According to Larry Selden and Geoff Colvin, there is a way to fix this problem: manage your business not as a collection of products and services but as a customer portfolio. Selden and Colvin show readers how to analyze customer data to understand how you can get the most out of your most critical customer segments. The authors reveal how some companies (such as Best Buy and Fidelity Investments) have already moved in this direction, and what customer-centric strategies are likely to become widespread in the coming years.
For corporate leaders, middle managers, or small business owners, this book offers a breakthrough plan to delight their best customers and drive shareowner value.
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The Trillion-Dollar Opportunity YouÆre Missing What It Meansùand What ItÆs Worthùto Be Truly Customer Centered True Story
A customer of a major money-center bank wanted a mortgage recently. He looked like every bankÆs dream customer. HeÆs a highly active trader through the bankÆs stock brokerage services, paying huge commissions, which are extremely profitable for the bank. He also keeps lots of money in the bank, and those large balances are very profitable as well. One thing he didnÆt do was borrow much from the bankùhis current mortgage was with another institution. Note: Mortgages can be highly profitable for banks. So when the day came that this customer wanted to refinance his old mortgage, he called the bankÆs mortgage department. He was sure theyÆd be delighted to hear from such a terrific customer as him.
It was as if he had called the Bank of Outer Mongolia.
The mortgage department had no idea whether he was a good customer or a bad oneù highly profitable or break-even or unprofitable. They gave him the same treatment and made him the same offer as if he were a stranger who had walked in off the street. He would have to fill out endless paperwork, even though the bank already had much of it. He would have to pay the same fees and interest rates as anyone else. When would the bank make a firm offer of the terms of the mortgage? They couldnÆt really say. In fact, the mortgage departmentùbeing ignorant of the customerÆs history with the bankù couldnÆt even offer him assurances that heÆd get the mortgage at all.
Instead of just being miffed, this customer called the manager of the branch where he has his accountùa manager who knew just how valuable this guy was. Then he patched in a manager from the bankÆs mortgage department. These two managers had never spoken to each other before. DidnÆt it make sense, asked the customer, for him to get his mortgage and get it at advantageous rates in light of his long history and high profitability with the bank? If he didnÆt, heÆd certainly see if some other bank could be more accommodating. ôSorry,ö said the mortgage manager, who explained that his hands were tied. This bank, like most major banks today, is the product of several mergers, and after the last big one all mortgage managers were put on a very short leash until the integration got worked through. He was strictly forbidden to do anything special for this or any other customer. ôWait!,ö said the branch manager, now pleading with the mortgage manager in an effort to keep this customer. ôIÆll pay you the first-year costs of giving this customer a better mortgage dealùjust give it to him! Make him happy! We make loads of money with this guy!ö ôSorry,ö said the mortgage manager. ôIÆm not allowed.ö
The customer got his mortgage someplace else, at an institution that could see what he was worth and was hungry for the business. He gradually began shifting his trading from the Bank of Outer Mongolia to the new institution as well. So the bank not only blew a great opportunity to deepen its relationship with this highly profitable customer, it let a direct competitor take a significant piece of the customerÆs business. And it made the customer angryùa lose-lose deal. Bottom line: a complete disaster for the bank. ItÆs no surprise to find that this bankÆs financial performance is lousy. Its ROE (return on equity)1 is a dismal 10 percent and falling; profits and its stock price have been plunging, and its P/E (price-earnings) multiple is much worse than mediocre, about half the average P/E for the S&P 500. As we write this, the newspapers are full of rumors that the CEOÆs days are numbered.
Sound like any bank youÆve done business with?
Now suppose that instead of this ludicrous, frustrating experience, the customer had encountered something different. Suppose the manager he spoke to wasnÆt in charge of mortgages or a branch but was in charge of him and customers like him. The manager knew everything about the customerÆs relationship with every part of the bank and exactly how profitable he was because this information was available on a computer screen at any time. More important, this manager was accountable for the profitability of this customer and others like him. A few layers up in the organization was an executive whose entire job was to manage the customer segment to which this customer belonged (the bank might call the segment something like ôwealth buildersö). Other parts of the bankùmortgages, deposit accounts, brokerage services, branchesùfunctioned as internal suppliers of products, services, and distribution to this executive and the handful of other executives who were in charge of other customer segments.
