RELATIONSHIP MARKETING.

How Small Stores Can Use Their Customer Data To Gain A Competitive Edge (Part Two In A Series)

Steve Weingrod

IN LAST MONTH'S ISSUE of Music Trades, I outlined some of the current thinking in the direct marketing field - Why establishing relationships with customers helps build loyalty. Specific examples were provided in three retail areas: car rentals, blue jeans, and books. The ultimate goal of relationship marketing can be boiled down to this: identifying and marketing to customers in proportion to their importance to your business.

Relationship marketing allows you to dramatically improve two key business areas: (1) improving customer loyalty by focusing on individual customers' interests and needs; and (2) supporting the bottom line by targeting communication to individual customers and then tracking the results of these marketing efforts.

You need a database to implement relationship marketing. Even a relatively simple database software program allows you to capture and store information about individual customers. You can then access this information to direct highly individualized marketing communications according to customers' interests and purchase history.

Database vs. Mailing List 

When you begin targeting individual customers and whole segments of customers within your database, you will be able to track how individual customers and segments respond.

If you're thinking, 'I already have a mailing list. Isn't that the same as a database?' ... the answer is 'No.' Here is an easy example that explains why.

Bob's Music Center has a mailing list of 5,000 individuals who have purchased from the store or simply signed up to receive the store's newsletters. Bob's list has names and addresses but little or no purchase history on these 5,000 customers. Newsletters are mailed bi-monthly. Approximately 30,000 newsletters are mailed per year. The store's annual budget for newsletters (a form of direct marketing) is $20,000.

What's wrong with this scenario? All 5,000 customers are being treated equally. Bob's is spending the same amount marketing to customers who buy little or nothing as it does marketing to its best customers.

Let's delve further. Once Bob's mails its newsletters, management can not track sales for any of the 5,000 individuals after the mailing drops. The store does not have any real quantitative data on the total sales volume for any individual, segment, or even the entire 5,000. With perhaps a few exceptions, it does not know the identities of its top customers. The result is that Bob's can not gauge the effectiveness of its newsletters as a 'sales generator' any more than it can for a newspaper display ad.

Across the country there is a similar music store, T&M Music. It, too, has a list of 5,000 individual customers and budgets $20,000 per year for its direct marketing efforts. Unlike Bob's, however, a wealth of information exists about the purchases of the 5,000 T&M customers in its database. T&M collects and stores purchase information on each individual customer at the point of sale. This allows the store to easily discover the categories of merchandise an individual customer buys, when the purchases were made, and how much the customer spent. With that information, T&M targets its marketing efforts to individual preferences.

T&M's owners figure that the store's most loyal customers should receive more marketing communication than its infrequent customers. From tracking sales results of the customers in its database, the owners discover that one-third of the customers on the database account for two-thirds of the sales volume of all 5,000 customers combined. It's akin to the '80/20' rule. With $20,000 budgeted, store management decides it should allocate at least half of that budget marketing to the top one-third.

Here are some of things T&M does. Like Bob's, T&M produces six newsletters per year; however, at T&M the top one-third receive all six, the middle-one third receive only four, and the bottom one-third receive just two. This results in about 20,000 pieces mailed (compared to 30,000 for Bob's). $7,000 of the $20,000 remains in the store's direct-marketing budget.

The remaining budget is used for even more targeted marketing. For example, prior to a store event, every customer in the database who has purchased items relating to the merchandise or services promoted during that event receives a letter or postcard announcing the event. Perhaps a pre-event offer or invitation to T&M's best customers makes sense. Perhaps a special gift or premium is available for a short period of time. This promotion greatly enhances attendance and subsequent purchases.

The same targeted, inexpensive postcard mailing strategy is employed to announce sales on special purchases. T&M sends lots of postcards and letters, and there is still money left in the budget. It starts a birthday club, adds some demographic information to its customer database, and conducts surveys. In short, the store learns as much as it can about its customers without breaking the bank. It discovers that the more it learns, the smarter they can be about its targeted marketing efforts.

