FALL 2005
VOL. 7 NO. 1

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Smith’s Roland Rust makes the argument for moving customer relationship management into the top spot on any company’s to-do list.

nformation technology has irrevocably changed the shape of the business world. Take the frequent shopper card at your favorite grocery store as an example. Swipe your card and a computer tracks your purchases, not just that day but every time you come in, so the managers know whether you like to purchase pesticide-free organic vegetables or whether you tend more toward disgustingly decadent desserts. That information is like gold to managers, who want to know how many people are purchasing apple juice and which brand they prefer.

Using the information gathered about you, the store managers can craft an individual offer based directly on your preferences, even printing out coupons at the register for goods you purchase frequently, or goods you might like based on the things you already purchase. This highly personalized form of marketing is part of your grocery store’s strategy to secure your loyalty and retain you as a customer. Grocery A and Grocery B may have equal market share, but the store which does a better job attracting and retaining customers will be the market winner in the long run.

Almost every industry is undergoing a shift from a goods economy and product-based thinking to a service economy and customer-based thinking. Customers are part of a company’s assets (equity), and effective business leaders understand how important it is to hear and understand what their customers are saying. It’s not enough just to make a good product, price it fairly and sell it with flair. In a service-based economy, the ability to keep customers for the long term will determine which companies succeed and which companies fail.

In his book “Driving Customer Equity,” Roland Rust, David Bruce Smith Chair of Marketing at the Smith School, chair of the marketing department and executive director of the Center for Excellence in Service, with co-authors Valarie Zeithaml (a Smith doctoral alumna) and Katherine Lemon, shows how companies can make savvy decisions about their customer equity by determining which of three key factors—value, brand or relationship equity—are most important to driving customer equity in their industry and their firm. The customer equity framework is effective because it bases marketing strategies and tactics on what is important to the customer.

“The biggest mistake firms make is not thinking about customer equity. A lot of firms have a brand focus or a product focus that effectively makes the customer second,” says Rust.

Three Keys to Customer Equity

Customer equity is driven by three key factors: value equity, brand equity and relationship equity. Value equity is the customer’s objective perception of the worth of a company’s products and offerings, and includes such things as quality, price, and convenience. Brand equity is the customer’s subjective and emotional perception about the brand, above and beyond the value of the products and offerings of the company. Relationship equity is the tendency of customers to stick with a brand and a company above and beyond its value equity and brand equity; it focuses on the customer’s relationship with the firm based on the actions taken by the firm and by the customer to build and maintain that relationship.

The customer equity framework lets you put a dollar value to the measures companies take to retain customers, making marketing financially accountable in a way that was almost impossible in the past. “One of the big problems with marketing was how very difficult it was to figure out what return on investment companies were getting from their expenditures. In other areas there is a clear relationship between investment and profit—if you build this plant, or cut these costs, the company knows what sort of return will result,” says Rust. “In marketing, we spend some money over here and eventually see some sales over there, but too often the linkage is unclear.”

Rust’s customer equity model involves a statistical linkage of marketing expenditures to changes in perception, to changes in brand switching, to customer lifetime value and customer equity. “Then you begin to get a handle on return on investment, because you have a chain of effects from the expenditure to the behavioral result and the profitability that comes from it,” says Rust. “We can project the return on investment before the company spends, and we can then measure the effectiveness of the expenditure after the fact.”

The customer equity model is used to measure the effects of marketing efforts and maximize the ROI on marketing initiatives. Survey instruments are used to discover what customer perceptions are, which are combined with the evidence of their purchasing behavior; these data are then fed into the model, which uses complex statistical calculations to give companies an accurate assessment of which marketing efforts really affect customer behavior in a profitable manner.

At least three of the top 10 Fortune 500 companies (and several more Fortune 500 companies that are not in the top 10) rely on the customer equity model to assess their marketing efforts. Rust and his co-authors work directly with companies through their consulting firm, but they are not the only ones applying this academic work in the business world. If imitation is the sincerest form of flattery, Rust should be deeply flattered: a number of other consulting groups around the world also use the model based on information available in Rust’s academic papers. “Though they don’t always apply it in the way I would,” Rust comments wryly.

