PETER FADER AND SARAH TOMS THE CUSTOMER CENTRICITY PLAYBOOK IMPLEMENT A WINNING STRATEGY DRIVEN BY CUSTOMER LIFETIME VALUE Contents Preface Introduction Chapter 1: Setting a Strategic Course to Maximize Customer Value Chapter 2: Customer Acquisition and Growing Your Best Customer Base Chapter 3: Using Customer Centricity to Tune Retention and Development Tactics Chapter 4: CRM’s Place in Creating a Value-Based Strategy Chapter 5: The Role of Customer Centricity in Corporate Valuation Chapter 6: Agile Change Management and Customer Centricity Conclusion: Customer Centricity from Concept to Playbook to Action About the Authors About Wharton Digital Press About The Wharton School Notes Preface With 18 Olympic gold medals, Michael Phelps is the most decorated athlete of all time. It isn’t surprising to learn that his training regimen would challenge demigods. At peak season, he clocks 50 miles per week in the pool and yet more hours in the gym. For other athletes wishing to join Phelps’s ranks, this all sounds like a simple enough formula to replicate: train hard, eat smart, get stronger, perform better, win Olympic gold. The problem is that training and nutrition alone can’t guarantee Phelps’s impressive collection of Olympic bling. Why not? If you train hard enough, you can achieve anything, right? In short, no. As a physical specimen, Michael Phelps was born to swim. His double- jointed ankles and size 14 feet work in conjunction with a double-jointed rib cage, meaning that his kick starts in his chest, generating a tremendous dolphin- like thrust. And even though Phelps is 6' 4", his arms measure 6' 7" from fingertip to fingertip, extending from a large and powerful torso that would be proportional for a man several inches taller than he stands. To add insult to injury for the mortals in the adjacent lanes wishing to challenge Phelps to a race, he produces less than half the lactic acid of other athletes, meaning he can quickly recover from physical exertion. Biomechanically and metabolically, Phelps was born with a substantial and natural advantage in the pool. So what does Michael Phelps have to do with customer centricity? Well, his inherent goodness as a swimmer is an analog for one of the pillars of a customer- centric marketing strategy: Even before a customer makes their first purchase with you, much of their potential value is already there, just as Phelps’s natural physical advantages were there when he was born. Sure, you can drag customers into the marketing and sales gym to develop their value a bit further, but by how much really depends on a number of predetermined factors that you don’t have much, if any, control over. You certainly won’t be able to transform the vast majority of your base into your best, most Phelps-like class of customer. On the other hand, knowing who your best customers are is not as clear as separating the winners from the losers in a quick swimming race. To get the clearest picture of a customer’s value means harnessing the insights that come from playing a long game—one that projects their entire lifetime with you. That’s what this book is about. Introduction We begin with a company that has been around for about 36 years, predating any modern notion of customer data analytics.1 Back in 2013, it was loathed so intensely by its customers that it was named the worst company in America—for the second year in a row.2 From the outside, this company appeared to be in such serious trouble that its days were surely numbered. Yet, over the past six years, its stock value has rebounded 1,000%,3 and in 2017 it managed to clear a billion dollars in profit.4 Would it surprise you to learn that the company in question is global gaming giant Electronic Arts (EA)?5 Sparking EA’s miraculous turnaround was the company’s realization that even if customers look the same on the surface, not all customers are the same—a principle that is fundamental to customer centricity. Today, we count EA in an elite class of companies that turned themselves around thanks to their steadfast commitment to their customer-centric strategy. We say steadfast because the turnaround has taken more than a decade to gain outward visible momentum, as reflected on Wall Street. EA’s turnaround actually began five long years before its stock price started to climb again, when a few data nerds working on the sales planning team decided to follow a hunch. They believed that the company was wasting vast resources in the way it invested its marketing budget—22% of revenue was spent on marketing at the time. Following this thread, the analysts wanted to see if they could use data to find a better way to advertise EA’s games. Back then, much of the budget was spent right before a game launch and went to TV ads and other broadcast spray-and-pray approaches, but no one at EA had any clear goals in mind for how to measure the returns on this spending. By optimizing a marketing mix algorithm, the data team was able to provide indisputable evidence to the decision makers at EA that the company was, indeed, spending its marketing dollars inefficiently. And thankfully for EA, the decision makers paid close attention when presented with alternatives. The result was a universal decrease in marketing dollars spent, with no negative impact to efficacy. This provided the first proof to EA that by leveraging data insights, it could forge a path to more successful decision making. When EA purchased Playfish, a digital-first gaming company, in 2009, one of those data nerds from the sales planning team—Zachery Anderson—was appointed to lead the analytics and insights arm of EA Digital. This team made it their mission to mine whatever data they could find. By standardizing metrics, they created a unified, reliable way for the company to analyze hundreds of data points. The company was abuzz with the possibilities that these newfound insights heralded, but many EA employees also worried about the company’s identity in light of this new flood of information. As Benjamin Tisdale, senior director of business