Marketing Model or Financial Model?
Newsletter #82 9/2007
Drilling Down - Turning Customer
Data into Profits with a Spreadsheet
Customer Valuation, Retention,
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Hi Folks, Jim Novo here.
This month, we've got a question that starts out as a marketing
model question and ends up as a financial model question. We're
up at the higher end of marketing work here, where the marketer is
actively participating in the business strategy.
So we're going to skip the article and blog links this month and
get right to the Drilling...
Questions from Fellow Drillers
Marketing Model or Financial Model?
Q: Been reading through your site a bit. I run
the CRM and online marketing at (large airline) - a business with
roughly XX million customers and X.X million members in our
loyalty program. Interested in your thoughts about RFM
algorithms as well as aggregated scoring. My predecessors set up ranked scoring along spend - essentially
taking paid purchases and ranking people from high to low in R, F, and
M and then built programs around this.
My issue with this approach is that we find very different behavior
in our top 20%, 10%, 5%, and even 1% (e.g standard deviation of
population is large). Additionally, rank ordering often grouped
individuals with the same underlying behavior in different categories
because of the arbitrary nature of where the snap lines fell. So
I altered our scoring as follows...(long description of new model)
A: Did you by chance see this
Latency may be a better way to go for an overall approach to
airline behavior in the business class; Recency in the tourism class.
It sounds to me what you have done is a similar idea - recognized
the generic RFM model is broken for your needs, extracted the essence
of the RFM idea, and rebuilt it into a model that works for you.
Q. But, if someone spends $200 on a
flight that is 400 miles vs. 1000, the revenue has differing
implications - both in terms of customer and non-customer driven fixed
and variable costs. If someone spends $200 on a flight that
sells out - we are potentially spilling revenue (not holding
inventory for a bigger spender) - and thus the opportunity value is
greater than the collected revenue. But if the
flight doesn't sell out...this may not be true?
A: For sure, it's a complicated business. I
think you need to ask yourself if it is the responsibility of your
model to deal with this complexity. If the model is a
"targeting" model, then targeting is what it can do.
It can't possibly deal with a bunch of semi- random margin scenarios.
That you would probably push back into the Financial Analysis of
program / marketing outcome - after the targeting model did that job.
Put another way, RFM and the many variants are fundamentally about
response rate. The "M" is a predictor variable, and a
weak one at that; it also tries to align the cost of marketing with
customer value potential. The financial implications of the
response generated by the RFM model is a different issue, one that
would be best dealt with in an offline analysis, outside the response
Q: To even further complicate matters - we can sell
product on other airline partners and vice versa. Should we be
looking at profit vs. revenue - even if some of the costs were
not driven by customers?
A: Sure, you can look at profit instead of sales if
what you want is to target higher profitability customers for
response. But again, RFM is not a financial ledger system, it is
not meant to make financial decisions, only targeting decisions.
Q: Customers can redeem miles to fly rather than
pay. How should this behavior be integrated? The value we
derive from redemption is often the switching cost we create with
customers to ensure high share of wallet. What about
scoring how customers earn miles - by flying on us or a partner, by
earning bonuses, by using bank affinity credit card. Then there
is other shopping behavior issues - the buyer may not be the ultimate
user. What if they choose a sister brand? What if they are
someone who flies little but influences spend of others or other
revenue (corporate travel manager or C-level exec or
purchases cargo revenue).
A: Yikes! OK, let's talk about
"scoring". The kind of scoring you really want to do
here I don't think has much to do with RFM at all. What you want
to build is a customer profitability model, and I'm not sure that has
anything to do with response at all. In fact, in many cases, the
highest responding groups - usually best customers - often do so at a
negative profit. This happens because you frequently eat into
margin dollars that would have occurred anyway: I spend $1000 a month,
you give me a 10% discount, I spend
$900 that month and then $1000 the next month. No incremental
Q: How to manage issue of purchase channel - with its
differing cost and loyalty implications - direct vs, agency, online vs,
offline; promotional response rates - only buys with promo or
doesn't change behavior with promo or uses promos for travel
they would have likely taken anyway; form of payment - with its
different credit risks and merchant fees; purchases of main
product vs. ancillary (hotel, car, cruise, vacations, gift cards
- some of which we are a supplier on - and some that we are not);
market contestability - if they are flying in a market
where either there are lots of equally sized competitors - lots
of competitors but of unequal strength and share - or only a few
competitors; relative market strength - are we a dominant
competitor, in the running for significant share, or an also
ran. Is it a new or mature market? Do we have a better or lower
positioned product? And what of data on the experience (late or
cancelled flights, long lines, call center hold times, lost or late
luggage) and satisfaction of customers?
