Posted in Customer Service The mismanagement of customer loyalty can cost a company a lot in terms of revenue. Serving loyal customers is less costly: they pay more for goods and services than other customers, and help attract new customers to the business through word-of-mouth. This is why many companies spend millions of dollars in launching effective customer loyalty programs. Mismanagement would only mean that a large number of loyal customers may not generate enough revenue and profits to sustain the business.

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They pay more than other customers, and attract new customers through word-of-mouth! Five years later, the company made disturbing discoveries: Half of its loyal customers barely generated a profit. And half of its most profitable customers bought high-margin products once—then disappeared. What happened? As recent research reveals, the loyalty-equals-profitability equation is surprisingly weak—and complicated.

Not all loyal customers are profitable, and not all profitable customers loyal. To strengthen the loyalty-profitability link, you must manage both—simultaneously. The Idea in Practice A study of 16, customers at four companies revealed surprising findings: Measure Loyalty—Accurately If the loyalty-profitability link is so weak, should you abandon loyalty programs?

Many tools generate dangerously inaccurate information. RFM also bases monetary value on revenue, not profitability. When customers buy only low-margin products, serving them may cost more than the revenue they generate. Companies chase the wrong customers—and neglect the right ones.

Example: By combining pacing with the average profit customers generate in typical purchase periods, an event-history approach lets marketers design effective loyalty strategies for each customer. Win loyalty, therefore, and profits will follow as night follows day. And it seems that many business executives agree. Indeed, for the last ten years, the gospel of customer loyalty has been repeated so often and so loudly that it seems almost crazy to challenge it.

Take the case of one U. Back in , this company set up an elaborate costing scheme to track the performance of its newly instituted loyalty programs. The scheme measured not only direct product costs for each customer but also all associated advertising, service, sales force, and organizational expenses.

After running the scheme for five years, the company was able to determine the profitability of each of its accounts over time. The answer took them by surprise.

Conversely, about half of the most profitable customers were blow-ins, buying a great deal of high-margin products in a short time before completely disappearing. In addition to the high-tech corporate service provider, we studied a large U. Collectively, the data have enabled us to compare the behavior, revenue, and profitability of more than 16, individual and corporate customers over a four-year period. Specifically, we discovered little or no evidence to suggest that customers who purchase steadily from a company over time are necessarily cheaper to serve, less price sensitive, or particularly effective at bringing in new business.

Indeed, in light of our findings, many companies will need to reevaluate the way they manage customer loyalty programs. Instead of focusing on loyalty alone, companies will have to find ways to measure the relationship between loyalty and profitability so that they can better identify which customers to focus on and which to ignore. Here we present one way to do that—a new methodology that will enable managers to determine far more precisely than most existing approaches do just when to let go of a given customer and so dramatically improve the returns on their investments in loyalty.

Is Loyalty Profitable? We expected to find a positive correlation, so our real question was how strong would it be. A perfect correlation that is, 1 would mean that marketers could confidently predict exactly how much money there was to be made from retaining customers. The weaker the correlation the closer it was to zero , the looser the association between profits and customer tenure.

The results were hardly a ringing endorsement of the loyalty mantra. The association was weak to moderate in all four companies we studied, with correlation coefficients of 0. But did the weakness of the overall correlation between profitability and longevity conceal any truth in the specific claims about the benefits of loyal customers?

We tested each of these hypotheses for all four companies by looking at several cohorts of customers at each who had begun doing business at the same time, tracking the profitability of each member of each group. Claim 1: It costs less to serve loyal customers. Many advocates of loyalty initiatives argue that loyal customers pay their way because the up-front costs of acquiring them are amortized over a large number of transactions.

But, of course, that argument presupposes that the customers are profitable in those transactions. Since they need less hand-holding, the company should find it cheaper to deal with them. Loyal—and therefore experienced—customers of software products, for example, should be able to resolve problems on-line without needing the direct intervention of a technical assistant.

Our analysis, however, offers no evidence to back that argument. It is certainly true that within any one company, the monthly cost of maintaining a relationship with an individual customer—not just for the actual transactions but also for communications through mailings, telephone, and so forth—varies enormously, sometimes by a factor of or more.

But in none of the four companies we tracked were long-standing customers consistently cheaper to manage than short-term customers. In fact, the only strong correlation between customer longevity and costs that we found—in the high-tech corporate service provider—suggested that loyal and presumably experienced customers were actually more expensive to serve.

These customers, who almost invariably do business in high volumes, know their value to the company and often exploit it to get premium service or price discounts. Indeed, we discovered that in its efforts to please the regulars, the corporate service provider had developed customized Web sites for each of its top clients. At the click of a button, these customers could obtain personalized service from dedicated sales and service teams.

