cgma - customer value tool

7/27/2019 CGMA - Customer Value Tool

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CGMA TOOLS

Ho to maagcstom al


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1

COnTenTS

Itoctio a oi 2

Maag cstom sgmtatio 3

Mas cstom magis 4

Mas cstom liftim al 5

Mas cstom impact 6

Maag cstom pofitability 7

Cstom pofitability: A comphsi xampl 8

Two o the worlds most prestigious accounting bodies, AICPA

and CIMA, have ormed a joint venture to establish the CharteredGlobal Management Accountant (CGMA) designation to elevate theproession o management accounting. The designation recognisesthe most talented and committed management accountants with thediscipline and skill to drive strong business perormance.


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CGMA TOOLS How to manage customer value

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InTrOduCTIOn And OvervIew

The ocus on customer relationship management has become central

to all organisations. Companies have increasingly recognised thesigniicant costs related to the loss o customers and are trying to betterunderstand, measure, manage and improve customer retention. Further,these organisations are examining how to measure and improvelong-term customer lietime value.

This tool provides a systematic approach or addressing customer valueissues that include: customer segmentation, measuring proitability,estimating customer lietime value, identiying additional sources ocustomer value and managing to enhance customer proitability. Thistool also demonstrates how organisations can create more value or

and derive increased value rom customers.

Fig 1: Th cstom al maagmt cycl

1: Manage customersegmentation

5: Manage customerprotability

2: Measure customermargins

4: Measure customerimpact

3: Measure customerlietime value


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Segments are oten determined on the basis o customer

similarities, such as personal characteristics, preerences or

behaviours:

Demographic segmentation segments customers

based on thei r observable characteristics, or example,customer demographics like age, geographic area or

income level. However, or many products and services,

demographic characteristics are not ully representative

o buying behaviour and have not been useul in

predicting customer behaviour.

Psychographic segmentation builds upon demographic

segmentation by including criteria that urther categorise

a particular group o customers. Segmentation based

on psychographic and liestyle characteristics includes

criteria such as attitudes and interests, values and social

roles. The psychographics approach assumes that a

customers choices and behaviour are related to the

customers habits and routines.

Behavioural segmentation based on buying behaviour

represents the most eective o the current segmentation

approaches used today. Customer relationship

management sotware available today enables

companies to harness this valuable data.

Analytic segmentation integrates criteria such as cost

into the value ca lculation o a companys customersegments. Analytic segmentation provides the rm with

an even more accurate picture o customer protability

and buying behaviour. This, along with psychographic

and demographic characteristics, allows companies to

more eectively target their most protable customers.

Customer segmentation reers to the process o dividing customers into

groups or decision-making purposes. Segmentation allows the companyto provide dierential advertising or value propositions to dierentcustomer groups. The appropriate level o segmentation varies accordingto (a) the purposes or which segmentation structures will be used and(b) cost and proitability variations between customers within segments.

MAnAGe CuSTOMer SeGMenTATIOn

Box 1: Aalytic sgmtatioxamplsBOC, a UK-based supplier o industrial and

medical gases, now part o Linde Group,utilises an analytic approach to segmentation.

The companys strategy includes identiying

the distinct requirements o its customers, such

as value placed on service and/or the desire

to obtain the lowest price. Ater identiying its

customers requirements, BOC is able to adapt

its business model to maximise the operating

perormance rom serving the requirements,

reducing cost and increasing customer value

rom the customers perspective.1

This is also true or the planning strategies

o the American industrial gas market. Air

Products & Chemicals seeks out customers who

need high levels o technical assistance or

their applications (eg, liquid nitrogen reezing

o hamburgers or oxygen enhancement o

blast urnaces) or which they can charge

a high premium price. They spend ew

resources competing in the area o low-margin

commodities such as argon and oxygen used

or welding.


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Many companies have used activity-based costing, or

ABC, to assign non-product costs. Activity-based customer

costing recognises that costs required to serve customers

extend beyond direct costs, and provides a method or

identiying and assigning indirect costs to the specic

segments or customers responsible or them. Activity-basedproduct costing can also be used to better estimate product

costs as well.

