The Customer-Base Audit: The First Step on the Journey to Customer Centricity

Introduction

Why a Customer-Base Audit?

In the course of the American Airlines Group Q3 2015 results earnings call, Scott Kirby, then the president of American Airlines, made the following comment:

A statistic that when I told people they find somewhat amazing is that 87% of the people that have flown American Airlines in the last year flew us only one time. So 87% of our unique customers fly us one time for a year or less, and they represent over 50% of our revenue.

We were surprised to read this. The numbers themselves were not surprising; any serious student of customer buying behavior would expect such a pattern. What surprised us was the fact that such a senior executive knew them in the first place.

As a senior executive, you will be very familiar with your organization’s key financial statements and monthly management reports. You have spent countless hours discussing budgets and expenditures. Focusing on the top line of the income statement, you will probably have looked at sales by product line and geography. You quite possibly have looked at product profitability as part of a product line rationalization exercise.

But how much time have you spent reflecting on the fact that these revenues are generated by customers pulling out their wallets and paying for your products and services? What do you really know about this primary source of your organization’s (inward) operating cash flow?¹

Consider the following questions:

How many customers does your firm have? How many customers do you really have?

How do these customers differ in terms of their value to the firm? For example, how many one-time buyers did you have last year? How many customers accounted for half of your revenue last year?

How many customers who bought your products last year can be expected to buy from you this year?

What proportion of your sales this past year came from new versus existing customers?

On average, what proportion of your new customers have made a second purchase within three months of their first-ever purchase? Within six months? A year?

Which of your products are most appealing to your most valuable customers?

If you are struggling to answer these questions, you are in good company. In our experience, most senior executives are unable to do so, regardless of whether their organization is primarily B2B or B2C, sells products or services, or is a for-profit or nonprofit.

Why is this the case? It reflects a fundamental failing in the reporting systems and structures of most organizations. It reflects a failure to have a true customer-centric mindset, even by many firms that claim to be customer centric.

We expect that some people, lurking in various parts of your organization, are conducting the analyses that can provide the answers to some of these questions. But it is rare to find them being pulled together in one place, let alone making their way to senior management. Yet without such a basic understanding of the foundations of the behavior of the firm’s primary source of (inward) operating cash flow, how can you be expected to ask the right questions and make informed decisions?

Enter the Customer-Base Audit

We believe that there is a set of fundamental analyses that are foundational for any executive wanting to gain an understanding of the health of their organization’s revenue and profit streams and the feasibility of their growth plans.

We call this the customer-base audit.

A customer-base audit is a systematic review of the buying behavior of a firm’s customers using data captured by its transaction systems. The objective is to provide an understanding of how customers differ in their buying behavior and how their buying behavior evolves over time.

It is important to note that we are not talking about knowing the customer through the lens of traditional market research. We are not interested in the demographic profile of our customers. We are not interested in their attitudes. We are interested in understanding their actual buying behavior.

Who would want to look at the results of such an audit?

Senior management teams and boards that recognize that to really understand the top line, they need to examine it through the lens of the customer.

A CEO who wishes to embark on a journey of making the firm truly customer centric.

Groups undertaking a due-diligence exercise as part of an M&A or investment decision that recognize the importance of understanding the health of the firm’s customer base.

A CMO wanting to get their team to start taking a more data-based approach to their planning and decision making.

A nonprofit supported by charitable donations may want to perform the associated analyses for both its financial supporters and the people it serves through its charitable activities. The same applies to two-sided markets such as Airbnb that often view both their constituencies (hosts and guests) as different kinds of customers.

We agree with the definition of analytics as the discipline that applies logic and mathematics to data to provide insights for making better decisions.² It is common to talk of four types of analytics capabilities: descriptive (what is currently happening or has happened?), diagnostic (why did it happen?), predictive (what will happen?), and prescriptive (what should we do?).

The general view among business leaders is that firms progress from simple (descriptive) to sophisticated (prescriptive) analytics engagement, with the derived value increasing as the firm adopts more sophisticated tools. We disagree with this view. At a time when everyone is caught up in the hype surrounding machine learning and artificial intelligence and believing that sophisticated equals better, the customer-base audit is unashamedly descriptive (and, to a much lesser extent, diagnostic) in its approach. Time and again, we have seen how the insights derived from these descriptive analyses can have a profound impact on a firm’s operations.

It is important to note that we are not repackaging the idea of a marketing dashboard. To start, most marketing dashboards do not have the customer as the central unit of analysis, which is rather ironic. Moreover, the customer-base audit is not a marketing endeavor. While it will surely be of interest to people working in roles associated with the marketing function, our primary audience is senior management (think CEO and CFO, not only the CMO).

More fundamentally, the dashboard metaphor implies constant feedback and immediate action. A customer-base audit is all about gaining a fundamental understanding of the behavior of the firm’s customers. It involves a serious engagement with the fact that revenue is generated by customers pulling out their wallets and paying for a firm’s products and services, and that any attempt to think about a firm’s revenue streams must start with a good understanding of how customers differ and how their behavior evolves over time.