Does this sound crazy? LetÆs get really radical: Suppose these segment executives had profit-and-loss responsibility. Suppose the bank could calculate the profitability of each individual customer or customer segment, and these executives were on the hook to deliver specific, budgeted improvements in their segmentÆs profit each quarter.
In this kind of organization, what kind of experience would our bank customer have had? Most likely one that was markedly betterùfor him and for the bank.
This fantasy bank is no fantasy. ItÆs Torontoûbased Royal Bank, which has reorganized its huge Personal and Commercial division in exactly this way. The results have been astonishing. The division has reduced expenses by $1 billion, in part because those product areasùmortgages, deposit accounts, etc.ùare no longer fiefdoms with their own separate administrative infrastructures and their own marketing efforts, which were often aimed in an uncoordinated way at the same customers; everyone in the bank realized that loads of money was being wasted as a result, yet it was virtually impossible to do anything about it. At the same time, the division is ahead of schedule in increasing revenues by $1 billion, a natural result of trying to meet customersÆ total needs rather than trying to sell individual products and services. ThatÆs a $2 billion swing, which the bank is sure resulted from its new approach to business. Because of the bankÆs high fixed-cost structure, most of that money fell to the bottom line. By contrast with the financial performance of the Bank of Outer Mongolia, Royal BankÆs Personal and Commercial division earns a return on equity of about 25 percent. If the division was a freestanding business, we calculate that its excellent profitability and growth prospects would win it a P/E greater than the S&P 500 averageùeven though most banksÆ P/E multiples are way below the average. And the stock of the corporation has outperformed that of most North American financial institutions over the period.
Other than these radically different financial results, whatÆs the difference between Royal Bank and the bank that failed so dismally in dealing with our unhappy customer? Not much, by most criteria. TheyÆre both giant, long-established banks offering a full line of financial services to millions of customers. Both have computers loaded with stunning amounts of potentially useful data about those customers. The most important difference between them is much deeper than matters of size, products, or even the business theyÆre in. It is that these banks conceive of the way they do business in profoundly different ways. Specifically, one of them, Royal Bank, has put customers at the center.
Do You Have Any Unprofitable Customers?
Maybe youÆre thinking, ôThatÆs fine for a bank, but my business is very different.ö ThatÆs just not the case. No matter what business youÆre in, the principles weÆre talking about apply to you. We believe that virtually every company in every industry will soon have to reconceive its way of doing business along these lines, with customers at the center. Why? Because the evidence is overwhelming that this is every companyÆs number-one opportunity to create new shareowner wealth, which is something all companies desperately need to do. Consider: Even when the U.S. economy was booming from 1995 to 2000, most of the biggest companies either failed the most basic test of businessùthey didnÆt earn their cost of capitalùor they passed by the slimmest of margins.
We know for sure that companies did much worse through the slowdown that followed the stock market bust in 2000, despite heavy layoffs, divestitures, and other heroic cost cutting. To put this in the starkest terms: Most companies are failing to achieve what they must achieve to make their share prices rise.
ThatÆs a big problem. In trying to solve it, the typical executive looks for troubles in the companyÆs products or business units or territories, which sounds sensible. But that kind of conventional analysis is no longer good enough because itÆs typically applied to all customers, profitable or not, high potential or low, in the same way. Ever more brutal competition, combined with demanding capital markets and suspicious investors, is challenging managers to rethink their businesses in a fundamentally new way. A number of companies are beginning to do so, using a crucial new insight: If a companyÆs return on capital2 isnÆt much better than its cost of capital, then its trouble is even deeper than bad products or business units or territories. By definition the company must have a boatload of unprofitable customers.