Today much available sotware a llows automatic

assignment o product costs, and in most companies,

inormation about the relative margins o customers

and segments is widely available. As might be expected,

the costs dr iven by a customer or segment extend ar

beyond the costs o the products they purchase. Service

and support requirements can vary signicantly among

customer groups. See box 2 or examples o cost categories.

Box 2: Assigig o-poct costsOne way to identiy cost categories and the

costs they might include ollows:

Order-level costs are costs associated

with order placement and processing. These

costs include order entry, picking inventory,

delivery and billing costs.

Customer-level costs are costs associated

with individual customers or segments. They

include costs such as acquisition costs,

advertising and promotions, selling, sales

returns, responding to enquiries, relationship

management and managing receivables.

Channel-level costs are associated withdistribution channels. They include xed

locations, delivery equipment, inormation

technology and marketing costs.

Market-level costs benet all channels.

These costs include general research and

development, branding and other general

marketing, market research and other

marketing unctions.

Enterprise-level costs are high-level

organisation costs. They includeadministrative costs such as administrative

salaries, acilities and nancing costs.

Measure CustoMer Margins

Although almost all companies have careully designed processes

or assessing the proitability o their products, most are ar behindin assessing the proitability o their customers. Assigning non-productcosts allows measurement o customer proitability through systematicallymeasuring customer-related costs and assigning them to the responsiblecustomers.


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Customer retention and customer loyalty are important

concepts or companies seeking to eectively measure and

manage lietime value. The retention rate, as included

in the CLV calculation, reers to the probability that a

customer will continue doing business with the company

in uture relevant periods. Customer loyalty reers toa customers level o satisaction with the company or

brand, as well as that customers intention to make uture

purchases. Understanding the loyalty o customers in a

segment is important or CLV calcu lations. The prot

component o CLV is based on estimates o how much

customers will purchase in the uture, and how much it

will cost to serve and retain these customers.

Companies begin incurring costs when they spend money

to acquire customers. As the customer makes purchases,

the acquisition costs are recovered, and the company earns

increasing prots rom customer sales margins as salesrecur over time. Additional costs to serve the customer over

time include ongoing promotional and service costs and

retention costs, which include the costs o maintaining the

customer relationship over time. In addition to recurring

margins rom repeat sales, companies can gain additional

prots through selling upgraded or new types o products

and services to existing customers.

Together, all o the costs associated with serving the

customer over time are netted against the total margins the

company expects to gain through sales to that customer. The

result is the CLV. It represents the present value to the rmo a customers lietime stream o prots. The CLV model

thus views the customer as an asset that generates revenues

throughout the lie o the relationship, and also draws

resources as it is acquired, maintained and, possibly, retired.

Box 3: Cstom liftimal fomlaThe ormula or calculating CLV is as ollows:

CLV = (prot t1 x retention rate t1 x discountactort1) + (p t2 x rt2 x d t2) + + (p tn x rtn x d tn)

CLVis the sum o prots earned in time

periods 1 through to n, where n represents

the last period the company deems relevant

or protability analysis. Expected customer

prots in each period are adjusted to refect

the expected customer retention rate during

the period and discounted to the present time

period, t0.

Proft (p) is the prot earned during the timeperiod. Prots include gross prot, and take

into account lietime costs and revenues such

as acquisition costs and growth in margins

over time.

Retention rate (r) is the rate at which customers

in the segment maintain their relationship with

the company and continue uture purchases.

This could also include the net dierence

between new customer acquisitions and

customer exits within the segment.

Discount actor (d) is the multiplier used to

discount uture prots to their present value.

The discount actor is based on the companys

hurdle rate (oten the a ter-tax cost o capital).

Customer lietime value (CLV) introduces a new dimension to understanding

the value a customer provides to the company. The lietime value o thecustomer relects the present value o all uture lows associated with thecustomer. Although the speciic ormulations vary, CLV calculations all sharethree essential components: proits, retention rate and discount rate. Box 3details the speciic components o the CLV ormula.