analytics, reflected, many employees were asking, “Is data going to decide everything for us now? We’re a creative company, and we didn’t want to lose sight of who we are.”6 Then, in 2013, Andrew Wilson was named EA’s new CEO. Wilson decided to address head-on the tension between data-driven decision making and the need to protect the creativity of the game studios. By leveraging some key correlations that the Digital team’s analysis revealed around engagement and customer value, Wilson championed a “Player First” mantra that translated into marching orders for the entire company to understand what exactly leads to higher player engagement. As part of Wilson’s “Player First” initiative, Anderson was asked to head up a new group called Global Analytics & Insights, which started to consolidate the company’s understanding about players, showing that in-game engagement was a good proxy for the future value of individual players. In fact, engagement was the single best predictor for whether a customer would purchase other games in the future. This finding may seem obvious now, but for a company that was not digitally native and had spent most of its history thinking about its customers monolithically, this pivotal insight ignited a transformation that has touched every aspect of how the company thinks about its customers and how it designs games tailored to attract and retain its best customers. EA’s culture has since matured to a point where it values data and creativity equally, recognizing that these two approaches are symbiotic. The game designers embrace the insights data provide about player engagement, which helps inform what specifically is working and what needs to improve in the games they’re producing. The studios aren’t necessarily living and breathing in data in the same way the data teams are, but they are using these insights as guideposts to help scaffold ideas as they brainstorm new game ideas. Certainly, the financial health of the company tells us this approach is working—really well! But if player engagement is one of the best indicators of the future value of EA’s customers, then the recent stats about the popularity of EA’s games are the best news of all. EA’s 2017 end-of-year fiscal report stated: “EA was the #1 publisher on PlayStation®4 and Xbox One consoles in the Western World for fiscal 2017, based on available sources and EA estimates.”7 EA is an almost-perfect case study in implementing a successful customer- centric business strategy. EA shows us how a firm can maximize its long-term financial value—and set itself up for long-term success—by drawing on the current and future needs of customers to guide the development and delivery of a company’s products. Granted, the route to becoming a customer-centric company is not always simple or direct; in fact, some companies that think they’re already customer centric don’t even have a clear understanding of what customer centricity actually is, much less how it should be executed effectively. Thankfully, that’s where The Customer Centricity Playbook comes in. About This Book The Customer Centricity Playbook will guide you through the specifics of many customer centricity success stories, providing you with a 360-degree analysis of all the elements that support customer centricity in an organization. You will learn to develop a customer-centric strategy for your organization; understand the right way to think about customer lifetime value (CLV); make informed investments in sales, marketing, and customer service based on the customer life cycle; foster a culture that sustains customer centricity; understand the link between customer lifetime value and market valuation; and understand customer relationship management (CRM) systems, as they are a vital underpinning for all these areas through the valuable insights they provide We lay out a straightforward methodology and set of concepts that are essential considerations for any organization looking to become customer centric. In fact, the goal of wanting to better explain the underlying principles of customer centricity is what brought us, your authors, together as collaborators. Why We Wrote This Book When we met in 2013, Peter’s first book, Customer Centricity: Focus on the Right Customers for Strategic Advantage, had recently been published. It was one of the first on the subject intended for a general business audience, and it had also been translated into Chinese, Korean, and Portuguese, revealing global interest in the topic. Peter was on the hunt for a capstone experience for students of his customer centricity MBA course at The Wharton School that would bring all the concepts of the course together in a challenging and realistic way. Sarah had recently become the director of Wharton’s Al West Jr. Learning Lab, a collaborative incubator for driving the development of groundbreaking, award-winning, high- tech applications in education. When Sarah heard about Peter’s desire to create an immersive learning experience for his students, she jumped at the chance to collaborate with him. She started by reading Customer Centricity. Together, we created Wharton’s Customer Centricity Simulation, a game that realistically simulates the acquisition, retention, and loss of thousands of customers and allows learners to put the customer centricity essentials they have learned into practice to win over those customers. It took more than two years to develop, and in 2015 we successfully launched it. During this time, we learned a great deal that we realized could also help those outside the classroom who are struggling with these issues in their organizations. We soon decided to write a book that would be a true playbook for developing a customer-centric organization. Whereas Peter’s first book, Customer Centricity, makes the case for moving away from a product-centric strategy to a customer-centric strategy, The Customer Centricity Playbook shows customer-centricity converts where to start to develop and implement a winning customer-centric strategy. What’s Next Chapter 