This is a huge idea: A company consists of both profitable and unprofitable customersù angels and potential demons. Some customers are making your company more valuable while some are draining value from it. Not that the demons are bad individuals; frequently theyÆre unprofitable simply because the company doesnÆt know who they are and is failing to offer them the right value proposition. Similarly, managers may be blissfully unaware of which customers are the all-important angels. Combined, your angels and demons determine your companyÆs value. This doesnÆt fit the way most managers run and measureùand thus think aboutùtheir businesses. Yet itÆs obvious that all the profits and value of a company come from its profitable, high-potential customers. If your company has a market capitalization of $20 billion, that value depends entirely on the future profitability of your existing customers and your ability to attract and retain profitable new customers in the future. Thus the first of the three most important principles that emerge from our work and that we will come back to again and again: ,Principle No. 1: Think of your company not as a group of products or services or functions or territories, but as a portfolio of customers.
We will see in almost endless ways why this perspective is so extraordinarily valuable, but to get a basic sense of it, just answer this question: Does your company have any unprofitable customers?
We recently asked that question of the top executives at one of AmericaÆs major retailers. (By unprofitable, we meant failing to earn the cost of capital.) Your answer may well be the same as theirs: No. Amazingly, these executives were quite confident they had no unprofitable customers, even though their business overall was failing to earn its cost of capital. If youÆre baffled by the apparent illogic of this position, well, so were we. Yet this companyÆs leaders insisted that through some dark financial voodoo, millions of profitable customers somehow added up to an unprofitable company.
Our analysis of customer profitabilityùan exercise they had never conducted and werenÆt even sure quite how to conductùshowed them they were wrong. The truth, which shocked them, was that some of their customers were deeply unprofitable. Understand the importance of what this meant: Doing business with these customers on current terms was reducing the firmÆs market capitalization by hundreds or thousands of dollars per customer. Since the company didnÆt understand these facts, it was aiming marketing efforts at these customers and others like them. So hereÆs how absurd the situation was: This company was actually spending money to bring in customers that were reducing the value of the firm.
If you believe your company has no unprofitable customers, we hope youÆre right. But experience has shown us that, like the executives of this retailer, youÆre probably fooling yourself. WeÆve found that most companies have some very unprofitable customersùas well as hugely profitable customersùbut managers rarely believe it or know who they are. In fact, as weÆll see in later chapters, the bottom 20 percent of customers by profitability can generate losses equal to more than 100 percent of total company profits. Even if you know you have unprofitable customers, you may be clueless what to do about it. (ôWe canÆt fire customers, can we?ö some managers ask; the answer is that in some cases you can, as we shall explain, though thereÆs almost always a better alternative. Those demons can often be exorcised.) Yet if a company canÆt figure out a way to earn at least its cost of capital with individual customers or customer segments, itÆs just a matter of time until its share price gets crushed. These days thatÆs something no company can afford to risk.
But suppose your company is fabulously profitable already. Are you immune to unprofitable customers? We doubt it. We have examined the customer profitability of two of the most profitable companies in North America and found that 10 percent to 15 percent of their customers are hugely unprofitable. So even in these cases, managers have an opportunity to make their company still more profitable.
ItÆs crazy so many managers refuse to believe they lose money on some customers. Wall Street analysts should be all over this issue, digging deeply into the facts of customer profitability at the companies they cover, especially at companies that are failing to earn their cost of capital. Yet most analysts arenÆt doing so. In fact, two of Wall StreetÆs top- rated food retailing analysts told us unequivocally there are no unprofitable customers at any of the companies they cover. Little did they know: We had performed analyses at some of these very companies and had found, as we find at every company, that some customers were deeply unprofitable. Yet the news wasnÆt all bad, for we also discovered highly profitable customers at these companies. But the analysts didnÆt have a clue.
A Better Way to Boost the Share Price
These analysts, like most managers, are missing what we consider the most powerful way to understand the true economics and influence the share price of a company: analyzing the profitability of its portfolio of customers. Here we begin to see the second of the three vital principles that leap out from this work and that will be elaborated much more fully in Chapters 2, 3, and 4:
Principle No. 2: Every companyÆs portfolio of customers can and must be managed to produce superior returns for shareownersùmeaning a consistently better than average share price appreciationùnot just to produce earnings per share or EBITDA or revenue growth or customer satisfaction or anything else.
