A Failing Grade
Why the Mathematics of CRM Don't Work
By Arthur Middleton Hughes
In many companies, Customer Relationship Management (CRM) has proven a failure. The National Retail Federation's annual CRM conference survey of North American retail companies found 69 percent of its respondents gained little or no benefit from their CRM investments. Why is that? What was CRM supposed to do?
There were two basic operating objectives:
>Build and maintain a large data warehouse with lots of information about customers and prospects accessed by million-dollar CRM software.
>Use that information to make the right offer to the right customer at the right time, thereby increasing sales and pleasing the customers.
These objectives are grounded on three assumptions, all of which proved to be invalid in practice:
Assumption No. 1: One-to-one marketing is an achievable goal given the right information and software. Customer and prospect purchasing behavior can be predicted accurately based on information you can collect about them.
Assumption No. 2: Customer and prospect behavior is heavily influenced by timely and relevant offers.
Assumption No. 3: The introduction of CRM has a positive return on investment by increasing sales and profits by more than its cost.
There has been a corruption in terminology. Many companies practice database marketing, and call it CRM because it sounds more modern and up-to-date. They don't have a data warehouse. They don't have million-dollar software. They just have a modest data mart and are creating marketing segments and then marketing to them. They call it CRM, but it is just plain old database marketing, which works wonderfully in the right situation.
The reason for using CRM is to make incremental increases in the current level of sales beyond what is being made now with mass marketing, retail stores, catalogs and database marketing. Somehow, the marketer assumes, that just knowing more about the decision-making process in the customer's mind could increase the sales level (of customers and prospects) by as much as 5 percent or 10 percent.
But will it? Let's look at an example.
Pricing the CRM Program
Let's say your company is selling some product or service for $150. It could be rental cars, small appliances or carpets. It contacts 20 million customers per year, with sales of $900 million. We'll assume that of the $150, its net profits per sale are 10 percent, after deducting all costs including marketing.
We'll assume a modest CRM warehouse contains data on 14 million prospects and past customers, and 6 million current customers. Let's also assume you can build it for $10 million including the software for access, with annual maintenance costs of $1.5 million, which includes the cost for the staff, NCOA and appended external data. Amortized over three years, the warehouse will cost $5.5 million per year.
Let's compare this to the cost of database marketing in the same situation. It costs far less. Assuming a cost of $500,000 to build the database—which will be enough to create a large corporate database with annual maintenance of $500,000—amortized over three years, this will cost about $700,000 per year.
So with these costs in hand, what will be the result of using CRM or database marketing?
Cost of Communications
To these CRM or database costs, add the cost of communications with customers and prospects. After all, if you are going to make the right offer to the right customer at the right time, you have to communicate the offer to them personally. Otherwise, what is the warehouse for? Assume that your firm has been collecting e-mails to reduce the cost of communications. It has e-mail addresses for half of all its customers. Chart A (shown on page 72) depicts the total CRM and database cost assuming an average of only three communications per customer per year.
As Chart B illustrates (also on page 72), using either CRM or database marketing, you can increase the average sale per customer by 10 percent to $165. You can do this by getting some customers to place larger orders, place more orders, by reducing your attrition rate, or a combination of these and other methods. Sales increase by $90 million with increased gross profits of $9 million. Unfortunately, when you factor in the cost of CRM, net profits decrease by $580,000. That is what virtually all companies installing CRM have discovered.
(Note: These figures assume CRM is increasing sales by 10 percent. But, in many cases, for reasons shown earlier, CRM has no valuable benefit. In the majority of companies, it does not affect the sales rate at all! Much of the money spent on CRM is wasted.)
Many companies believe a data warehouse and CRM software will achieve profitability. This is a mistake. What makes for profits is communicating with customers in ways that change their behavior for the better. You don't need a giant warehouse to do this. You don't need million-dollar software. Spend as little as possible on the database and the software. Spend most of your time studying your customers and their behavior. Dream up strategies to improve their loyalty, retention and increased sales. We need imagination and advanced strategic thinking—not expensive, massive projects.
Arthur MIDDLETON Hughes is director of database marketing strategy at DoubleClick Data Management Solutions. He is the author of "The Customer Loyalty Solution" (McGraw Hill 2003). Hughes can be reached at firstname.lastname@example.org or at (954) 767-4558.