MeASure CuSTOMer LIFeTIMe vALue


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Measure CustoMer iMPaCt

The inal component o value provided by the customer is customer

impact. O course, proits resulting rom current or uture sales tocustomers are the most signiicant source o value or most customersegments. But value can be created (or destroyed) by customers inmany other ways that all outside the reach o CLV and other methodso assessing customer value.

The power o customers is greater than ever and continues

to increase due to a var iety o actors. In addition to their

own value-generating behaviours, customers have the

capacity to aect corporate protability by infuencing the

perceptions and behaviours o others.

The most widely recognised source o customer infuence

comes in the orm o product reerrals. Customers who are

satised with a product might encourage other customers

to try the product, or when dissatised, they may dissuade

customers rom buying it.

Another important source o infuence is wielded by

customers who possess h igh levels o power or prestige.

These customers may infuence others by serving as

expert users, legitimising the products use or other

customers. Some customers infuence others by serving

as a role model. High-prole customers such as celebrity,

sports or political gures can serve this unction, as can

infuentials opinion leaders who infuence the thoughts

and actions o others.

Customers also contribute value by providing useul

inormation to the company and its stakeholders.

Customers who post product reviews provide value to

potential customers. Other customers may actively share

their technical knowledge and expertise, providing tips

or eective use o the product and solving problems or

other customers. Leading companies are crowd-sourcing

inormation rom their customers in order to improve their

products and services.


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Customer prot margins in each period during the

customer relationship make up the largest share o

customer lietime value or many segments. Thus,

improving prot margins on individual transactions is a

logical starting point or companies.

In addition to normal revenues and costs, companies

can increase the lietime value o customers by

(a) improving customer retention, (b) reducing

the costs o acquiring and maintaining customer

relationships and (c) improving customer protability

through expanded purchasing.

Box 4: Statgis fo maagig cstom pofitability

Managing customer proft margins Managing customer lietime value Managing customer impact

Re-price products and services Improve retention and acquisitionrates

Increase reerrals

Reduce customer costs (reduce cost perservice and reduce services available)

Upgrade customer prots (share owallet, up-selling and cross-selling)

Pursue infuential customers

Manage cost drivers (policy changesand charge or services)

Reduce liecycle costs (acquisition,ongoing promotions)

Enhance data capture (captureevery interaction)

Measuring, improving andmanaging customer satisaction Increase customer participation(communities, direct requests,employees)

Use data eectively(experimentation, innovationand customisation)

Companies can also take measures to enhance customer

impact by (a) increasing customer reerrals,

(b) cultivating highly infuential customers and

(c) capturing and using customer knowledge.

To translate these strategies into action, companies must

use the inormation provided by protability analyses

to inorm decisions and develop metrics that can be

incorporated into incentive programmes.

By developing a more complete picture o the value o a customer or

segment, a company can improve overall proitability by improvingproit margins, increasing the lietime value o customers and enhancingcustomer impact. Box 4 outlines strategies or managing customerproitability. In summary:

MAnAGe CuSTOMer PrOFITABILITY


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CustoMer Profitability: a CoMPrehensive exaMPle

Tabl 1: r a xpss by cstom sgmt (i millios)

In-house support

$60.0

5.0

65.0

24.0

41.0

32.5

$8.5

13%

No in-house support

$70.0

30.0

100.0

40.0

60.0

50.0

$10.0

10%

New to sotware

$20.0

15.0

35.0

13.0

22.0

17.5

$4.5

13%

Total

$150.0

50.0

200.0

77.0

123.0

100.0

$23.0

12%

Sotware

Consulting

Total revenue

Cost o goods sold

Gross margin

Operating expenses

Operating income

Percent o revenue

In this section, we provide an illustration o how measuring customer

proitability can pay o. We apply the customer value managementcycle to a ictitious company that will be called Sagu Systems.A brie description o Sagu Systems is as ollows:

Sagu works through the customer value management

cycle in the step-by-step ashion shown in gure 1 on

page 2 o this tool.

