Evaluating customer profitability key

Customer retention programs are often viewed as the magical means by which customer and portfolio profitability is obtained.Rather, research indicates that a focus on customer retention should be designed as part of a larger, on-going customer management program.Such marketing activities should...

Customer retention programs are often viewed as the magical means by which customer and portfolio profitability is obtained.

Rather, research indicates that a focus on customer retention should be designed as part of a larger, on-going customer management program.

Such marketing activities should focus on profitable customers and those who are considered to have a reasonable chance of becoming profitable.

Indeed, any customer retention program that assumes all customers are equal, or worse, that all customers are equally profitable, is likely to perpetuate the myth that increasing retention rates automatically boost profits.

Research suggests that a link has to be developed between retention programs and customer profitability.

Each stage

Accordingly, within each stage of a customer’s relationship with a firm, an assessment of his or her profitability is the key to an effective and efficient customer management program.

It is important to have a clear understanding of who the profitable customers are, and to establish a rigorous system to track and target the best clients in order to establish an effective retention program.

The common argument for adopting a retention program is based on the observation that portfolio profitability improves as the tenure of the customer base increases, hence, if retention rates are boosted, increased profits will follow.

The previous argument ignores one critical fact: improving portfolio profitability is more often a function of low balance, low purchase level or inactive customers leaving at a higher rate than those remaining in the base.

As a result, portfolio profitability increases over time because of the increasing proportion of more profitable customers.

Profitability is not achieved by increasing the average tenure of the entire file. This difference in interpretation is critical when determining the economics of a retention campaign.

Otherwise, employing the first type of reasoning results in a retention program targetted to the entire base, which will lower overall profitability.

Similar reasoning is employed by some who argue that selling more services or products to a customer will increase retention and profits.

However, selling additional products or services to an unprofitable customer is a losing proposition. Research indicates that if an individual customer is already unprofitable, any additional services sold to that account are unlikely to boost profits or reduce attrition risk.

A more efficient retention plan is based on a net present value (npv) assessment of individual customer profitability, combined with the probability the customer will leave.


The end result is an assessment of the ‘profit dollars at risk’ and the ability to set out according to priority your marketing efforts and resources. Numerous software packages, database programs and consultants are available to develop predictive attrition models and npv.

The key to developing a successful attrition model is the collection of data on customers that accurately reflect the behavior you are trying to predict.

For example, in a credit card portfolio with an annual fee, one could isolate a sample of customers two to three months in advance of their renewal date. After the fee is charged, cancellations would be identified within the sample.

The attrition model is then built to accurately predict attrition, but with a key benefit: the risk of attrition is forecast two to three months in advance, allowing time to implement a communications strategy which reinforces the product’s value and reduces the risk of attrition.

Entire portfolio

Ultimately the model is used to score the entire portfolio, and the probability of attrition and an individual customer’s npv are calculated.

If you multiply the attrition probability for that customer by his or her npv, the ‘profit dollars at risk’ can be determined.

A communication strategy is implemented for those customers who have high ‘profit dollars at risk,’ thereby maximizing marketing efforts and achieving the biggest return on marketing investment.

When used in tandem, an attrition model and a profitability assessment can become a powerful retention tool to segment and target your customer base in order to retain the most profitable accounts.

Over time, this process can be refined so that retention communications are sent via an in-statement or direct mail program driven by the ‘profit dollars at risk’ assessment.

Most appropriate piece

With on-going testing, your firm can even determine the most appropriate communications piece for each individual customer.

It can be argued that the proposed strategy ignores the potential of low-profit clients within the customer base.

In fact, if the retention program is a part of an overall customer management strategy, your low-profit customers should become high-profit customers over time.

A key characteristic of such a program is the on-going profitability assessment for all customers, and a segmentation analysis that incorporates spending estimates for all low-profit customers.

The challenge is then to move these low-profit customers up the profitability curve. Spending potential models are the easiest way to identify these customers.

The behavioral differences between existing high-profit customers and potential high-profit customers can become the basis of your on-going communications strategy. This strategy is focussed on encouraging greater spending or activity within the potential high-profit group.

Customer management programs (of which retention programs are a part) should be designed to increase the average tenure of the most profitable customers.


A customer management program and retention campaign should only promote cross-selling of additional products and services if they are profitable on a stand-alone basis and will contribute to a strengthened and profitable customer relationship.

Going one step further, marketing and sales efforts should be designed to acquire the higher profit customers from the outset. A net present value approach is an invaluable marketing tool for deciding which customers to acquire.

Dedication by your company to an overall customer management program will ensure that all customers are not treated the same when they come through the door, and that your customer management and retention programs increase the profitability of your customer base.

Richard B. Peake is project manager, visa segmentation, with the Canadian Imperial Bank of Commerce in Toronto.