why some customers may be unprofitable to keep because the time, effort, and expense required to sell or service them may outweigh their value or profit to the organization. The inventory of full-service customers should be nurtured in order keep them fully satisfied with the goods and services that continue to meet their needs.
The three components of inventory (raw material, work-in-progress, and finished goods) represent cash not available for use. They should be minimized as much as possible to promote cash liquidity. On the other hand, the customer asset represents cash potentially available for use and should be maximized as much as possible.
When Customer Assets Get Old and Tired…
The fourth type of inventory is scrap. Since this term better describes things than people, we’ll suggest viewing some customers as low margin customers. Low margin customers are those who are no longer economically or strategically viable for the company to acquire or retain.
When a product or service reaches the stage where it is no longer economically feasible to sell and support, the product is generally scrapped. However, many companies have no clear-cut guidelines or policies for eliminating products with diminished value from their product line offerings. In fact, they may not have a measurement system in place that will identify products with diminished value. Products may be technologically out-of-date, no longer appeal to customers, or be functionally integrated into other products. Services may no longer meet the changing needs or desires of customers.
When companies identify products with diminished value, the solution is either to redesign the product or service for increased value or eliminate the product or service from the offerings of the company. For instance, a company may have a direct sales force as well as a wholesale distribution channel. When conflicts arise because the direct sales force and the distributor are selling to the same customers, one option the company may choose is to eliminate one of its sales channels along with the customers associated with that channel. Essentially, the company decides that the customers in the distribution channel that was eliminated no longer fit the characteristics of customers the company wants.
Scrapping can also occur for raw material (too old, out-of-date, material characteristics changed, etc.). In these cases, the cost to restore the raw material to a useful condition is not economically feasible. The material may also have a shelf life which, when exceeded, would cause the raw material to change. This can also occur with customers when, for example, it is discovered that the cost to acquire the customer is prohibitive. A distribution channel may be discontinued when it is found that the type of customer attracted by the channel is not consistent with the type of customer envisioned by corporate strategy. Another reason that a new customer may have diminished value is that the cost to acquire and maintain the customer is too high when compared to the value of the customer asset. For example, Egghead Software closed its retail outlet stores when it changed its strategy to sell online over the Internet. A reasonable guess for this change is that the cost of the retail stores was too high compared to the value of the retail store customer. There are a number of other reasons that would also lead a company to “scrap” certain groups of new customers, not the least of which is distribution channel conflict.
There are potential customers who may also have characteristics that no longer meet the requirements (or new strategy) of a company and hence should no longer be sought. As firms change products, services, or strategy, there are customer groups that no longer fit the characteristics of a target customer. In this case, an optimal customer is one whose needs are being adequately met and who is providing adequate profit margin on products and services provided. As companies change strategies, distribution channels may be modified or eliminated such as when Pepperidge Farm dropped its toll-free catalog order line in order to concentrate on retail business.
AST Computer stopped making internal parts for computers and switched to manufacturing whole computers. They relinquished the internal parts market because they changed their business strategy from being a parts-supplier to being a computer manufacturer. The decision to change may result from a change in internal strategy or because of an inability to compete in a market with sufficient profit margin to justify the use of the company’s resources.
Increasing Profits and Cutting Costs
Firms can identify new ways to effectively service customers by recognizing that each customer is at a distinct stage of development. Managers can thus target prospective customer assets more accurately and initiate pre-customer service, and savings may be realized by committing fewer resources to low margin customers. By changing the way the customer is perceived and measured, the business leader will see a variety of ways to manage the customer asset for a greater return.