Like many music stores, T&M does a significant percentage of its annual volume in November and December. In order to make sure its best customers conduct their holiday buying at T&M (and not somewhere else!), a special 'thank you' letter from the store's owners is mailed to the top 10% or 20% of the customers. Enclosed is a coupon for $25 off a purchase of at least $100 (or some other combination of $$ off on a minimum purchase) good through December 31st.

Lifetime Value of Customers

Predicting the Financial Payoff of Relationship Marketing

Once you have a working database that stores information on actual individual purchases, you can track results from your relationship marketing campaigns. This means that even the most elementary relationship marketing program can help you predict future sales in ways that conventional marketing can not.

The standard measurement of future sales in the direct marketing industry is lifetime value. Lifetime value measures the net present value of the profit you will realize on the average customer in your database during a given number of years. Once you can build a financial model of future business with your customers, you will begin to develop strategies that employ reasonable marketing strategies that control your costs.

We are going to build our Lifetime Value calculations into a simple table. (see p. 117) In this table we are looking at a group of customers over a five-year period. These customers' purchase records are captured and updated in the store's database. Five years is the typical timeframe for these calculations. As we go through this example, remember that the particular figures are for example only. Each store has its own unique financial model.

In the first year (YR1), 1,000 customers (Row A) shop at the store. All stores lose customers, especially in the first year. General industry data suggests that with a good relationship marketing program, a retail store can retain 50%-75% of its customers after the first year. We use a 65% Retention Rate (B) for this table. Retention rates increase over time because once customers purchase one or more times, they are likely to keep purchasing from the same store again. Conversely, most infrequent customers are lost in the first year or two.

In this example, the average annual purchases of an average customer (C) are $100. This figure may be small for many music stores, but it is easy to use for the purpose of this case example. Average annual purchases generally increase over time as only the most loyal customers are left from the initial group of 1,000. Multiplying the number of customers by the average annual purchases (D) calculates the total sales volume.

Row E represents the store's overall 40% gross margin. Row F shows inventory costs. Row G is the cost for the store's Relationship Marketing activities to the customers in its database. For this example we use $10 per customer. Row H totals all costs.

We then calculate gross profit (I). Then another factor is added that we call increased cost and risk' (J). Here we attempt to 'discount' future sales by assigning a percent on the unknown. Costs go up. Competition might heat up. Many other factors can throw off the accuracy of predicting future revenue and costs. In this case we will use 10% per year after YR1.

Now we get to NPV - Net Present Value. After calculating sales, customer retention and costs, then discounting our future predictions, we arrive at the value of our relationship marketing efforts (K). In Row (L), we simply add the cumulative amount year by year.

Finally, we arrive at Lifetime Value per customer (M). Simply dividing the cumulative NPV makes this calculation by the original 1,000 customers. This tells us that after five years we have realized a net profit of $95.52 per original customer. While this may seem modest, remember that this calculation is for each individual customer of the 1,000 we started with, and, as the chart shows, only 312 remain after five years. Another way to look at this: Under this particular model, the store realizes $95,520 in profit for each 1,000 customers. For T&M Music, this would mean $477,610 in gross profit for the 5,000 customers in its database. We can assume the customer database would grow over the five years, so the number should be even higher.

This is how you can begin to analyze your relationship marketing program. You can build your own table in a spreadsheet, then plug in assumptions. Watch how they change the bottom line. Marketing strategies can be determined from this exercise. When utilizing a database to track results, you can test and then analyze almost an endless number of initiatives.

The retail music business has very special characteristics that make relationship marketing a critical business strategy. It also has some unique challenges when creating pro-active marketing programs that launch and sustain customer relationships. In the next issue we will explore how relationship marketing might be applied in the retail music business.

Steve Weingrod is a consultant with the firm of Great Lakes Communications, Inc. He can be reached at [phone] ext. 212 or by E-mail at: [e-mail].