Building Customer Equity - A new way of thinking
Table of contents
Lifetime Customer Value
Dimensions of Customer Equity
The E-commerce Evolution
Mass Market Retailing
Factors That Drive Switching
Traditional accounting methods value a company by comparing the ratio of market value and fixed assets. However, balance sheet numbers represent only 10 to 15 percent of the actual value of most companies. Today, newer business models based on profit potential, knowledge-based assets, and the value (equity) of different types of customers are taking form.
In response to these trends, E SOURCE believes that over the next few years, more and more energy companies will implement competitive strategies for developing customer loyalty. The experiences of energy companies abroad suggest that customer loyalty and switching are strongly influenced by these three customer equity factors, and that price setting alone is not the soundest long-term competitive strategy.
In its recently released report, "Customer Loyalty and Switching: The New Dynamics of Retail Competition" by James Newcomb and Anne Peters, E SOURCE discusses how companies can improve customer loyalty and exploit emerging e-commerce opportunities. The report also discusses the switching experiences of energy companies worldwide, as the industry is deregulated.
Lifetime Customer Value (Back to top)
E SOURCE reports that lessons from competitive energy markets suggest lifetime customer value can be calculated from customer acquisition costs, revenue in profit per customer, and customer loyalty.
Successful companies are launching aggressive measures to acquire customers: door-to-door selling, online marketing, in-store kiosks, and marketing alliances with brand name companies outside of the energy industry. The average time required to recoup acquisition costs ranges from 24 to 36 months, given low profit margins. So, the lifetime value of this customer relationship depends heavily on churn rates.
America Online (AOL) is one of the best-known examples of a company that created value by building customer equity. Although AOL spends about $68 to acquire each customer, the company has managed to create a $120 billion market value, as well as significant barriers against competitors. Amazon.com has demonstrated that markets value brands for their ability to attract and retain customers in the "new economy," just as the "old economy" values profit margins and hard assets.
Dimensions of Customer Equity (Back to top)
E SOURCE posits that there are three dimensions of customer equity: value equity, brand equity, and customer loyalty. Value equity is the customer's objective assessments of the value of the firm's offerings: price, convenience, and quality. Brand equity is the customer's subjective and intangible assessments of the company's brand. This assessment is influenced by marketing and sales tactics, as well as the customer's life experiences and associations with the brand.
Above and beyond objective and subjective assessments of the brand, loyalty can be created out of a deep sense of trust, community, or belonging. Loyalty programs include such add-on services as home energy audits, year-end premiums, and bonuses for loyal customers.
E SOURCE lists the following variables for use in the customer equity model: churn rate, cross-sales revenue per customer, cross-selling rate, customer acquisition cost, customer lifetime horizon, discount rate, electricity margin, electricity revenue per customer per year, and other services margin.
The E-commerce Evolution (Back to top)
E SOURCE believes that without ongoing investments in both online and off-line strategies to acquire and retain customers–to build their trust–the economies of e-business will ultimately fail. According to Frederick F. Reicheld, the author of The Loyalty Effect, "it all starts with trust. If you don't earn your customer's trust, you won't make money on the Internet." The author goes on to point out that "American companies lose roughly half their customers in five years, half their employees in four."
Securing trust and loyalty from online customers, who are inherently suspicious and fickle, is far different than in the bricks-and-mortar world, according to Jakob Nielsen, author of the well-known essay, "Loyalty on the Web" (August 1997). To keep online customers loyal, Nielsen recommends the following: make the site navigation and functions easy to use and understandable by both novice and experienced visitors; keep content solid and timely; provide excellent online customer service; incorporate nonmonetary rewards or incentives to take advantage of quick data mining and timely communications; and use clickstats and purchase pattern data to understand customer preferences and measure satisfaction.
Mass Market Retailing (Back to top)
Authors Newcomb and Peters analyzed the experiences in a variety of competitive retail energy markets around the world to address variances in switching rates, levels of interest in energy purchases, and factors that drive switching. E SOURCE found that in most markets, "suppliers have failed to create value propositions that are compelling enough to overcome customer inertia and transaction costs."
In the United Kingdom, customers that switched typically saved 8 to 10 percent on their annual electric bill. However, after a year and a half, only one customer in eight elected to switch suppliers. Market research studies suggest that the reason for this has more to do with customer indifference than with flaws in the way competition was introduced. Apparently, a large portion of customers are reluctant to switch suppliers unless cost savings are 10 to 30 percent.
Switching rates in New Zealand have been low, amounting to less than 5 percent over a ten-month period. Some retailers have complained that delays in processing switching requests have "damaged the reputation of the competitive market with customers." The evidence from the New Zealand market suggests that switching rates will remain between 5 and 10 percent per year unless the potential cost savings from switching – the source of value equity – can be pushed above the common level of 10 to 15 percent.
When Germany introduced retail choice in 1998, prices fell dramatically – 30 to 60 percent for the largest customers. Even residential customers could save 20 to 25 percent. Increased savings combined with massive mainstream media campaigns heightened customer awareness and interest, providing a high watermark for switching rates. Peters and Newcomb believe these factors will probably not be replicated in other markets because of lower profit margins.
In the United States, the availability of retail choice for electricity customers is occurring in a patchwork fashion, as the individual states restructure legislation or regulations. The evolution of this restructuring is uncertain. William Smith, federal and legislative programs coordinator for the Iowa Utilities Board points out that "We've seen the high watermark for bold restructuring in the states. Progress from here on will be timid and glacially slow." Some analysts are even more pessimistic, predicting re-regulation for residential customers in a fashion similar to the cable industry. Approximately 10 percent of total U.S. electricity load has switched to competitive retail electricity supply. Only about 760,000 residential customers have switched as of June 2000.
Factors That Drive Switching (Back to top)
E SOURCE draws the following conclusions about switching behavior among mass-market customers:
- Where margins for suppliers to residential customers are small, little switching occurs. Unless customers can save more than 10 percent, don't expect more than five percent to switch during the first year.
- The time and effort required of both customers and suppliers affect switching rates. For example, strict rules to prevent slamming imposed by regulators in California have stifled competition and switching.
- Switching convenience can provide a strategic advantage. For example, SCANA's grocery-store kiosks and Commonwealth Energy's door-to-door campaigns lowered barriers to switching and gained new customers.
- Where retail choice is introduced in a fragmentary way, many suppliers may choose to sit on the sideline. By contrast, in Germany, all the major competitors participated.
- Clearer rules of the road for retail competition smooth the way for suppliers to develop sales and marketing strategies, as well as minimize customer confusion.
Steve Hoffman is president of Hoffman Publications, Inc. (www.hoffmanpubs.com), a California-based firm that specializes in writing for the energy industry. Steve authors a monthly ElectricNet column entitled "Plugged In with Steve Hoffman." (Back to top)