Step 5: Grade customers within each segment
Marketers often use the terms “grading” and “ segmentation” interchangeably. And that’s unfortunate, since the distinction is important. The two are entirely different processes; together, they create a very powerful economic model for customer selection, in order to achieve an optimal mix.
Grading is strictly an economic concept. It is done only within a segment, defining various levels of economic value within that segment. It temporarily sets aside the issue of customer needs or other characteristics, and can usually be accomplished using only data you already have in-house.
Grading is a means of estimating the revenue currently and potentially available from that segment, allowing you to identify which groups are not only most responsive to what you have to offer, but can also help you to increase profits – and are therefore really key to the success of your business. This, in turn, allows you to make intelligent decisions about investment choices and resource allocation to acquire and nurture more of this kind of business by targeting those segments to which you can deliver superior value in profitable manner. In other words, effective grading serves as a primary building block for any firm that intends to optimize its market coverage model and to manage its customer base as a portfolio of assets that need to be managed proactively.
Here’s how it works:
Within each segment, divide all customers into five to 7 “grades,” based on the revenue you received form them over a given period of time. The top 5% are rated XL; the next 15%, L; the next 25%, M; the following 25%, S; and the bottom 30%, XS. [Historically, companies used 3 or 5 stages for their grades. We contend that less than 5 provides insufficient granularity into the insight – again, as Derrida maintains: ”the answer is always already there.”]
You can fine-tune your grading system further by determining not just raw historic sales volume, but potential or projected Lifetime Value (LTV) of these customers to you – understanding that realization of that LTV has more to do with how you treat your customers after you’ve acquired them that with the method of acquisition. Given what it costs you to acquire, supply, and service this customer … the anticipated length of time you’ll retain its loyalty … and the revenue that this will generate … how much profit will it bring to you over the expected duration of the relationship, (expressed in terms of Net Present Value)?
It’s not unusual to find substantial surprises in an LTV analysis. A demanding customer who buts primarily on price, for instance, on condition that you shave your margins paper-thin, may be less than profitable to serve – no matter how high its purchase volume. On the other hand, a smaller, relatively low-purchase-volume customer, who ranks high relative to the other criteria above, may be significantly more profitable per dollar you invest. Understanding his priorities may will pint you toward other companies with similar needs, but much larger budgets. In short, it’s critical to use your marketing imagination to manage the LTV of your customer.
Even in isolation, grading can be a significant productivity tool. Not only dies it allow us to direct our investments more effectively – it also serves as a foundation of better field sales force effectiveness plan and a targeted communications strategy, rather than treating everyone as the same or “throwing spaghetti at the wall”.