Stp 1: Maag cstom sgmtatio

Sagu begins with an analysis o current customers and their

purchasing patterns. The analysis results in three customer

segments:

1. In-house support: customers with in-house IT sta

capable o supporting the sotware

2. No in-house support: customers lacking in-house IT stacapable o supporting the sotware

3. New to sotware: customers that are rst-time users operormance-monitoring sotware and lack in-house IT

sta capable o supporting the sotware

Basic nancial inormation or the three segments is shown

in table 1.

Sagu is a sotware company located in

Dublin. Its primary product, SaguNetwork, is

perormance monitoring sotware or corporate

networks. Sagu currently sells SaguNetwork

and related consulting services to clients. The

market or perormance management sotware

is expanding rapidly, and Sagu is pursuing

an aggressive growth strategy. In an eort to

maintain protability through the growth period,

the board o directors has mandated that Sagu

analyze the protability o its customers.


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In-house support

$60.0

5.0

65.024.0

41.0

28.5

$13

20%

No in-house support

$80.0

20.0

100.040.0

60.0

53.7

$6.3

6%

New to sotware

$20.0

15.0

35.013.0

22.0

18.3

$3.7

10%

Total

$160.0

40.0

200.077.0

123.0

100.0

$23.0

12%

Sotware

Consulting

Total revenueCost o goods sold

Gross margin

Operating expenses

Operating income

Percent o revenue

In the next steps 2, 3, and 4, Sagu will calculate the

current and expected uture value contributions or each

segment. In step 5, Sagu will use the results o this analysis

to make changes in the management o customer value

in each segment. Finally, Sagu will return to step 1 and

begin the cycle again re-segmenting customers based on

protability-related behaviours.

Stp 2: Mas cstom magis

Sagu has historically allocated operating expenses based on

total revenue o the segment. However, Sagu rea lises that

operating costs vary across segments as a result o dierent

customer behaviours within the segments. In particular,sales commission costs are associated with sotware and

consulting sales, and technical support costs are associated

with the number o maintenance requests submitted by a

customer. Sagu separates these costs rom other operating

expenses and assigns them to segments based on the actual

commissions awarded and technical requests made by each

segment. Results are shown in table 2.

When segment prots are re-calculated using the new

operating expense numbers, the results are shown in table 3.

With the reallocation o operating expenses, the companys

$23 million prot has shited, increasing the protability

o the in-house support segment, and decreasing the

protability o the other two segments.

Tabl 2: Opatig xpss allocat by cstom bhaio (i millios)

In-house support

$4.0

8.0

16.0

$28.0

Operating expenses

Sales commissions

Technical support

Other administrative

Total

No in-house support

$14.0

21.0

18.7

$53.7

New to sotware

$2.0

11.0

5.3

$18.3

Total

$20.0

40.0

40.0

$100.0

Tabl 3: ris a xpss by cstom sgmt (i millios)


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Stp 3: Mas cstom liftimal

Armed with inormation about current protability, Sagu

can begin to assess the long-term value o each customer

segment. To do this, Sagu will estimate growth in prots

or each segment and change in size o each segment as

Sagu loses old customers and adds new ones over time.

Table 4 shows the CLV calculat ions or each customer

segment during the coming six years. CLV shows the

value o a segments customers to Sagu today, based on the

discounted value o anticipated uture prots. To calculate

CLV, Sagu estimates:

1. Operating income or each segment based on anestimated growth rate applied to current period

operating income

2. A retention rate based on the expected dierencebetween customers gained and lost each period

3. A discount actor, which is the net present value

(NPV) o $1 in a uture time period at 10% interest

Here, to simpliy the example, income growth and retention

rates are held constant or the coming six year period. Sagus

CLV analysis provides a new perspective on the relative

value o the three customer segments. The in-house support

segment is expected to grow at a 10% rate, as a result o

additions in sotware users to existing sotware packages. In

addition, the number o clients in this category is expected

to grow each year, as the number o new clients entering

the segment exceeds the number that exit. Discounting each

years anticipated prots back to the present using a 10% rate

results in an expected lietime va lue or the segment o $73.1

million. The segment is currently the largest, in terms oprotability, and expected to remain that way or the coming

six years.

