Putting the 'Relationship' Back Into CRM Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for Putting the 'Relationship' Back Into CRM case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Putting the 'Relationship' Back Into CRM case study is a Harvard Business School (HBR) case study written by Susan Fournier, Jill Avery. The Putting the 'Relationship' Back Into CRM (referred as “Relationships Crm” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Supply chain.

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment

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Case Description of Putting the 'Relationship' Back Into CRM Case Study

Many managers think that the way to capture value through relationship marketing is to focus on the "good" customers and get rid of the "bad"ones. But there is a lot more to best practice relationship management than maximizing revenues on individual customers and minimizing costs to serve. The authors studied people who were in emerging, existing and terminated relationships with companies and identified three important ways in which the current practice of CRM fails. First, companies forget that their relationships are not just with consumers, but with people who live rich and complicated lives. Second, because relationships come in different shapes and sizes, companies need to be cognizant of the requirements of diverse types of relationships beyond the loyalty ideal. Finally, companies don't recognize that relationships are two-sided and that these relationships evolve with each interaction. These three failings, illustrated with examples, led to the identification of three principles: Get to know customers as people; think beyond loyalty; and take responsibility for relationships that are two-way. The authors provide guidelines for companies that want to improve the overall value of their customer relationships. They suggest that companies first catalog and analyze the types of customer relationships they have, then develop a portfolio of relationships, optimizing those they have and identifying which new ones to focus on. Companies then need to determine which metrics to use to track the health and performance of those relationships, adjusting as they go. For most companies, the transition to a relationship-based approach will require a significant shift in mindset and practice. Managers will need to expand the type of data collected by their CRM systems, customize CRM solutions to the specific types of relationships the company is managing and retrain customer-facing employees to be sensitive to the relational clues they receive and send. This is an MIT Sloan Management Review article.

Case Authors : Susan Fournier, Jill Avery

Topic : Sales & Marketing

Related Areas : Supply chain

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Calculating Net Present Value (NPV) at 6% for Putting the 'Relationship' Back Into CRM Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10015699)	-10015699	-	-
Year 1	3466992	-6548707	3466992	0.9434	3270747
Year 2	3972985	-2575722	7439977	0.89	3535943
Year 3	3940720	1364998	11380697	0.8396	3308705
Year 4	3240504	4605502	14621201	0.7921	2566783
TOTAL			14621201		12682177

The Net Present Value at 6% discount rate is 2666478

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting

What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.

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Capital Budgeting Approaches

Methods of Capital Budgeting

There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Profitability Index
2. Internal Rate of Return
3. Payback Period
4. Net Present Value

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Relationships Crm shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.
2. Timing of the expected cash flows – stockholders of Relationships Crm have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of Putting the 'Relationship' Back Into CRM

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Sales & Marketing Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Relationships Crm often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Relationships Crm needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 15 %	Discounted Cash Flows
Year 0	(10015699)	-10015699	-	-
Year 1	3466992	-6548707	3466992	0.8696	3014776
Year 2	3972985	-2575722	7439977	0.7561	3004147
Year 3	3940720	1364998	11380697	0.6575	2591087
Year 4	3240504	4605502	14621201	0.5718	1852769
TOTAL					10462779

The Net NPV after 4 years is 447080

(10462779 - 10015699 )

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Calculating Net Present Value (NPV) at 20%

If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 20 %	Discounted Cash Flows
Year 0	(10015699)	-10015699	-	-
Year 1	3466992	-6548707	3466992	0.8333	2889160
Year 2	3972985	-2575722	7439977	0.6944	2759017
Year 3	3940720	1364998	11380697	0.5787	2280509
Year 4	3240504	4605502	14621201	0.4823	1562743
TOTAL					9491430

The Net NPV after 4 years is -524269

At 20% discount rate the NPV is negative (9491430 - 10015699 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Relationships Crm to discount cash flow at lower discount rates such as 15%.

Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Relationships Crm has a NPV value higher than Zero then finance managers at Relationships Crm can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Relationships Crm, then the stock price of the Relationships Crm should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Relationships Crm should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

Understanding of risks involved in the project.

What can impact the cash flow of the project.

What will be a multi year spillover effect of various taxation regulations.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.

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Negotiation Strategy of Putting the 'Relationship' Back Into CRM

References & Further Readings

Susan Fournier, Jill Avery (2018), "Putting the 'Relationship' Back Into CRM Harvard Business Review Case Study. Published by HBR Publications.