How many companies call themselves “customer-centric” while failing to see issues through customers' eyes?

Larry Selden, professor emeritus of finance and economics at Columbia University, and Geoffrey Colvin, senior editor at large at Fortune magazine, argue in their book, Angel Customers & Demon Customers, that any company that claims it's customer-centric is “an outright fraud” unless it can pass a three-part test:

• Is there a specific person who “owns” the customer and can develop specific value propositions?

• Who is accountable for the profitability of a customer or segment?

• And how significantly does the company differentiate interactions with customers?

The subtitle of the book is Discover Which is Which and Turbo-Charge Your Stock, which summarizes the book's premise well. The only way to achieve a P/E superior to the market—not your industry—is to understand that a company is no more than a portfolio of customers.

Companies that want a superior stock price must understand the relative profitability of customers, develop different value propositions for customers of varying profitability and organize around customers.

Here's what the authors say:

You can build gross margin by making capital investments that reduce labor costs; it works because the capital costs aren't included in gross margin. You can buy market share with price cuts. You can increase customer satisfaction and retention through all sorts of giveaways to the customer that will cost the company dearly.

Only by looking at customer economic profit and a contribution to a premium P/E can one make a sound judgment about the success of an initiative….

Selden and Colvin offer a new way to calculate customer equity—although, curiously, the term is never used. A “Customer Segment Value Creation Scorecard” divides each demographic or other segment into current, new and lost customers.

Sales to each group are broken out by products, services or intellectual capital, and reflect cross-sells and up-sells. Costs include COGS (costs of goods sold), account management, acquisition costs and, interestingly, Customer Knowledge Management (CKM), which represents the costs of acquiring, maintaining and using customer information. Subtracting these costs (and taxes) from revenues gives the familiar figure of net operating profit after tax, reached in a new way.

Then the approach grows complex. Using these figures, companies can calculate return on invested capital (ROIC) for each category of customer. The ROIC for each customer segment is used to calculate current and future P/E.

Understanding the explanation of how to calculate future P/E would have required someone with much more financial expertise than I have. Knowing the current and future P/E lets companies determine which customer segments are profitable and which are dragging down shareholder value.

Once the Customer Scorecard is complete, companies must understand why the segments studied generate excellent or subpar returns, and alter strategies accordingly. The next step is to organize around specific, mutually exclusive customer segments instead of products, regions or functions.

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ABOUT THE AUTHOR

Nick Wreden is the author of ProfitBrand: How to Increase the Profitability, Accountability and Sustainability of Brands (named "Best Business Book of 2005" by strategy+business) and FusionBranding: How to Forge Your Brand for the Future. Reach him at nick@fusionbrand.com.