We helped the bank determine that supermarket and airline customers, for example, are better customers to have. Why? They have high volumes of large credit card purchases over a long lifetime ($2 million to 5 million value as a bank customer).
On the other hand, restaurant customers, for example, offer only low volumes of small credit card purchases over a short lifetime (no value or value-destroying bank customer).
The CEO of the bank was very surprised to see the stark differences in customer value by industry. We also were able to show him that much of his recent growth came from value-destroying customers. The next question was: why was he adding so many “bad” customers?
Sales Force Incentives
Further analysis showed that the bank’s sales force was generating a much higher return on their pursuit of small, low-volume, short-life merchants, for three reasons:
More attractive merchants (high-volume, long-lifetime customers such as airlines, supermarkets, casinos, department stores, etc.) were pursued by many banks, whereas the unattractive merchants (low-volume, short-lifetime customers such as restaurants, small shops, bowling alleys, etc.) were not. The sales force found unattractive merchants much easier to acquire.
Although the sales force received lower commissions for low-value customers, they still found it more financially rewarding to chase them. A salesperson needed to acquire four low-value customers to make the same commission as one high-value customer. While this seems like a big disincentive, we found that the most productive salespeople could sign 10 times as many unattractive customers in a month as they could attractive customers. On balance they were much more incentivized to sign low-value customers.
The incentives were heavily front-loaded, which meant a salesperson would receive the same commissions whether a customer lasted 24 months or 24 years. Not much incentive to pursue long-lasting customers!
Our conclusion: The sales force compensation plan was actually incentivizing salespeople to sign up value-destroying customers.
Revamping Sales Force Compensation: A 3-Step Program
Once we identified the problems in the compensation plan, the fixes were fairly straightforward:
Step 1: Realign commissions much more closely to customer value. Our goal with the revamped plan was to pay a consistent percentage (roughly 20 percent) of customer value as commission. Under this plan, a mid-sized hotel customer (200 rooms, $5 million of credit card charges per year) that was worth $20,000 to the bank would generate a $2,000 commission. A small shop ($2 million of credit card charges per year) that was worth only $1,800 to the bank would only generate a $180 commission. This resulted in a dramatic increase in commissions for the most attractive customers.
Step 2: Pay out the commission over three years (and pay less if the customer attrites early). Because customer value was highly linked our ability to retain them, we wanted the sales force to share the risk that the customer would leave.
Step 3: Re-price the value-destroying customers. Many customers simply could not create value, even before we paid commissions. They simply had too-few, too-small transactions over too short a lifetime with the bank. For example, a modestly priced restaurant might have an average credit card bill of $40 and only have 20 credit card transactions per day. Also, industry data and the bank’s own experience suggested that the restaurant was likely to go out of business within two years. Over those two years, they might generate $600 of fees but incur $1,000 of costs. For these customers, we added a large upfront surcharge and paid very low commissions. In essence, we actively discouraged the acquisition of those customers.
The net effect was a dramatic decrease in the signing of unattractive customers. We also saw a couple of happy side effects:
Low-skilled salespeople who were unable to compete effectively for attractive customers saw their pay drop dramatically and left the bank. The remaining salespeople were in many cases able to increase their pay by successfully reorienting toward more attractive customers. As a result, the bank was able to keep overall commissions flat but acquire a much more valuable new customer mix. They also ended up with a smaller, more-skilled, better-paid sales force.
Because salespeople were incentivized to care for their new customers during the three-year commission window, customer satisfaction rose after we implemented the program.
We projected these changes would increase the value of the business from the $11-12 per share it was trading at before the new plan took effect to roughly $18. A year after our engagement, the company was acquired at $18 a share
Customer value varies dramatically; every business has “good” and “bad” customers from a lifetime value perspective;
It is critical to align your sales force incentives with lifetime customer value; and;
If you give your people the right incentives, they can work wonders for you.
KARL STARK AND BILL STEWART are managing directors and co-founders of Avondale, a strategic advisory firm focused on growing companies. Avondale, based in Chicago, is a high-growth company itself and is a two-time Inc. 500 honoree. @karlstark