This sounds obvious. Why is it so important? Because it truly is a matter of corporate survival, now more than ever. Capital today travels around the globe instantly, continually, relentlessly seeking its best use. Information about your company and everything that affects it is far more widely available than ever in history, and it, too, travels instantly, globally, continually. Every company now gets a daily report card, in the form of its share price, on how itÆs doing in the worldwide competition to attract capital, and the grading is getting tougher. Even in Japan and Germany, former bastions of what some analysts used to call, admiringly, ôpatient capital,ö the party is over. No capital is very patient anymore. Global capital is demanding performance, and companies that donÆt deliver are finally being forced to do the unthinkable: fire CEOs, reform boards of directors, and face the new music.
This new imperative is truly unavoidable. Even if your company has an eccentric majority owner who just sits at home watching MTV and couldnÆt care less what his stock is worth, failure to beat the crowd in making it worth more will lead to trouble in the companyÆs day-to-day operations:
The best employees, who increasingly want to be paid partially in stock so they can participate in the success they help create, wonÆt want to join a company that lacks a reputation for creating superior returns for shareowners. Further, companies that donÆt offer stock-based compensation may have a tougher time holding excellent employees; if theyÆre paid only in cash, itÆs easy to leave for a better deal elsewhere. Without the best employees, the company will only go further downhill.
A history of poor value creation makes new capital more expensive to attract, so the company will have a harder time funding research, development, and expansion that will let it serve customers better. As disaffected customers turn elsewhere, the situation gets worse.
Companies often need to buy other companies in order to acquire technology, customers, or employees and keep them out of competitorsÆ hands. Valuable shares make an excellent currency for such acquisitions, but if a companyÆs shares havenÆt grown sufficiently in value, then these acquisitions may be too expensive. The companyÆs competitors win these prizes instead, and yet another downward spiral begins.
We hope itÆs obvious that creating superior returns for shareowners isnÆt just in the shareownersÆ interest. ItÆs in everybodyÆs interest. The company that creates tons of shareowner value will employ more people, pay more taxes, and serve more customersù all while enriching shareowners, who nowadays are most likely ordinary citizens who need their pension funds and mutual funds to perform well in order to pay for retirements and college educations. Failing to create superior shareowner value means none of these good things will happen.
Now a number of leading companiesùincluding Dell Computer, Torontoûbased Royal Bank, Fidelity Investments, Best Buy, BritainÆs Tesco, and othersùare getting a grip on their portfolio of customers and managing it to build substantial competitive advantages. What they are doing contributes powerfully and quickly to topline growth, profitability, and a rising share price. The risks of not putting customers at the center therefore become unbearable, and companies that donÆt do it will face an ugly future. Companies that do it ahead of their competitors will position themselves to dominate.
We must declare up front that this isnÆt easy to do. ThatÆs good news and bad news. The bad news is that it will strain your organization and require a lot of work. The good news is that it will probably be just as hard for your competitors. The even better news is that putting customers at the center offers significant first-mover advantages. So if you can do it first, your company may be able to establish competitive advantages that will last an extraordinarily long time.