1 lays a foundation for the book by defining customer centricity, a term that is used widely but often incorrectly. In this first chapter we discuss the importance of customer heterogeneity and explain the right and wrong ways to think about CLV—a key building block for a customer-centric strategy. Chapter 2 delves into the first step in the customer journey—acquisition—and explores various strategies and tactics. We also discuss why personas and demographics are archaic customer acquisition approaches that should be retired. Chapter 3 shifts the conversation to fine-tuning retention and development activities by leveraging CLV. Chapter 4 focuses on the data analytics, technology tools, and processes that are the pillars of customer relationship management (CRM) and are all essential to customer centricity. Chapter 5 discusses the differences between traditional approaches to corporate valuation and why it is beneficial to use customer-based corporate valuation to draw a fuller picture of an organization’s financial health, which will also drive specific operational decisions. Finally, chapter 6 discusses organizational transformation, culture, and leadership, which are all key to sustaining any customer-centric strategy. Chapter 1 Setting a Strategic Course to Maximize Customer Value In this chapter, we provide a working definition of customer centricity that will carry through the rest of the book. We also delve into the issues of product centricity versus customer centricity, explore the concept of customer lifetime value (CLV), and take a look at Best Buy, which has transformed itself in recent years into a customer-centric success story. Defining Customer Centricity Despite its increased use in the world of commerce, customer centricity remains a tricky concept for many organizations to define or enact successfully. The problem lies in the fact that many organizations assume they’re already customer centric, because they believe customer centricity is all about perfecting customer service or shifting corporate strategies to better align with the needs of their overall customer base. The term certainly sounds like it has something to do with making the customer the central focus of your organization. But it doesn’t. Asking what “the average customer” is worth or how the customer will respond to various types of products and offerings is an outdated way of thinking that fails to recognize the distinct attributes of customers on a more granular level. Their propensity to buy, their tendency to be loyal, their ways of communicating with one another, their categorically different responses to the same offers—these inherently varied qualities all affect the way they react to your company, and thus their value to your company. If you conventionally consider the customer as a singular, monolithic entity, then you are selling yourself (and your customers) short. More importantly, you have not yet grasped what it truly means to be customer centric. In Peter’s first book, he defined customer centricity as “a strategy that aligns the development and delivery of a company’s products and services with the current and future needs of its highest valued customers in order to maximize these customers’ long-term financial value to the firm.”8 Key to this definition is the idea that not all customers are created equal, which means that they don’t all deserve an equal share of your organization’s valuable time and resources. To be clear, this doesn’t mean you should “fire” your worst customers or ignore them wholesale, but it does mean that you should know at what point you’re throwing away valuable resources on customers who aren’t valuable enough to deserve the level of attention you’re giving them. When someone becomes your customer, they are born to you with their own set of characteristics, categorized by preference, propensity, and potential. These traits manifest in different ways, and we refer to them collectively as customer goodness. Preference refers to the degree to which your offering aligns with a customer’s needs and the degree to which a customer chooses your offering over a competitor’s. Propensity examines the actions of your customers: their likelihood of being loyal, of referring others, of buying higher-valued offerings, and so on. Potential is the future value of each customer and what we might be leaving on the table by looking ahead; we ask ourselves, What can we do to maintain, enhance, and extract value? Once you start breaking down customer value into these three forms of goodness (among others), you realize just how heterogeneous your customer base really is —and you can better see the opportunity to grow your business by focusing on the right customers. (We discuss customer goodness further in chapter 2.) A truly customer-centric organization seeks to understand the inherent characteristics that make up its highest-valued customers, often leaning on modern customer relationship management (CRM) systems (which we discuss in chapter 4) to deliver the necessary insight and then—having gained newfound perspective—find and acquire other customers with similar characteristics. From a customer retention and development standpoint, knowing who your best customers are allows the limited resources within your organization to be spent more wisely on serving those customers better, thereby driving up the market value of your business. Customer Centricity versus Product Centricity Now that we have defined customer centricity, let’s compare the concept with another common—yet floundering—business strategy: product centricity. Many commercial enterprises still take a product-centric approach to business, which derives value creation from a lone proposition: selling as many products and services to as many faceless, nameless customers as possible. When companies ignore customer value in favor of being product-obsessed, they must organize around their products (or services9) to maximize product expertise rather than investing in strategies that will garner higher returns by