Why are firms not undertaking the types of analyses that would answer these questions on a more systematic basis? There are several reasons. First, most managers have not been exposed to such analyses. If you have never been exposed to the idea of thinking about the customer as the unit of analysis when analyzing your firm’s revenues and profits, how can you be expected to ask such questions in the first place?

Another reason for failing to undertake these types of analyses is technological barriers, be they real or imagined: We don’t have the data, or It’s too difficult to get the data. That may have been true 20 years ago, but now it is a rather hollow excuse. (If you are working in a digitally native company, you have no excuse!)

If you are over a certain age, you grew up in a world where, even if the data were accessible, such analysis was expensive. You probably had to hire consultants to do it. It is much easier these days. Analyses we undertook 20 years ago, which required days or weeks of expert analyst time using complex software with expensive licenses, can now be done by someone with minimal training on easy-to-use software, much of which is open-source. If you have a small transaction database (fewer than one million transaction records), you can even do the analyses using spreadsheet software (such as Microsoft Excel), an exercise we do with our MBA students.

About This Book

This is not your typical business book. We are going to take a deep dive into detailed customer data. We are going to explore a set of fundamental analyses that we hope will change the perspective from which you think about what underpins the performance of your firm.

If you have read either of Pete’s two prior books, Customer Centricity and The Customer Centricity Playbook, you might be wondering how this book is different. In many ways, this book can be viewed as a prequel to those books. Similar to those books, we define a customer-centric firm as one that:

views the customer as the fundamental unit of analysis;

has (customer) acquisition, retention, and development at the core of its (organic) growth accounting framework;

makes decisions through the lens of (long-term) customer profitability; and

recognizes—and acts on—the fact that not all customers are equal.

But Pete’s two books focus a great deal on the future. He emphasizes the use of predictive models and forward-looking concepts such as customer lifetime value (CLV). However, before we look to the future and start running such models, there is plenty we can learn from the present—and the trajectory from the recent past—to guide our decision making and to prioritize our analytical endeavors.

Exploring the results (and implications) of a customer-base audit is a natural and valuable starting point for many management teams on their journey to be customer centric, as they move from mere talk to grappling with what it means for how they think about their business.

Regardless of the size and sophistication of your team of analysts—one or two people with standard Excel and database querying skills or a large group with PhDs in statistics and computer science—you can undertake a customer-base audit. In our experience, serious engagement with the issues raised via the audit has played an important role in getting skeptics on board with the idea of being more analytics- and data-driven.

If you have looked ahead in the book, you will have seen that there are lots of figures and tables. And that may be a bit scary. But have no fear: First, we will make everything clear and practical, even as we get deeper into the data. Second, that bit of discomfort is a good wake-up call. No senior executive can be financially illiterate. Anyone without the background will acquire basic accounting and finance literacy as they rise through the ranks of an organization.

Likewise, we are now operating in an environment where you cannot afford to be data illiterate; you cannot be scared off by such analyses. It is important that engaging with these types of analyses becomes second nature. Our goal is to provide a gentle introduction to a set of analyses that you can then have an analyst in your organization produce for you and your firm.

Why We Wrote This Book

Pete and Bruce started working together in the fall of 1989, when Pete was an assistant professor of marketing at the Wharton School and Bruce had just started the PhD program there. During their first decade of working together, they spent a lot of time using consumer panel data (as collected by market research firms such as IRI, Kantar, and Nielsen) to develop data-based brand choice models and new product sales forecasting models. As e-commerce took off in the late 1990s, they turned their attention to the development of predictive models of customer buying behavior that made use of the data in a firm’s customer transaction databases. Over the years, they have developed a number of key customer analytics tools for computing customer lifetime value (CLV) that have been used by thousands of data scientists and researchers around the world.

Around the time Bruce and Pete were starting to work with customer transaction data, Michael left McKinsey & Company and cofounded figleaves.com, a UK-based online lingerie retailer. Having studied mathematics at Cambridge, he was comfortable with data but had no immediate sense of what types of analyses he should undertake to gain actionable insights into the behavior of his firm’s customers. Working from first principles, he identified some basic analyses of the type presented in this book and has refined them in his subsequent start-up and consulting activities. Bruce and Michael now co-teach a course at the London Business School that covers many of these concepts and methods.

The types of analyses presented in this book have become second nature to us. And we know from working with firms that the analyses we group together under the heading of the customer-base audit can have a profound impact on an organization. However, whenever we have been asked for further readings on the topic, we have not been able to come up with a simple reading list. Some of the ideas are contained in obscure academic articles that are not easy to read. Some practitioner-oriented books touch on these topics, but do not pursue them with the full depth and rigor that they merit.

The absence of any single comprehensive book or other resource that lays out all of this content was a critical missing link in the journey toward customer centricity. We decided to address this important issue, and you now have the results of our efforts in your hands.

Chapter 1

Setting the Scene

Let us revisit the first question we posed in the introduction: How many customers do you have?

If you are having trouble providing an answer, you are far from alone. We have long stopped being surprised by the inability of most CEOs, let alone CMOs,