Measuring the value of customers

What annual profit is the Financial Services industry generating from each of their customers, across Europe?
A Pitney Bowes Group 1 Software study

Measurements of corporate value that relate to return on capital employed are now seen to be increasingly inappropriate for service businesses. And as the relative importance of manufacturing in many European economies dwindles – albeit at differing rates - in favour of services, new metrics are required to measure company value. After all, the profits that a well-favoured brand can generate have little or nothing to do with cost of manufacture and distribution.

The value that a brand delivers for shareholders is defined by the way customers behave towards it. Are customers fickle or loyal? Do they buy more as time goes by? Can more products be added under the brand umbrella? And what is the cost of winning and keeping each customer?

Most marketplaces in European economies have become more competitive over the last couple of decades. Former state or regional monopolies have deregulated (in the UK) or are embarking on deregulation (in continental Europe). Other markets, such as banking and retail, have simply become more crowded. And for every bricks-and-mortar business on the high street, there is an online equivalent (with lower overheads). This has made companies very focused to two things: first, to ensure that they provide such a good proposition for customers that they stay, increase their spend (if possible) and become more profitable; secondly, to understand better the cost of winning, keeping and growing customers, so that value is returned to shareholders.

The ability to keep and grow customers at as low a cost as possible is increasingly exercising the minds of investors. Too many instances of highly trumpeted mergers or acquisitions have resulted in reduced, not increased, shareholder value. Not surprisingly, investors are fed up with the situation and are looking around for metrics that reveal how organically, efficiently and sustainably, companies are producing profits. Institutional investors – who make up the vast majority of the investment community (in contrast to the US) – are interested in longer-term gains that reliably, for instance, build successful pensions funds.

The efficiency with which companies produce their profits is absolutely critical to sustainable shareholder value. Revenues and profits may be built in the short-term through scale growth, either organically or by acquisition (and cross-border M&A continues to accelerate). But if with each year that passes, profit per customer is dwindling, then the future will be bleak – offering the prospect of either the cost of winning and servicing customers becoming unaffordable, or even running out of customers entirely as market share reaches saturation point.

The database marketing industry has produced extremely powerful tools with which to analyse and target the right people with the right offers. But unless one understands profitability trends at the individual customer level, then companies will not know who to target, why, and with what.

Profit per customer helps to measure the value of different customer groups and the efficiency with which that value is produced. It reveals whether companies have to recruit twice as many customers to achieve the same profit growth – and therefore whether or not current growth rates are sustainable. By extension, profit per customer is the final output of earnings minus costs of obtaining, keeping and growing the customer. Also by association, the quality of the value proposition being put to customers is being measured – i.e. more compelling proposition, greater efficiency, higher profit per customer.

In order to contribute hard information to this vibrant new area of corporate measurement, Group 1 Software commissioned research to evaluate the profit per customer being produced by top players in five of the country’s main industry sectors – Banking, Utilities, Mobile Telecoms, General Insurance and Retail – across the main European economies (Germany, France, UK, Italy and Spain). For the purpose of this discourse we examine the Banking and General Insurance sectors.

Banking sector

It has been widely publicised that the top retail banks in Europe generated many billions in profits in 2005, in many cases record figures. Much of this profit came from international capital markets activity, in contrast to such ‘big league’ business, consumer retail banking receives less attention. If anything it is the business banking side, which comes in for regular scrutiny and criticism from governmental standing committees.

Nonetheless, of all the sectors analysed by this report, retail consumer banking managed to generate the highest profit per customer in the UK, and the second highest in continental European countries. This may well be the product of creeping structural change in the sector, as the role of branches is changed and economies have been introduced in the form, for instance, of centralised customer service contact centres. A 2005 Group 1 report, however, revealed that, for instance, UK banks are experiencing customer defection rates of around 17.5%/year, where just a few years ago that figure was sub-10%. So banking organisations are going to have to watch and monitor the quality of their service provision very carefully if they are to maintain profit per customer growth to the end of the decade

In the UK, the top 5 UK Banks have made a year-on-year profit of 23% per customer; In 2005, these banks made £100.50 profit per customer, up from £81.60 last year. Overdraft penalty charges and late payment fees on credit cards contributed in part to the increase.

However, much of the increase is attributed to vastly improved means of communicating with the customer; targeted mailings and better use of cross selling on statements and other customer communications. In all, this demonstrates their success in an ever-competitive environment, where for every bricks-and-mortar business on the high street there is an online equivalent. Good news for UK Economy but is it for the consumer?

Some banks are resigned to customer inertia and will continue to propel charges; these customers will suffer in the short term. However it is these banks, in this instance, that will feel the greater pressure. Our report, earlier this year, into customer defection, revealed that the number of customers changing their bank accounts doubled in 2 years to 8.1million people.

Those banks that understand their customers and are driven to providing a customer centric approach to deliver targeted offers to different customer segments will benefit. Both customers and banks alike. Banks will increase their profitability and customers will grow evermore satisfied with service and personalised attention, thereby creating a sustainable future herein."

General Insurance sector

General Insurance industry delivers the lowest, or next to lowest, absolute return per customer, with the exception of Spain. This finding is evidence of the market difficulties experienced by general insurers over the last decade. In the late nineties, underwriters priced for market rather than for risk, and the result was a severe decline in business results in the wild frenzy to gain customers. Whilst this had been recognised and reversed by the time we were passing the millennium, a number of factors – flooding, terrorism in Spain and the UK, etc – had a depressing influence on business.

Moreover, as we move into the second half of the “noneties”, general insurance has become an industry chasing customers who are much more mobile and prepared to switch, and who can access real-time quotation comparisons from a plethora of different providers.

Many have done much work identifying who their loyal customers are and, instead of ignoring them (an attitude of “they’re not going to defect, so why bother”), underwriters are starting to value customers who do not switch and pay more attention ot retaining and growing their custom. The recovery of the industry, in terms of growth of profit per customer, is the result of better underwriting loss containment, plus improved customer relationship management.

However, there is some way to go before the general insurance sector returns to profit per customer levels comparable with the other industries studied.

General Insurance delivers the lowest profit per customer of the sectors studied, but is rapidly recovering. In Europe, General Insurers in the UK yield the least profit per customer relative to the other major EU economies. This is reflects the competitive nature of the market place in the UK, where there are a number of players and price competition is rife.

UK General Insurers have made a year-on-year profit of 50.3% per customer. In 2006, Insurers made £35.10 profit per customer, up from £23.20 last year. The following graph details how profitable EU Insurers are;

Conclusion

Snapshot inter-industry comparison that results from this study is interesting in its own right. But most compelling is the trend within each industry that the study reveals. Different industries, of course, face different commercial pressures. Yet whatever those pressures are, sectors that are producing an increasing profit per customer are the winners, and conversely those with declining profit per customer are the losers.

A declining sector trend does not mean all players in that industry are experiencing declining efficiency in the production of profit, but the sector figures provide a useful yardstick for marketers and investors.

Nevertheless, it is also important to recognise country differences. Levels of privatisation vary from country to country – and it is arguable that less deregulated economies can produce higher profits per customer than those which have to face true competition. This is an important factor in assessing a snapshot view of current profit per customer, in that one has to ask how sustainable this will be once the sector is deregulated – a critical factor for France and Germany where the Utilities sector is commencing deregulation.