Generally, customer value is defined as the value that is created by customer rela-tionships from a service provider’s perspective.2 There are very different approaches to define customer value more specifically. For example, a very simple definition understands customer value as the current revenues generated by a
customer. However, this definition neglects the cost a customer relationship gen-erates. In many industries, the cost to service a customer may vary considerably.
For example, the cost for an online banking transaction is only one-tenth of the cost of personal contact between customer and contact personnel. Furthermore, future potentials are neglected in this definition. Depending on the use of the cus-tomer value results (e.g. investment in the cuscus-tomer, retention of the cuscus-tomer), it is more important to know future potentials than current revenues. These simple examples show that there is a variety of different customer value components that can be subsumed into four generic types of customer value components.
These differ according to the customer value component applied and to the underlying time perspective (see Figure 2.6):
• Profitability concerns the value component from a past-oriented time perspec-tive. This figure states the value of a customer in terms of current revenues or contributions.
• Potential also concerns the value component, but from a future-oriented per-spective, where the future profitability of a customer is taken into account.
• Lifetime means the current lifetime of a relationship, defined as the time period between the relationship’s starting point and the current point in time.
• Loyalty represents a future-oriented interpretation of the relationship lifetime and is measured, for example, by the probability that the customer will stay or the estimated future lifetime of the relationship in question.
At first sight, it seems obvious that customer value should be defined in terms of future-orientation. When planning the investment potential of the customer base,
Profitability (Revenue or contribution)
Potential (Revenue or contribution)
Lifetime Loyalty
Value component
Time component
Past value Potential value
Component
Time perspective
FIGURE 2.6 Generic customer value components
a customer’s future potential is more relevant than their past profitability.
However, consider the following statement of an airline manager:
We planned valuing our customers solely according to their potential. But, imagine this situation: at the check-in, there is the 63-year-old president of a huge company as well as his 32-year-old assistant. Purely because of their ages, our employee could estimate without any computer system which of the two has greater future potential for us . . . the assistant. But imagine what would happen if we were to upgrade the assistant to business class as a relationship measure and wouldn’t do so with his boss because of his lack of potential.
This example illustrates that there is no ideal definition of customer value. The choice of customer value definition depends on various factors, among others on the prerequisites for customer value analyses in the firm, based on existing data and the purpose of the analyses applied (e.g. cross-selling versus retention). The fol-lowing pairs of customer value orientations represent extreme forms of how customer value definitions can differ.
Time versus value orientation. A holistic definition of customer value encompasses both components of the customer value construct: time and value. However, in most cases companies only follow a value orientation for the valuation of their customers, where profitability and even future potential are analysed statically, which leads to the fact that the dynamics of customer relationships are neglected.
In companies where a time perspective is applied, both orientations are often treated in a segregated manner. For example, customer loyalty analyses are undertaken within market research studies, while customer profitability is exam-ined by the control or datamining departments. Occasionally a combexam-ined approach relating to customer lifetime value is applied.
Past versus future orientation. Past-oriented customer values are determined using data from the past, such as last year’s revenues, that are often easier to determine than future-oriented data. Future-oriented data are, however, more useful for most investment decisions. When deciding whether a firm should invest in a cus-tomer relationship, the future potential is a more valid scale for orientation than past value. However, future value is always an estimation, and associated with a certain amount of measurement error. Furthermore, in many industries, if the revenue with a certain customer is relatively stable over a certain time period, then past value is an important indicator of future value.
Revenue versus contribution orientation. For many companies, attributing revenues to individual customers is already a major challenge. However, attributing cost to individual customers seems to be unrealistic for many industries. While product cost can be attributed to an individual customer in many industries, like credit cost, cost of products sold by a mail order business, other costs, like the cost of serving the customer or marketing cost, are difficult, if not impossible to allocate
to a single customer relationship. For example, it is difficult to allocate the expen-ditures for an advertising campaign to a single customer. However, companies try to integrate cost as comprehensively as possible in their value calculations for a good reason: studies show that cost can differ a lot. Consequently, analysing only customer revenues produces misleading results. However, of course, there are also decisions that can be taken sensibly based only on revenue figures. For example, for a given response probability the revenue potential of a customer without taking into account the associated cost is a good indicator of the value of cross-selling activities.
The most important methods for a financial valuation of the customer relation-ship are customer profitability analysis and customer lifetime valuation which will be explained below.