The CLV analysis, however, tells a di erent story about the

relative value o the no in-house support and new to sotware

segments. Using current period prots alone, these segments

showed incomes o $6.3 million and $3.7 mil lion respectively.

Analysing protability over time, however, shows marked

dierences in the ability o the two segments to generate

value or the rm. The no in-house support segment shows

a modest growth rate, at 5% and a loss o market size, due

to a low customer retention rate. The new to sotware segmentshows rapid growth both among clients who have adopted

perormance management sotware or the rst time, and in the

number o net clients entering the segment. Thus, this segment

is expected to achieve rapid growth in prots over time.


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Tabl 4: Cstom liftim al (i millios)

1

$13.7

110%

.91

$13.7

1

$6.7

90%

.91

$5.4

1

$4.4

130%

.91

$5.2

2

$14.3

110%

.83

$13.0

2

$7.0

90%

.83

$5.2

2

$5.3

130%

.83

$5.7

3

$15.0

110%

.75

$12.4

3

$7.3

90%

.75

$5.0

3

$6.3

130%

.75

$6.2

4

$15.8

110%

.68

$11.9

4

$7.7

90%

.68

$4.7

4

$7.6

130%

.68

$6.8

In-house support

No in-house support

New to sotware

5

$16.6

110%

.62

$11.3

5

$8.1

90%

.62

$4.5

5

$9.1

130%

.62

$7.4

6

$17.4

110%

.56

$10.8

6

$8.5

90%

.56

$4.3

6

$10.9

130%

.56

$8.0

Operating income(5% growth)

Retention rate

Discount actor (10%)

Current value olietime prots

Total CLV


Retention rate



Total CLV

Operating income

(20% growth)Retention rate



Total CLV

$73.1

$29.2

$39.2


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Stp 4: Mas cstom impact

To supplement the CLV analysis, Sagu est imates the

potential impact o each customer segment. Through

this analysis, shown in table 5, Sagu realises that a

small number o its large clients in the in-house support

segment generate hal the revenue o this segment, and

virtually all o the customer impact. These loyal clients

are very well-known and highly respected in the sotware

industry, and Sagu estimates that they are responsible or

a signicant portion o the client growth that contributes

to avourable retention ratesboth through reputation

and through reerrals. In addition, these customers are

very knowledgeable, and are used as test ing sites or new

sotware enhancements and sounding boards or the

technical planning personnel.

The benets rom these high-impact in-house customers

reerring other customers and testing and improvements

prior to release are estimated to be nearly $7 million as

shown in table 5.

Tabl 5: Cstom impact fo i-hos cstoms (i millios)

1

$6.5

110%

.91$6.5

1

$1.0

0.8

.91

$1.6

2

$7.2

110%

.83$6.5

2

$0.7

1.2

.83

$1.6

3

$7.9

110%

.75$6.5

3

$0.6

0.9

.75

$1.1

4

$8.7

110%

.68$6.5

4

$0.5

0.8

.68

$.09

CLV Calculation

Impact Calculation

High-impact in-house customers

Additional value or high-impact in-house customers

5

$9.5

110%

.62$6.5

5

$0.4

0.8

.62

$0.7

6

$10.5

110%

.56$6.5

6

$0.3

0.8

.56

$0.6


Retention rate existing

Discount actor (10%)Current value olietime prots

Total CLV

Value o reerrals

Value o knowledgegained


Current value o impact

Total Impact

Total value: High-impact in-house customers

$39.1

$45.7

6.6


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Stp 5: Maag cstompofitability

Sagu has learned a great deal about the protability o

its segments through this analysis, and will use this

inormation to more eectively manage the value o these

segments. First, through the step 2 analysis o customer

margins, Sagu has learned that the no in-house support

and new to sotware segments have higher operating costs

than were apparent under the ormer cost allocation system.

In part, this was the result o high maintenance costs or

these clients.

To address this issue, Sagu has decided to change the

maintenance agreement it provides to customers. In the

uture, customers will be provided with a limited number

o technical support hours, and will be charged or any

support hours above this amount.