Playing the High-Service Game

Perhaps the biggest impact the customer equity model has is that it allows companies a way to justify the costs of increasing and improving service to customers by linking those costs and resulting revenues to customer equity. Most CEOs try to cut costs to improve profits because that is where they are able to see a financial return. “There are tremendous opportunities for companies that look at it from the other direction,” says Rust. “Companies that decide to increase service and go out of their way to provide better service to their customers will do really well, because chances are that their competitors are just cutting cost, and you can only cut costs so far.” The customer equity model provides business leaders with a way to quantify the results of their marketing efforts, and thus justify the service increase in terms of improved profits.

The ability to see the financial impact of increased services on value perception, brand perception and relationships will allow firms to play what Rust describes as the “high-service game,” as opposed to the cost-cutting game. Hotels are already in the high-service game, attempting to woo and win consumers with frequency clubs which provide special services and perks to those who stay often.

“The industry where that should be happening more, and isn’t, is the airline industry,” says Rust. “The legacy airlines—Delta, United, American—are trying to make themselves just like Southwest, but they don’t have the cost structure of Southwest. They should be trying to compete on quality rather than cost. That is a potentially winning strategy for somebody. But for CEOs, it comes down to being able to quantify the financial accountability for actually increasing services.”

The Future of Marketing

When Rust looks ahead, he sees a future of increasingly targeted brands focused on increasingly narrow markets. Information technology has fragmented the mass media market, making it impossible to really reach large groups of people anymore (with the exception, he concedes, of Super Bowl Sunday.) But what technology takes away with one hand, it gives back with the other: the astonishing amount of data available about individual consumers makes it more and more possible to customize and personalize marketing efforts—and do it in real time. Ultimately, Rust believes that in the future business world, all the value-added will be in services tailored specifically for individual consumers.

Television is a good example of this evolution. Fifty years ago, everyone watched the same three channels, providing a near-captive audience for marketing efforts. Today hundreds of channels are available. In the future, television may become an Internet-based pay-per-view experience. You may be able to choose programs in real time over the Internet, allowing you to select just the programs you want to watch, just when you want to watch them, paying a little bit for every program you watch.

Technology would also allow you to construct programs tailored specifically to your tastes. You could see the Nationals game from behind home plate, or from right field. Your customized news program could include the local news from Shanghai, the stock prices in Singapore, and the weather report for Los Angeles.

Such a world is better and better for the consumer, but it will prove more profitable for companies as well. Personalized services also allow for personalized pricing, because each consumer is offered a product unique to himself. “That will result in monopoly pricing,” says Rust. “And people will be happy to pay it, because they are getting a better product. Monopoly pricing is also higher than free-market competitive pricing, making it most profitable for companies to try to offer the greatest personalization to their customers. The key is to build the relationship over time, so the customer will stay loyal to you.”

Training Tomorrow’s Leaders

Rust writes about customer equity both in sophisticated academic journals as well as articles aimed toward the business practitioner, in magazines like the Harvard Business Review.

“A professor can’t write important, influential work without having one leg in the business world,” Rust says. “Business is an applied field; it’s important that the work we produce has relevance to the real world. I want to be able to talk to companies and affect what they do. And it’s a two way street—I get ideas from the companies I work with. They make it clear what the key issues are, and what they’re really worried about. Then I can bring that into my writing and my teaching.”

Rust’s very modern view of marketing is folded throughout the marketing curriculum, not just in the classes Rust teaches. The marketing core course for MBA students, for example, presents a very modern take on the idea of marketing exploiting the power of information technology. Smith students are being exposed to these ideas in their formative years.

Rust’s potent combination of business acumen and teaching excellence will influence the thinking of tomorrow’s business leaders for years to come. Rust says, “Teachers can teach better if they know what is going on in the business world. And if they can drive change in the business world, that’s even better. Then you are on the forefront, and you can train your students to be on the forefront.”

• Watch a video interview with Prof. Rust on Smith Business Close-Up

• PODCAST 

Marketing Department Faculty

The Smith School’s marketing department is making a name for itself through cutting-edge research on some of the most compelling issues in the digital economy. The department offers an active PhD program as well as numerous classes at the MBA and undergraduate levels. The MBA program in marketing has been named one of the nation’s top 13 programs by Business Week Online. Supporting the department’s customer focus, the department sponsors the Center for Excellence in Service, the annual AMA Frontiers in Services Conference, the Journal of Service Research, and the first MBA course in e-service. The department also has a global focus, as seen from the department's sponsorship of the Center for Global Business.

In July 2006, the Smith School will have the honor of hosting the American Marketing Association’s Doctoral Consortium, at which distinguished faculty from around the world along with the best and brightest doctoral students gather for an exchange of ideas.