February 2001
Generational Revenue Analysis
By Alan D. Campbell
Generational revenue analysis (GRA) considers how customer relationships affect revenues and profits. The basic premise behind GRA is that a company derives enhanced intangible value from knowing the source of new customers—whether from advertising, employee efforts, or customer leads or referrals—and from analyzing how leads and referrals provide incremental generations of revenue. In professional and financial services firms, GRA is especially useful for analyzing marketing strategy, cost-benefit ratios, and customer profitability.
Leads Versus Referrals
A lead occurs when someone gives the name of a prospective customer directly to a company. A referral occurs when a current customer informs a prospective customer about a company. GRA’s effectiveness depends upon a good system for recording leads and referrals and tracking the revenues and profits derived from each successive generation. The most common method for recording this information is asking new customers or clients how they learned about the business and systematically recording this information.
For example, Charles is a new customer referred by Paul. The company records Charles’ name and the revenues and profits he generates as a level-one referral on Paul’s customer record. If Charles refers a new customer, George, then the company records revenues and profits realized from George on level one of Charles’ customer record and level two on Paul’s customer record. The referral tracking can continue in this way for as many generations as desired for marketing purposes.
A lead may reflect customer satisfaction, but it could also indicate a desire to reciprocate, to satisfy a salesperson, or to receive a discount.
Most people would prefer to be referred to a company and have the choice of contact, rather than have their name given as a lead. Referrals generally outrank advertising, information from sales representatives, and other forms of marketing and promotion as the dominant influence on the buying decision.
The Referral Value Chain
For professional services firms, the ability to create a loyal customer base is the cornerstone of success. Each customer is acquainted with about 250 people, which are in turn acquainted with another 250 people, and so on. By delighting just one customer, a business has the chance to grow geometrically. Management consultant Tom Peters suggests that corporate clients consider customers as appreciating assets, just like more traditional investments on balance sheets.
Customer dissatisfaction can have the opposite effect: A study by the White House Office of Consumer Affairs found that 90% of unhappy clients will switch firms and share their dissatisfaction with approximately nine other people. Other consumer research indicates that dissatisfied bank customers complain to 11 acquaintances and dissatisfied automobile customers tell 22 acquaintances (Ivan R. Misner, The World’s Best-Known Marketing Secret: Building Your Business with Word-of-Mouth Marketing, 1994). Although amazing clients or customers with the level of service is necessary for a positive referral, something tangible that provides both an incentive and a means to referral is also important. Useful promotional items with the company’s name and contact information are particularly suited for this purpose.
Active and Passive Referrals
An active referral occurs when a customer actively recommends the company’s products or services in person, through the telephone, or by mail and e-mail. A passive referral occurs when a customer voluntarily, without compensation, does something other than directly speaking or writing to promote the company’s products or services (for example, purchasing and wearing an article of clothing that promotes the company’s services or products).
Direct and Indirect Referrals
A direct referral occurs when the individual making the referral and the new customer obtained from that referral have direct contact in person, through the mail, e-mail, or via telephone. An indirect referral occurs when the individuals referred to the company have no direct contact (for example, where contact exists solely through a message posted on a computer bulletin board). Referrals can be classified accordingly in the following matrix as a basis for additional analysis.
Examples. An active-direct referral occurs when a customer contacts another individual either in person or through a communication medium and recommends the company’s products or services. An active-indirect referral occurs when a customer does not directly contact another individual; a talk-show host’s personal on-the-air endorsement would be an example of a powerful active-indirect referral.
An example of a passive-direct referral is a customer wearing a T-shirt or cap that promotes the company’s products or services. An example of a passive-indirect referral would be a customer displaying a bumper sticker promoting the company’s products or services. A passive referral could become an active one if the individual is asked about the company.
Benefits of Generational Revenue Analysis
Applying GRA to marketing strategy, cost-value analysis, and customer profitability analysis can identify essential steps to obtain new customers at a low cost, assess the relative merits of cutting costs or adding value to the company’s products and services, and decide whether to drop unprofitable customers.
Marketing strategy. GRA leads to a clearer understanding of the source of new business by categorizing new customers into groups: those obtained through advertising, employee efforts, leads, or referrals. Categorizing the referrals in the matrix and quantifying the resulting revenues and profits will provide insights into the company’s most effective means of generating new customers. Communicating GRA findings to managers and employees through newsletters, seminars, and training sessions will focus marketing efforts.
Cost-value analysis. In a cost-value analysis, the company seeks to learn whether it can improve profits by reducing costs or adding value to its products and services. GRA can add important information to this analysis. For example, a company decides that the increased revenues from adding value to a product would be less than the costs incurred at the current volume. However, if adding value to this product stimulates referrals, the generation of additional volume could justify the costs.
Customer profitability analysis. Many companies have uncovered apparently unprofitable customers by applying activity-based costing to customer profitability analysis (the customer would be the cost object). GRA takes this a step further by considering the additional profits realized because of the customer relationship. An unprofitable customer might generate referrals that lead to more profitable sales.
Applying activity-based costing to customer profitability analysis involves the following process: Costs incurred serving the customer are accumulated in activity centers. Each activity’s cost is calculated by dividing the costs in the activity center by the number of activities. Activities are traced to the customer that uses them. The cost of the activities is assigned to the customer and the total costs of the activities performed for a customer are subtracted from the revenues earned from that customer.
Customers as Loss Leaders
GRA can be useful in identifying customers or clients that provide substantial loss-leader benefits. For example, an accountant does most of her securities trading with her broker brother but maintains a small account at another securities broker because she values the firm’s research. She refers her clients to this broker rather than her brother to avoid the appearance of a conflict of interest. Although the accountant’s account is so small that its servicing costs are greater than its revenues, profits from the referrals are significant. GRA allows the broker to recognize the true value of her relationship with the accountant.
Future versus present. The probability of a customer providing future referrals or future profitability should also be factored into a profitability analysis. A complete GRA system can obtain, usually through surveys, information about current customer demographics. An unprofitable customer might become profitable in the future or provide a rich source of profitable referrals. Moreover, it might be advisable to keep an unprofitable customer to retain the business of past referrals—even if the customer no longer provides new referrals to the company.
Editors:
Paul A. Pacter, PhD, CPA
Deloitte Touche Tohmatsu
Eyal Feiler, CPA
PricewaterhouseCoopers
Robert H. Colson, PhD, CPA
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