Why YouÆre Not Really Customer Centered
What weÆre asserting here is much more far-reaching than you may be tempted to think. We can hear you (or your boss) objecting: ôWe already do this!ö The fact is most managers will insist they already put customers at the center. ôWe put our customers first!ö and ôWeÆre committed to our customersÆ success!ö claim virtually all companies. Indeed, customer centric is one of the loudest business buzzwords of the era. One of AmericaÆs largest retailers, which weÆll identify in a moment, claimed in 2001 to have just three ôstrategic imperatives,ö one of which was ôcreating a customer-centric culture to better satisfy and serve our customers.ö A Wall Street analyst reports that one of this retailerÆs top executives told him at the time, ôWe have a heightened sense of urgency and a clear focus on the customer, and we are working as one unified team to make retail history!ö Which retailer was this? It was Kmart. We have to admit the firm did make retail history: In 2002 it filed the largest bankruptcy petition of any retailer, ever. The claims of customer centricity at most companies are an outright fraud. These companies donÆt put customers at the centerùnot really, not as if they truly mean it, not like weÆre talking about. If you doubt that, ask three questions:
1. Who in the company ôownsö the customer? That is, which one, specific, identifiable person is responsible for understanding a designated customer or customer segment thoroughly, for figuring out those customersÆ total needs and desires, and for figuring out and executing a value proposition that meets them better than the competition, driving the share price as a result? At most companies the answer is: no one. Or rather, more insidiously, the proudly declared answer is, ôLots of people own the customer!ö But when a number of people have responsibility for any given customer, the truth is that nobody owns him. Probably not one of those people is responsible for the customer on behalf of the whole company. Instead, each probably represents only a part of it, most likely a product or a function or a territory. Employees in any of those organizational areas may say they own a given customer, but they canÆt all own him. In fact, they are responsible only for those needs and desires of the customer that happen to intersect with the employeeÆs area of the organization. Does this arrangement seem logical? It does to the vast majority of companies everywhere, which are organized in exactly this way. Just remember that it is precisely what got the Bank of Outer Mongolia into so much trouble.
2. Who is accountable for the profitability of any given customer or customer segment? Again, the answer is usually: no one. In fact, as we will see in shocking detail very soon, most companies donÆt even know how profitable any customer is. ItÆs ludicrous to claim youÆve put customers at the center if you donÆt know which ones are making you money and which ones are costing you money, and no one is in charge of managing profitability through creating, communicating, and executing value propositions.
3. How significantly does the company differentiate its interaction with different customers? Companies that put customers at the center donÆt treat them all the same. On the contrary: These companies understand the importance of a mutually beneficial value exchange, treating different customers very differently because they know that customers have widely varying needs and desires. Meeting these needs better than competitors offers the company the opportunity for earning superb profits, thus turbo-charging its stock. To treat all customers the same makes no senseùyet many companies try hard to do just that and even try to claim that itÆs a virtue.
For most companies, answering these questions in a customer-centered way amounts to a deep reconception of how they do business. ItÆs a real mind bender for many business people, but the companies doing it are hardly the ones youÆd think of as radical. Royal Bank is 138 years old and has 10 million customers. Dell Computer is the worldÆs largest maker of personal computers. Fidelity Investments is one of the worldÆs largest sellers of mutual funds. The surprising fact is that many of the companies at the leading edge of a clear trend toward putting customers at the center are big, establishedùand producing spectacular results.
Remember Where the Money Comes From
Putting customers at the center has always made sense for a simple reason that seems so obvious it wouldnÆt be worth saying except that managers continually forget it:
Customers are where the money comes from. We will return to this simple but profound truth a number of times because it is, after all, the ultimate reason for putting customers at the center. Ignoring it will almost always get a manager into trouble, if only because it will render him unable to maximize profitability.
Consider: If your company is organized around products, then top management makes decisions based on measures of product revenue or product profitability. But that is not really what management most needs to know. Why? A major retailer with which we worked was earning a handsome profit selling certain dresses to Customer A and losing money selling those very same dresses to Customer B. The reason was that Customer B demanded an enormous amount of the salespersonÆs time, made lots of returns, was always unhappy with alterations, causing rework, and always paid her house charge account promptlyùa potential demon. If the retailer had known this, it might have found ways to turn that demon into a profitable angel, perhaps by discouraging returns (ôLetÆs make sure this is the right size, shall we?ö), by offering a broader selection of sizes to replace problems with alterations, or by offering the customer highly profitable products (shoes, handbags, belts) that would logically go with the dresses but that she hasnÆt been buying.
