What's Your Relationship Return on Investment?

by S4 Consulting

You know that you have to treat your customers right.  Your competitors are offering them high product and service quality and continually trying to chip away at your share of their purchasing dollar.  You've heard what it will take to develop and maintain strong customer relationships: customized offerings, preferred pricing, account management attention, and supporting information systems.  All of that takes money and seems to eat away at your profit margins.  You wonder, is it worth it?

The truth is, it may or may not be worth it, depending on the specific economics of each relationship.  Fortunately you can determine whether it's worth it, in each case, by analyzing those economics in terms you're already comfortable with.  All you have to do is consider your key account relationships as you do every other financial investment you make in your business.  As long as the investment provides a sufficient financial return to you, you can make those investments with confidence.

Key account relationships are no different.  RROI, or Relationship Return on Investment, is calculated the same way as a traditional return on investment.  Just follow these four steps:

1. The first thing you'll want to know to evaluate the purchase of a new piece of production equipment, or a computer, or any other business asset is the expected useful life of that asset.  For how long can you expect the asset to produce value to your business?  One way to evaluate the life of your customer relationships is by looking at the defection rates.  How many customers do you lose each year?  30%?  20%?  Your defection rate implies the life of your typical customer relationship-- a 30% defection rate implies an average customer relationship life of 3.5 years; a 20% defection rate suggests a 5 year average relationship life.  By looking at your current defection rate, you can estimate the average useful life of your relationships for purposes of projecting costs and benefits for an investment analysis.
2. If you were evaluating an investment in a new piece of equipment, the next thing you'd want to know is what kind of output you could expect it to produce.  How many pieces will the new machine make per hour?  What's the economic benefit produced by the investment?  Key customer relationships are no different.  The whole idea in a key account management program is to produce and protect a long lived business relationship between you and your customer--where your customer consistently comes back to you for the value you deliver to them.  The longer that situation continues, the more valuable that relationship is to you.  So, for your investment analysis, you need to estimate what the dollar amount of increased business, reduced marketing, selling and setup costs, and extra referral business will be for the estimated life of the relationship.  The present value of this stream of revenues and benefits is the return part of your RROI calculation.
3. Obviously, the cost of your investment is a critical element in any investment analysis.  What will the new equipment cost, including shipping and installation?  What will the ongoing maintenance and operating costs be?  The present value of these costs is the investment part of your RROI calculation.  In a key account relationship, your costs are those incremental costs you incur to take special care of your most important customers.  In this sense, preferred pricing, increased service levels and additional service delivery expenses are among the costs to be considered part of your investment in the relationship.  Perhaps, for example, you decide that your key account managers can only properly manage 3 or 4 key account relationships instead of the 20 you now have assigned to them.  The cost of the additional people required to make this change is part of your investment in the key account relationships.
4. You're ready now to calculate your RROI.  Just as in a traditional return on investment analysis, your RROI is a percentage calculated as Return/Investment.  The resulting percentage can be compared to your cost of capital and alternative investment opportunities to determine whether it appears to be an attractive investment.  Our experience is that you'll find investments in key customer relationships produce RROIs that far exceed most other business opportunities available.

We believe this kind of number crunching is important for top management to understand the importance of properly serving and managing key customer accounts.  At first, the magnitude of staffing increases and service improvements necessary to compete for key accounts may be intimidating.  But, putting those investments in terms that can be understood and compared to other business decisions will likely cause you to view them as defensible and prudent.

© S4 Consulting