High cost of supporting the average customer

Did you know that 16 per cent of UK households account for 73 per cent of fish finger consumption? Or that nine per cent of air travellers account for 44 per cent of airline revenues? Or that the Lexus brand accounts for one-third of Toyota’s total profits, but just two per cent of its volume? Or maybe that just seven brands account for 70 per cent of Bass’ sales?

It’s tempting to consign such facts to the dustbin labelled “interesting, but so what?”. In fact, the 80/20 rule, or Pareto Principle as it’s known, is fast becoming the biggest thing to hit marketing since the invention of the modern system of mass production, distribution and advertising. Mass production is driven by “averaging”: it treats things and people as if they were identical because the cost of doing anything else far exceeds the benefits.

But today, as the information revolution unfolds, it’s crunching into reverse, driving us down the road of “deaveraging”. The journey promises to be long, complicated and extremely dangerous – and full of amazing opportunities.

The logic of deaveraging is mind-numbingly simple. To say that the average of five numbers such as one, two, three, four and 90 is 20 is true, but very misleading. This simple observation is increasingly driving business decision-making. As computer guru Michael Dell argues: “Aggregate financial statements are pretty meaningless.” Companies which are not deaveraging their business “by business, by customer, by geography, don’t know anything”.

In a crude sense, deaveraging has already dominated marketing for decades. Instead of producing products for an undifferentiated “mass” market, marketers have sought to “segment” (by attributes such as lifestyle) and “target” consumers, tweaking both product and brand communications accordingly. However, the IT revolution is catapulting deaveraging to new levels.

Stage one is huge: the realisation that, in theory at least, marketing communications could be deaveraged down to a so-called segment of one. Stage two is also familiar: the emergence of retention and loyalty marketing strategies driven by deaveraging – companies’ increasing ability to identify and woo their most valuable customers. BA’s Executive Club scheme, for example, targets 1-2 million passengers, who account for half of its 30 million flights – and a lot more than half of its profits. As O&M’s Garth Hallberg’s notes: “All consumers are not equal.”

But it’s in the next stages that things begin to get really hairy – and exciting. Stage three is when companies begin segmenting by life time customer value, moving beyond deaveraging communications and changing the nature of offers. It starts by tweaking at the edges – for example, giving frequent flyers executive lounges or regular upgrades. But it quickly moves on. For example, having discovered that its top quintile of customers are 976 times more valuable (in terms of gross profit) than its bottom quintile, one US supermarket chain has introduced what retail guru Brian Woolf calls customer specific pricing to keep that top quintile happy.

Stage four is when this process reaches back into the structure of the business. Many business-to-business operations, for example, have taken strategic decisions to “focus”. Instead of serving 100 customers in an average way, why not serve 20 customers in a deaveraged way – so superbly that you become indispensable. This is the logic of partnership sourcing.

A more radical challenge to existing businesses comes when “cherry pickers” target other companies’ most valuable customers. If you do not deaverage your own business then someone else will. Credit card companies such as Barclaycard depend on the 25 per cent of customers who maintain large amounts of rolling debt to subsidise the 40 per cent who take advantage of the interest free credit period but pay promptly. To target this 25 per cent, entrants such as the Co-op Bank are offering astonishingly low APRs but no interest free periods. If they migrate towards such superior offers, then existing “averagors” such as Barclaycard risk being left with a growing proportion of loss making customers.

Something similar is happening in utilities, where new players are targeting more affluent customers, putting pressure on incumbents such as Centrica whose 1 million poorer prepayment customers account for five per cent of its business but 20 per cent of its costs.

Which is where it starts to get extremely difficult. One conundrum for marketers is that deaveraging marches at a different pace through different types of business and different aspects of the same business. This leads to a conflict between deaveraging marketing logic and scale-driven operations logic.

It is much easier, for example, to deaverage direct mail than operations. While BA pampers a tiny minority of Executive Club members, it still needs to fill empty seats at almost any price.

This mismatch may provide start-ups with big advantages over existing brand leaders. Tesco, for instance, needs volume for its superstores like humans need air.

For Tesco, home delivery is an extra cost which may cannibalise its existing business. But a start-up home delivery company may be able to target Tesco’s most profitable money rich/time poor customers better and more cheaply.

Another conundrum is what deaveraging does to brands. Is it part of the brand’s fundamental ethos to treat all customers as if they are equally important? Does the BA brand mean the same thing to a platinum card holder as a once-a-year holiday maker? And for how long can it encompass high-class exclusivity and bargain basement promotions under the same umbrella?

A third conundrum is the social and political implications. Is the provision of banking services to those with poor prospects and low balances a purely commercial decision, or is there an element of social obligation?

Deaveraging probably has further to go.

One possible outcome is that brands will increasingly end up being built around groups of customers rather than bundles of product or service attributes. Either way, as we enter a world where the motto is “deaverage or be de-averaged”, few brands are likely to emerge untouched.