seeking to acquire, retain, and develop the highest-value customers. A product- centric approach ignores customer heterogeneity and wastes valuable resources on chasing down product sales to anyone and everyone, at any cost. For an example of product centricity’s failings, look no further than shopping malls and the alarming number of store closures and bankruptcies that have happened in recent years. No retailer is immune to the bottom dropping out of their business, from small specialty stores such as Rue21, which closed a third of its stores in 2017,10 as well as large retailers such as Macy’s, which since 2016 has closed 15% of its stores, representing a loss of over 10,000 jobs.11 Indeed, 2017 was a year most brick-and-mortars would rather forget, with almost 9,000 stores in the United States closing their doors for good.12 This trend continues on a downward trajectory. A number of indices have been created to track and pick over the carcasses of struggling brick and mortars, such as Bespoke Investment Group’s “Death by Amazon” index. This index tracks the stocks of 62 retailers13 and Proshares’ “Decline of the Retail Store” (EMTY) exchange traded fund (ETF), which is composed of 56 retailer stocks. With a certain level of grotesqueness, EMTY is the first ETF designed to benefit from the decline of brick and mortars, making capital by shorting its very own Solactive-ProShares Bricks and Mortar Retail Store Index. Given that 70% of the stocks tracked in EMTY declined in 2017, with 25 stocks falling more than 20% in value,14 vulturine investment tactics like this fund are reaping some tidy returns. You may be wondering whether product centricity is to blame for such declines or whether customers are simply moving their business to online retailers with better prices. As a case study, let’s look at Best Buy, a company that for a long time looked like it would go the way of CompUSA, Circuit City, and Radio Shack. Against all odds, Best Buy has managed to rebound in spectacular fashion—a recovery that is reflected in its current status as a Wall Street darling, and that can be credited to the fact that the company pivoted to a customer- centric strategy. Best Buy: An Unlikely Customer-Centric Cinderella Story Best Buy’s stock price shot up from $10/share in December 2013 to more than $70/share at the close of 2017, indicating further robustness by gaining 50% in value in 2017 alone.15 So how was Best Buy able to contradict most analysts’ gloomy predictions that it too would go bankrupt and instead become the rare success story of a big-box retailer thriving in an Amazon era? In mid-2012, the company was in an undeniable crisis, as shown in Figure 1.1. Its stock was continuing to plummet to the point where it had lost 50% of its value in six years, made worse when a scandal erupted that implicated Best Buy’s most senior leadership: An investigation led by the board found that then-CEO Brian Dunn was having an inappropriate relationship with a female employee. The report also uncovered that Best Buy’s founder and chair, Richard Schulze, had known about the affair and had chosen not to report it. In the wake of the investigation’s findings, Dunn was fired and Schulze tendered his resignation. The board then surprised the public when it named Hubert Joly as the new CEO. Joly, an executive from the hospitality company Carlton, had spent a decade as a business consultant at McKinsey but had absolutely no retail experience. This choice left most people scratching their heads, and many wondered whether the board’s decision to hire Joly would self-sabotage Best Buy’s chances of recovery. To get a clearer assessment of the problems plaguing the company, Joly spent his first weeks visiting stores and speaking to employees. In his first report to the board, he said, “This is the most dysfunctional organization I’ve ever seen, but this is good news because this is self-inflicted, and so this is something we can correct.”16 He was right in saying this. But why? In the stores, he learned about a common practice called showrooming, where potential customers came to Best Buy to view a product in the flesh and would then search the internet for the cheapest provider, which in many cases was not Best Buy. Joly decided the only way to curtail this practice was to take price off the table, and thus Best Buy would be in a better position to compete head-on with the Amazons of the world. By making sure that any price offered by competitors was matched, Best Buy ensured that potential customers who came to its showrooms to view a product were not immediately lost when they did quick searches for the product on their phones and found a better offer. Next, Joly worked to improve the online side of the business, creating a “showcase-and-ship” strategy that leveraged the 1,000-plus big-box stores to make a network of micro warehouses. This strategy allowed Best Buy to support online deliveries that rival and in many cases beat the turnaround offered by other major online retailers.17 Why, then, didn’t Joly decide to just shift the entire business online at this point? The answer lies in an analysis of Best Buy’s customer base that was originally conducted in 2010. This study found that 55% of the company’s business came from women who sought more than simply the cheapest product.18 Rather, this highly valuable customer segment wanted help from knowledgeable staff who could assist them with assessing the comparisons, purchasing ancillary products, and, in many cases, providing in-home installation. And with technology becoming increasingly complex with products that integrate multiple devices via the Internet of Things,19 Joly also recognized an emerging demand for more expertise in product services from male and female customers alike. Indeed, smart-home integrated devices have been the fastest-growing class of customer electronics in recent years.20 Joly realized that by not catering to the service and support needs of women and customers in the smart-home category, Best Buy was inadvertently walking