PROFITABILITY CONSIDERATIONS IN CUSTOMER RELATIONSHIP MANAGEMENT
by Inderpal Bhandari, executive editor at large

We all know that the customer is always right. But how do we know if we have the right customer? That, in a nutshell, is what customer relationship management is all about.

CRM is the latest twist in the evolution of database marketing techniques. The emergence of large on-line databases led to the targeting of customers -- specific products were pitched to the specific customers most likely to purchase those products. Such targeting -- while quite effective as a mechanism to increase sales -- did not necessarily translate to profit as explained below.

I remember a conversation I had with the manager of the database marketing department of a large catalog retailer. He described a program that they had implemented to acquire new customers. After identifying the prospects likely to buy a class of products in a database of demographic information, they would mail the corresponding catalogs to those people along with an offer of a reward for first-time buyers.

The promotion was hugely successful. Throngs of new orders came in and the purchasers were duly rewarded. However, the new orders did not translate to profits. The retailer had a return policy that allowed a customer a full refund if they returned an item within 30 days. Savvy customers were taking advantage of this policy to claim the reward.

By putting the focus on profitability, customer relationship management attempts to avoid situations such as above. The right customer is the one who makes a profit for the company. Initial efforts in CRM had one simple goal in mind -- to identify who the profitable customers were. While simple in concept, this can actually be quite a challenging exercise in practice. Consider the situation in a large bank that offers many different types of loans to its customers. The costs associated with administering these loans could vary greatly.

Therefore, to compute profitability, it is no longer enough to track the activity of the customer. It is also essential to know the detailed costs of every activity to the bank.

Recent efforts in CRM are quite sophisticated. Customers are segmented into three classes, popularly referred to as the good, the bad and the ugly. The good customer is one who is profitable. The bad customer is one who could be profitable. The ugly customer is one who is not and will not be profitable. The spending of marketing dollars can now be optimized, specifically, to acquire and retain good customers, to convert bad customers to good customers, and to select out ugly customers. Even more sophisticated are CRM efforts that project the profitability of customers, thereby identifying the good, bad and the ugly customers of the future.

In summary, CRM is based on customer profitability and its underlying philosophy: Ask not what you can do for the customer, ask what the customer has done for you.

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Inderpal Bhandari can be reached via http://www.virtualgold.com