Through the CLV analysis in step 3, Sagu learned that

the no in-house support segment was expected to show

protability losses over time, due to low protability

growth and retention rates over time.

As a result o this analysis, Sagu conducted interviews with

key clients in the segment to determine reasons or the

decline. These clients suggested that they needed additional

consulting support to help them make the best use o their

sotware. Sagu has increased eorts to inorm customers

about available consulting services, and anticipates both

growth in consulting revenues and increased retention in

the segment as a result.

Finally, in step 4, Sagu analysed customer impact, and

realised that the customers with the greatest impact on

both attracting new customers and on gaining valuable

knowledge, were a subset o their in-house customers.

This group o clients consists o highly knowledgeable

users, who both contribute product and service knowledge

to Sagu, and also encourage other clients to adopt the

sotware either through direct reerrals or through

reputation.

Through the customer impact analysis, Sagu has

recognised the high value o these customers to the rm,

and has initiated new policies designed to provide special

benets to these customers. They wi ll receive a discounted

rate or adding sotware seats, which is expected to grow

prots more rapidly and strengthen customer loyalty.

In addition, they will be invited to sit on a newly-ormed

user advisory board, which will provide them with prestige

and the opportunity to interact directly with Sagu and

other high-powered users to share insights and strategies.


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rpat: Stps 1 thogh 5

Sagu has learned a great deal by working through the

rst round o the customer value management cycle. It

will use the knowledge gained through the process as a

oundation or continuous improvement in its ability to

evaluate customer protability, and to develop management

strategies leading to continual improvements in both the

value provided to these customers, and the va lue delivered

by them.

Moving into the next cycle, Sagu plans to re-segment thein-house support customers into high-impact and low-impact

segments. In step 2, the company plans to trace a greater

proportion o operating expenses to segments, or more

accurate estimates o current operating income. In step 3, the

company plans to gather more detailed analysis o historical

rates o both prot growth over time, and o the actual rates

at which clients exit the rm. These can be used to develop

more accurate predictions o prot growth and retention.

In step 4, the company will begin to more careully track

reerrals, through interviews with both high-impact and

new clients. In addition, it will ask the R&D department to

attach value estimates to sotware and process improvements

suggested by clients. This will allow or more accurate

measurement o customer impact over time.

At the same time Sagu gradually improves its capacity

to measure, it will also improve its ability to manage

protability. It will careully monitor the eects o the

initiatives introduced in the rst round, and make changes

to these strategies based both on their eectiveness and

on the new inormation obtained through enhanced

measurements in the second round.

eot1 Oliver, K., Moeller, L. and B. Lakenan. 2003.Smart Customization:

Protable Growth Through Tailored Business Streams. Strategy

and Business, Issue 34.


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The inormation and any opinions expressed in this

materia l do not represent ocial pronouncements o or

on behal o AICPA, CIMA, the CGMA designation or

the Association o International Certied Proessional

Accountants. This material is oered with the

understanding that it does not constitute legal, accounting,

or other proessional services or advice. I legal advice

or other expert assistance is required, the services o a

competent proessional should be sought. The inormation

contained herein is provided to assist the reader in

developing a general understanding o the topics discussed

but no attempt has been made to cover the subjects or i ssues

exhaustively. While every attempt to veriy the timeliness

and accuracy o the inormation herein as o the date o

issuance has been made, no guarantee is or can be given

regarding the applicability o the inormation ound within

to any given set o acts and circumstances.

The inormation herein was adapted romManaging Customer

Valueby Marc J. Epstein and Kristi Yuthas. Copyright

2007 by The Society o Management Accountants o

Canada (CMA Canada), the American Institute o Certied

Public Accountants, Inc. (AICPA) and The Chartered

Institute o Management Accountants (CIMA).

Copyright 2012 American Institute o CPAs. All rights reserved.


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The Association o International Certied Proessional Accountants,

a joint venture o AICPA and CIMA, established the CGMA designa

Chartered Institute oManagement Accountants

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