Right, so let's talk about the steps we can take as far as understanding customer equity. Well, everything that we do from a marketing standpoint there are going to be spill over effects. We may have the intention to put money and put resources into customer retention. We may do a new advertising campaign, we might do quality improvements, we might do branding initiatives aimed at increasing customer retention. Well, of course that's also going to have an impact on customer acquisition, it's going to end up affecting both of these. The challenge becomes where is it going to have the bigger impact? So the quality efforts that we invested, is that going to have a bigger impact on acquisition behavior? Is that going to have a bigger impact on retention behavior? The branding efforts, maybe it's going to have some impact on retention but chances are it's going to have a bigger impact on the acquisition process. So when we're investing marketing dollars, chances are it's going to end up hitting both processes. It's just a question of how effective is it for each of these? This is some work that was Is done by Reinartz, Thomas, Kumar that look at this decision of trying to balance investments in acquisition versus investments in customer retention. And this is the framework that they offer, so they look at both processes, first the acquisition process. So who are my prospects? Of those prospects I'm only going to acquire some of the customers, not necessarily going to acquire other customers. For those customers that I've acquired, now we're in the retention process. How long do they stick around? And what's their ultimate probability driving both of these processes? Actions taken by the firm, actions taken by the company, actions taken by the competitors, as well as customer characteristics that we can't necessarily have an impact on. And so, if we look at three different aspects of the customer relationship, there's the acquisition process that we've talked about. There's the duration process, so think about that as our retention process. The longer you stick around, you've decided to be retained, you've decided not to churn. The other aspect here is customer profitability. Now over all profit is going to depend on how long you've chosen to stick around. But it's also going to be affected by the depth and breadth of the customer relationship, so that's that customer development phase. And so in the boxes below that identifies the predictor variables that were included in the authors' analyses. So they looked at the acquisition process. They look at the duration, how long the customers are retained, and how much are they are spending throughout the course of their particular relationship? And the nice thing about looking at all three of these processes together is we can take a look at trade-offs if I make an investment in one process versus another. And that's what the authors had done in terms of, do I put money into customer retention or do I put money into customer acquisition? Now they've identified through their research what is the optimal levels of spending on both of these. And so then they then play a series of what if analysis to say, well what if I didn't invest the optimal amount? What if I drop it down to 90% of optimal or 75% of optimal? Or what if I invested too much? Ultimately what is that going to end up costing us? Now obviously the optimal amount is going to be the profit maximizing amount. Well, what happens if I make mistakes from that, if I overspend, if I underspend? And what we see, in terms of magnitudes at least, what looks like the most costly mistakes are underinvesting in customer retention. Those seem to be the ones that stand out the most. The others that are on this graphic look to be about less than 1% percent in terms of the cost of those mistakes. But the big cost seems to be from Investing too little in customer retention. And so, similar in spirit to the work by Gupta, Lehmann, and Stuart, we do need to find out how much needs to be spent on customer retention, and we can't shortchange that. Because if we retain customers, we keep on getting that revenue for multiple periods in the future. I'll give you a more recent example to think about that really applies these same principles, this daily deal market. So think about Groupon and Living Social. And there's been a lot of work that looks at the fact that yes, it does generate business for us. The thing that we've gotta be cognizant of is, well, what's the long run impact? Yes, it generates short term business. What's the potential long run impact? And so imagine you run a small restaurant or you run a nail salon or entertainment venue where you've got limited space. Now you can promote your business and engage in customer acquisition through Groupon. And in fact some of the numbers that Groupon does make public and reveal in some of their reports are about customer acquisition. So 91% of businesses report acquiring new customers. That's great, that's the acquisition piece. Of those customers that 90% spend more, all right? That's also good news. It means that they're not just redeeming their vouchers that they purchased, they're spending more on top of the vouchers, and promoting increased awareness. Well, that's also good. Well, all of these are really aimed at understanding customer acquisition. What about customer retention? What about the impact of these deals on your current customers? Well, one place that we run into problems with this would be that your current customers might use Groupon to get price discounts. And so these are customers who might've come back regardless of the Groupon deal. But now that the Groupon is available, you're making less money off of those customers. So that's one potential risk. The other potential risk, these promotions tend to be very costly. Let's say that if you're offering a price discount, you also have to pay Groupon for the promotion that was run through them. You might be getting a significantly reduced fraction of the revenue from the transactions relating to Groupon. And that's fine if you're reaping the benefits of that through repeat purchasing from these customers. But if a lot of the customers using Groupon are just taking advantage of the deal and never planning to come back, you just put a lot of money potentially into that customer acquisition piece. You're not getting the benefit of repeat business. Ideally we invest in customer acquisition and that's going to help us attract customers and they're going to keep on coming back. The Groupon piece, if it only works for customer acquisition, you might actually be hurting yourself compared to putting that money into other types of promotions. So what is the impact on customer acquisition? What does that do to the experience that your current customers have? If you run a small business and you attract so much traffic that's great. But if those Groupon customers aren't coming back down the road that's a problem for you. And if you attract so many customers, let's say its a restaurant, that your current customers get turned off because the level of service has potentially declined. Now you've potentially hurt yourself in the long run because your loyal customers may have had a negative experience due to this promotion that you were running. So in evaluating the effectiveness, we really need to take a look at not just customer acquisition, as a lot of these metrics report, but also long run. Are these customers coming back? Are we seeing any negative effects on our current customer base? And just to get you thinking through some other examples, acquisition, development and retention. These show up across the board for businesses. Whether you are a social network like Facebook, an online business primarily like eBay, or a traditional retailer like Macy's, you're dealing with, I've gotta get the customers, I've gotta deliver the experience that's going to keep them coming back and spending more with us. And I have to keep them around as customers. So acquisition, development, and the retention aspect. It's going to be hit on across a number of different industries. You can think about it the same way, the predictor variables that we put in might be a little bit different. We may have to contend with slightly different time frames, but the foundation of customer equity, thinking about the revenue in terms of customers acquired, customer relationships, and length of the customer relationships, that's going to cut across the board. Now the exercise that we're going to walk through next, is one where we try to make this trade-off between customer acquisition and customer retention, recognizing that we have different customer segments in the population. So we're going to look at this exercise of how can we build a tool within Excel to try to help us address this challenge of where do I spend my next dollar? How much should I be putting into these different processes? So that's the Excel piece that we're going to tackle next.