Most companies, however, amalgamate all their financial data into a measure of product revenue or profitability. As a result, the clueless product manager in charge of those dresses just keeps trying to sell more of them, and her effortsùrepositioning the garments on the sales floor, motivating sales and alteration people, running advertising, and sending out mass direct mailingsùmay very well cause Customer B to continue behaving in an unprofitable way, dragging profits further downward. Because product managers typically have no idea which customers are profitable and which ones arenÆt, they waste lots of resources on the wrong products and customers and leave vast amounts of money on the table by not fully meeting customersÆ needs.
The benefits of putting customers at the center go far beyond fixing unprofitable customers. When accountable operating executives focus on customer segments rather than on products, functions, or territories, their behavior changes. Rather than just trying to sell more of the product or service for which theyÆre responsible, they try to fulfill more of the customerÆs total needs. In the previous retail example, the accountable executive focuses on customer segments. She may discover that some of the highest profit potential customers may be petite Asian women who require extensive, expensive alterations due to lack of appropriate sizes. Fixing this problem could easily spark huge increases in profitability through lower costs and increased revenue.
Rather than trying only to take product market share away from direct competitors, managers try also to capture more of specific customersÆ total spending. Their perspectiveùand the companyÆs opportunities for profitùexpand enormously. This observation leads us to the third of our three vital principles:
Principle No. 3: Companies enhance customer profitability and drive their stock by creating, communicating, and executing competitively dominant customer value propositions.
Consider our bank customer. For the Bank of Outer Mongolia, this story is even more tragic than it first appears. Not only does this customer trade lots of securities through the bankÆs brokerage operation, he also does loads of trading through other institutions as well. He maintains big cash balances at the bank but also elsewhere. He buys insurance, but not through the bank. Someday soon he will need trust services. HeÆd like technical help getting his whole financial life on-line and would be happy to pay for it, but he doesnÆt even know where to start. In short: huge opportunities for the bank.
Needless to say, no one at the bank knew any of this. Yet someone there could have known all of it and more, either through third-party data sources or simply by paying attention to the customer. (For example, just knowing how much money he made by trading should have tipped off managers that he wasnÆt keeping all his cash balances with the bank.) Armed with this knowledge about the customerÆs specific needs, the relative importance of these needs, and the degree to which competitors were meeting them, the bank could have put together a knockout customer-value proposition to attract all of this customerÆs financial services business: lower commissions and faster execution on his trades, lower interest rates charged on his margin debt, higher interest rates paid on his cash deposits, a better deal on his mortgage, lower premiums on his insurance, technical help getting his finances on-line, and trust planningùthe customer would have been better off in every way. WeÆre well aware that if it isnÆt careful, the bank could discount itself to a loss. But in this case the bank could have been much better off because it could have more total business and more total profit from this customer even after allowing for discounts. Indeed, if the customerÆs primary need was saving timeùone-stop shopping with a single, high-quality point of contactùdiscounts might not have been needed. His relationship with the bank would be so deep that competing banks would find it almost impossible to pry him loose. Because the bank would know him so well, it could offer him products and services tailored to his needs, on which the margins would likely be substantial. The customer would be such a fan of the bank that heÆd help generate new business through friends, family, and business associates. The bank would be more profitable immediately and for years in the future.
But of course none of this happened.
This customer went to the head of the bankÆs retail operations. He called him and told him this story. Yes, said the executive, it sounded all too familiar. HeÆd love to do something about the situation. Trouble was, every idea for addressing the problem seemed to take power away from the managers who ran the product fiefdomsù mortgages, brokerage, etc.ùso they found ways to kill every proposal. Because this bank puts products at the center, not customers, it never came within a million miles of realizing its huge opportunity with this customer or the thousands like him. Nor does it even realize how awful its performance is, since it measures itself against other similarly awful institutions and therefore thinks itÆs doing fine. Heaven help it if Royal Bank ever comes to its turf."
Table of ContentsAngel Customers&Demon CustomersAcknowledgments
The Trillion-Dollar Opportunity You're Missing
What It Meansand What It's Worthto Be Truly Customer Centered
Will This Customer Sink Your Stock?