A: OMG !! Not just a customer model, but a
financial model of the entire business, with all the moving parts!
Jeepers, are you the Marketing guy or the CFO?
Q: Would be interested in your thoughts on how to
approach these issues - to eventually end up with a single or small
set of KPIs to use for customers in marketing applications.
A: Here's what I think. That's one heck of a
complicated business and you really need to sort out what you can have
an impact on. There are certain parts of the business that you
really have no control over, and so the question is, if I can't do
anything about it, does it belong in a marketing model?
Seems most of your questions have really to do with net profit,
which clearly is a marketing issue, but in a different way. More
similar to a fundamental ROI question: if I sell 1000 miles, how much
money did I actually make? Then if you know the answer to this
question, you can go back to the financial analysis and plug that
If I'm understanding the issue correctly, here is what I would do.
If your need is short-term, create a proxy variable like "Net
Income per Mile" or something like that right from the balance
sheet of the company. This gets you pretty close to where you
want to be as a generic starting point to build out from.
If you have a little bit of time, I would simply start having this
very same conversation with the CFO - what number, in the CFO's mind,
best represents the profit "flow-through" from an
incremental mile generated by marketing?
There are a heck of a lot of lines on an income statement and any
one of them might not be appropriate for this particular situation.
What does the CFO want to generate? Cash flow? Earnings?
EBITDA? That's what you really need to know. From there,
you can start to look at income scenarios - start with the largest /
highest volume ones first - where you perceive the income metric to be
higher or lower than the baseline "Cash Flow per Mile" or
whatever provided by the CFO - sales on other carriers, source of
sales, market conditions.
We did this when I was at HSN. There was a desire to get to
the net productivity of marketing efforts, and we worked closely with
the CFO to develop the model. What was the true profitability of
an incremental sale generated by Marketing?
This model was loaded with every variable to order cost you could imagine - cost of the order phone call,
cost to pick, pack and
ship an order, cost of customer service
calls after the order, cost to process the projected return,
etc. These costs were deducted from any net gross margin (after
to arrive at "flow through" from a sale, where THEN you
deducted the cost of marketing, discounts, etc. Yet we still
often generated a 60-day ROMI
of 2 to 1 or better - even though the flow-through was about 20 points
below product gross margin. Makes me really want to chuckle
about incredibly weak online marketing metrics like ROAS
- what a joke.
It was tough to generate profits, but the flip side was every time
we told the CFO we generated a profit, he knew precisely what we
meant. That's when Finance started really throwing money at us,
because they had such a high degree of confidence in the results we
were producing for the company.
If you're going to go as deep as you are considering, you first
need a financial model of the business. Then you can build a
customer scoring application. And then you can build a response
model that will do what you want it to do. Nice challenge for a
Marketing guy, plenty of work to do. But I would really start
with the CFO - or whoever in the Finance chain is appropriate. You
just might find they have a lot of these models already and that will
save you a ton of time!
Besides, rooting around in the business model like this will
probably raise some questions that don't have answers - why do we do
this? Now you're really into the guts of it and are
participating at the Strategic level - where Marketers ought to be, in
my humble opinion.
If you are a consultant, agency, or software developer with clients
needing action-oriented customer intelligence or High ROI Customer
Marketing program designs, click
That's it for this month's edition of the Drilling Down newsletter.
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'Til next time, keep Drilling Down!
- Jim Novo
Copyright 2007, The Drilling Down Project by Jim Novo. All
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