Question

How does the life time analysis differ from the basic customer profitability approach(500 words)

Answer 1

The Chartered Institute of Management Accountants defines Customer Profitability Approach as “the analysis of the

revenue streams and service costs associated with specific customers or customer groups.”

Following are the steps for an effective Customer profitsbility approach implementation:

Step 1: Selection of Sctive Customers

Step 2: Design Customer profitability module

Step 3: Customer Profitability calculation

Step 4: Interpretation of results

Step 5: Attune strategies and programs

Step 6: Establish Infrastructure

Customer Lifetime Analysis is a measurement of how valuable a customer is for the company with unlimited span of time as opposed to first purchase. This helps in understand a reasonable cost per acquisition. It is basically the total worth to a business of a customer over the whole peroid of their relationship.

Following are the points which show the difference between lifetime analysis and customer profitability approach:

1. Reliability of the analysis: According to Ryals, there is generally a greater certainty about the reliability of customer profitability approach data, as it is based on actual transactions with the customer. Such data is readily available to the company. On the other hand, Customer Lifetime Analysis is based on forecasts, and it is very difficult to make highly accurate forecasts. This leads to some uncertainty in the minds of managers, leading to hesitance in using this approach. As mentioned in Section 3, a regular updating of the Customer Lifetime Analysis calculation is necessary, in order to increase the reliability of the data.

2. Estimating future potential of a customer: The fact that customer profitability approach uses historic data may have led to a generally favorable opinion on its reliability, but it is also a disadvantage that the future potential of a customer is overlooked. For robust decision-making, it is important to also look into what would happen in the future. This is where Customer Lifetime Analysis can prove to be advantageous. It provides a look into the future and it enables the customer relationship to be managed as an asset that might require investment in one period that will not pay off until future periods.

3. Collective limitations: Both the approaches fall short in two areas which are as follows:

• Tax effects on cash flows are not incorporated in the models. This will lead to multinational companies that operate under different taxation systems to undervalue customers in low-tax regimes and overvalue those in high-tax regimes.
• Ignoring customer’s risk contribution to the company’s risk. The treatment of risk related to the predicted future cash flows from customers has not received the due attention so far.

It advocate further research for expanding the current customer profitability approach and Customer Lifetime Analysis models in order to capture the impact of tax effects and customer’s risk on the outcomes of customer profitability calculations. It also observed that simple net present value (NPV) based Customer Lifetime Analysis models do not capture the high risks in B2C e-commerce markets.

4. Implementation in complex environments:

It was concluded from their detailed investigation into customer profitability approachand Customer Lifetime Analysis models that there is a need for an integrated customer profitability approach/Customer Lifetime Analysis model to measure customer profitability in organizations having high complexities in customer service as well as customer behavior. The individual customer profitability approach and Customer Lifetime Analysis models are insufficient to capture CP in such scenarios. Sophisticated Customer Lifetime Analysis techniques for estimating retention patterns, gross profits per transaction, and direct marketing costs must therefore be integrated with sophisticated customer profitability approach techniques for estimating the amount of service activities required to fulfill the future customer demands that the CLV technique predicts. This can be achieved by converting Customer Lifetime Analysisestimates of future customer behavior into predicted service activity demands in future periods that, in turn, can be translated into cost estimates by utilizing the service activity cost drivers from the customer profitability approach technique.