Understanding How Your Average Customer Creates or Destroys Shareowner Value
The Astonishing Truth About Customer Profitability
The Surprising Things You Discover When You Learn How to "Deaverage" It
Managing Customer Profitability the Right Way
What Your Real Goal Is and a Practical Scorecard to Track Progress
Organizing Around Customers
Why Do It and Why More Companies Don't Do It
The Right Way to Segment Customers
Reconceiving Your Company as a Customer Portfolio
Knowing and Winning Customers
The Beginning of Value Proposition Management
Driving It to the Ledger
Making Value Proposition Management Pay
Becoming Truly Customer Centered
The Nuts and Bolts of Making It Happen in Your Organization
A Better Way to Do M&A
How to Stop Takeovers from Making Shareowners Poorer
Your Action Plan
What to Do on Monday Morning
Most Helpful Customer Reviews
Recommended to me by someone at Best Buy, where it is taken very seriously. This book starts observes there are "good" customers (profitable), and "bad" customers (costly), and how to manage your business based on this. The message is clear, with helpful suggestions and real world examples. Bonus points for stressing the critical role that IT plays in enabling a business strategy around this (CRM, specifically).
How many companies call themselves 'customer-centric' while failing to see issues through customer eyes? Larry Selden, professor emeritus of finance and economics at Columbia University, and Geoffrey Colvin, senior editor at large at Fortune magazine, argue in 'Angel Customers & Demon Customers' that any company that claims it's customer-centric is 'an outright fraud' unless it can pass a three-part test. Is there a specific person who 'owns' the customer and can develop specific value propositions? Who is accountable for the profitability of a customer or segment? And how significantly does the company differentiate interactions with customers? The subtitle is 'Discover Which is Which and Turbo-charge Your Stock,' which summarizes the book's premise well. The only way to achieve a P/ E superior to the market - not your industry - is to understand that a company is no more than a portfolio of customers. Companies who want a superior stock price must understand the relative profitability of customers, develop different value propositions for customers of varying profitability, and organize around customers. 'You can build gross margin by making capital investments that reduce labor costs; it works because the capital costs aren't included in gross margin. You can buy market share with price cuts. You can increase customer satisfaction and retention through all sorts of giveaways to the customer that will cost the company dearly. Only by looking at customer economic profit and a contribution to a premium P/E can one make a sound judgment about the success of an initiative,' say the authors. Selden and Colvin offer a new way to calculate customer equity, although, curiously, the term is never used. A 'Customer Segment Value Creation Scorecard' divides each demographic or other segment into current, new and lost customers. Sales to each group are broken out by products, services or intellectual capital, and reflect cross-sells and up-sells. Costs include COGS (costs of goods sold), account management, acquisition costs and, interestingly, Customer Knowledge Management (CKM), which represents the costs of acquiring, maintaining and using customer information. Subtracting these costs (and taxes) from revenues gives the familiar figure of net operating profit after tax, reached in a new way. Then the approach grows complex. Using these figures, companies can then calculate return on invested capital (ROIC) for each category of customer. The ROIC for each customer segment is used to calculate current and future P/E. Understanding the explanation of how to calculate future P/E would have required someone with much more financial expertise than I have. Knowing the current and future P/E lets companies determine which customer segments are profitable, and which are dragging down shareholder value. Once the Customer Scorecard is complete, companies must first understand why the segments studied generate excellent or subpar returns, and alter strategies accordingly. The next step is to organize around specific, mutually exclusive customer segments instead of products, regions or functions. Such an organization produces both higher returns on invested capital as well lower capital costs resulting from higher retention. For example, Fidelity Investments transformed its structure from one based on marketing, distribution and other functions to one centered around four customer segments - Private Wealth Management, Active Traders, Core Customers, and Retirees. Each segment's customers are then grouped by profitability decile to guide resource allocation. Once this grouping was done, Fidelity found that 10% of customers in the Private Wealth Management segment - those with more than $2 million invested with Fidelity - were u