I've already shared with you a bit about segmentation when I related how Vegas thinks about minnows, dolphins and whales. You'll recall that I suggested that almost all the revenue comes from dolphins and whales, even if there are a lot less whales. And maybe you'll remember that my point wasn't to suggest that you stop servicing minnows. Everyone needs minnows. And if you serve them well, they bring the dolphins and whales. My point was about managing your cost.
You can't afford to treat minnows, dolphins and whales the same.
A Different Segmentation Paradigm
Today I want to share with you another segmentation framework, but to do so, I need to circle back to something just as important as how much a customer is willing to spend with you. After all, the minnow, dolphin, whale paradigm is focused on their wallets. Today I want to talk to you about loyalty.
True or false: your most loyal customers are also the ones that will be your most profitable segment?
Don't tell me what you think is the right answer. Don't tell me what you think I'm going to say is the right answer. Tell me what your gut tells you.
For the longest time I've heard people tell me that the customers who buy from them consistently and/or who have been with them the longest are their most profitable customers. But when you dig into the data (assuming someone is collecting data), you don't see the same thing. What do you see? Do any of these fit in your own world:
- They bought in at early prices that were lower than today's
- You don't really want them sharing what they're paying with others
- They feel like they deserve some special treatment
And even if they make more transactions, what most analysis misses is not the recency or the frequency of purchases, but the profitability of those purchases.
It turns out that in several studies, but especially nicely laid out in this Harvard Business Review article, the data comes back conclusively. Loyalty isn't a proxy for profitability.
- They don't cost less to serve.
- They don't pay more than others.
- They don't share (word of mouth) more than others.
Managing for loyalty and managing for profitability are two different things entirely.
Not All Customers are Equal
The other day I wrote about understanding your Customer's Lifetime Value. One of the ways you can do that is to calculate first a customer's average profitability over a period (quarter, year, etc) and then calculate the probability that they'll stay active in the next (one or more) period(s). You can then get a sense of their future profitability, which is a key component (other than your Cost of Acquisition) in calculating an CLV. Let's look at some examples.
Let's say a customer has been your customer for three years. As you analyze their spending habits you notice that they tend to make decent size purchases 1 or 2 a year. You set your period to a 12 month period and you review their purchases each year. Turns out they're making 1.5 purchases every year. But the key is that they've been doing it consistently for 3 years. So your probability that they'll stay active in the next year is high.
That's good news.
Now look at the profitability of each of those transactions. In this case, let's say this customer yields a profit of $1200 every year (and has for 3 years). If you assume an 85% probability that they'll be active in the next period, that represents an additional $1,000 per year. Not a bad customer at all.
Let's say this customer purchases more frequently. Almost every quarter. Over the past four years, they've made a lot of little purchases. Their profitability is much lower – $50 per transaction. They buy little add-ons. Nice but not the same thing at all, is it?
You may remember their name because they've been around a long time and you see transactions come thru, but even with a relatively decent probability that they'll be active, the math will show they're not going to bring in much over the whole of next year. Maybe $175.
Trust me when I tell you that even answering their call will mean you've lost money.
Where it gets tricky…
You know where it gets tricky? You likely remember the name of customer two. They've been around a lot. They tweet you every time they make a purchase. They tell others they did it too – which is great if they don't disclose that they're spending almost no money on you. Oh, and you grandfathered them in, because of an early deal they joined with. So your profitability is low. But you're not thinking with the math side of your brain. You're just remembering fondly the early days of your company. And how they were “there” for you.
- So you likely send them the same coupons you send everyone else. Bad call.
- You likely send them the same promotional offers you send everyone else. Bad call.
- You may even ring them up to get feedback, because you know them by name. Bad call.
Your first job must be to figure out what's really going on with them – do they have a bigger wallet that you can tap (because you're taking a small part of a big wallet), or do they have a tiny wallet and you're getting most of it already?
Finding that out is critical to help you know how you keep interacting with them.
Butterflies, Barnacles, Strangers and Strong Friends
If you looked at the research by Werner Reinartz and V. Kumar, in the earlier referenced HBR article, The Mismanagement of Customer Loyalty (2002), you'd see this graphic which lays out a different framework, a new paradigm for how to treat different kinds of loyal customers.
It's based on a customer's profitability and their longevity. The matrix is pretty simple.
- Low Profitability, Short term Customers: Strangers
- Low Profitability, Long term Customers: Barnacles
- High Profitability, Short term Customers: Butterflies
- High Profitability, Long term Customers: Strong Friends
The trick is how you treat them.
- Strangers: Make money every transaction, don't invest.
- Barnacles: If wallet-share is small, upsell. Otherwise, control costs.
- Butterflies: Deliver well. When they move on, you need to too.
- Strong Friends: Communicate consistently, delight them.
Bringing it around to the WordPress Community
You know I've been spending a decent amount of my free time talking with small businesses in the WordPress community. So I wanted to highlight and showcase one company/individual that I think really gets it. He is the guy behind the fastest and best performing WordPress slider. Thomas Griffin is the creator of Soliloquy and he's more than just a developer. Over the past year it's been awesome to watch him move into other roles, like a marketer, sales person, and entrepreneur.
He's also a guy who tracks his data and can spot trends that will, not today but in the future, bring his company to its knees if he doesn't start segmenting and shifting his business model. So we spent some time together talking about what he was thinking about and his thoughts are now publicly available as he's announced a shift today.
I can't say enough positive things about how intelligent this move is. Every customer isn't the same. They have different value to Thomas. But they also have different costs.
When you create a support program that treats everyone the same, you're doing it wrong (in my personal and limited opinion- no need to ‘educate' me in the comments).
Some people cost you more, others less. As I wrote above, with barnacles, if they don't have more wallet for you to pursue, cost management principles need to get put in place. Giving them unlimited options to burn your time via support tickets is just plain silly.
So check out what Thomas is doing. Check out what smarter people than I say about this, via HBR. And by all means, check your own data.