What surprised us more was the weakness of the correlation between customer loyalty and lower costs in the other three companies, where we had expected to find service costs falling over time. It turned out that customers who processed their own orders through a Web site expected lower prices, which offset any cost savings the company may have garnered by using a cheaper channel.

The disparity between the cost-to-sales ratios for recent and long-time customers at the French grocery chain and the German brokerage firm was also smaller than we had expected. At these companies, too, customers expected something in return for their loyalty. These findings suggest that, at the very least, the link between loyalty and lower costs is industry specific.

Claim 2: Loyal customers pay higher prices for the same bundle of goods. Many proponents of the loyalty movement argue that customers who stick to one company do so because the cost of switching to another supplier is too high.

They will, therefore, be willing to pay higher prices up to a point to avoid making the switch. This seemed to us to be highly implausible in most corporate contexts, where customers regularly guarantee greater frequency of purchase in return for lower prices. But we did think it could describe many consumer markets. Mail-order customers, for instance, might well pay a little more for using a catalog they could find their way around.

Indeed, charging established customers more is the norm in some industries. Credit card companies routinely lure in customers with promises of low initial interest rates, only to raise them later.

What was surprising was that we found no evidence that such loyal customers paid higher prices in the consumer businesses. Indeed, we found that like corporate clients, consumers also expect, and get, some tangible benefits for their loyalty. At the French grocery chain, there was no significant difference in prices paid in any product category.

In that case, any willingness on the part of loyal customers to pay higher shelf prices was probably canceled out by the discounts many got from using the loyalty cards they were entitled to. At the brokerage house, all customers were charged the same fee—a percentage of their trade volume—regardless of their history with the company.

In general, then, it seems that a loyal customer—whether corporate or consumer—is actually more price sensitive than an occasional one. A number of theories could explain this phenomenon. First, loyal customers generally are more knowledgeable about product offerings and can better assess their quality.

That means they can develop solid reference prices and make better judgments about value than sporadic customers can. This was certainly in evidence at the mail-order company; loyal customers typically would choose cheaper product alternatives—a lower-priced blender, say—in the catalogs than would those who were less familiar with the company.

Perhaps more fundamental, though, is the fact that customers seem to strongly resent companies that try to profit from loyalty. Surveys consistently report that consumers believe loyal customers deserve lower prices. This may well explain why U. Remember how close Amazon came to destroying its brand when it attempted to charge different prices to different customers for the same DVDs.

Claim 3: Loyal customers market the company. The idea that the more frequent customers are also the strongest advocates for your company holds a great attraction for marketers. Word-of-mouth marketing is supremely effective, of course, and many companies justify their investments in loyalty programs by seeking profits not so much from the loyal customers as from the new customers the loyal ones bring in.

First, to gauge the extent of passive word-of-mouth marketing, we inquired whether they named the company when asked to recommend a particular grocery retailer.

Then, to measure the level of active word-of-mouth marketing, we asked whether they ever spontaneously told friends or family about positive experiences with the company. Overall, the link between customer longevity and the propensity to market by word-of-mouth was not that strong. But when we looked at attitudinal and actual loyalty separately, the results were intriguing. To identify the true apostles, companies need to judge customers by more than just their actions.

But if managers are investing in a loyalty program for its supposed marketing benefits, then they are looking at a potentially misleading indicator. Customers may well buy all their groceries at the same supermarket out of inertia and convenience. Knowing When to Lose a Customer Our empirical findings are clear-cut. The link between loyalty and profits is weaker than expected, and none of the usual justifications for investing in loyalty stands up well to examination.

In our opinion, the reason the link between loyalty and profits is weak has a lot to do with the crudeness of the methods most companies currently use to decide whether or not to maintain their customer relationships.

The most common way to sort customers is to score them according to how often they make purchases and how much they spend. Many tools do that; one of the most familiar is called RFM which stands for recency, frequency, and monetary value. Mail-order companies in particular, including the one in our study, rely on this tool to assess whether a customer relationship merits further investment. This company measures recency by finding out from its database if the customer bought something in the last six months, between six months and a year ago, or more than a year ago, assigning a higher score the more recent the purchase.

It then measures how frequently the customer made purchases in each of those three time frames—twice or more, once, or never—assigning a score in a similar way. Then it adds the two scores together. In general, the more items a customer purchases and the more recent the transactions, the higher the overall score and the more resources the company lavishes on the person. In actual application, many companies weight the scores in favor of recency. Unfortunately, our study of the mail-order company suggests that scoring approaches of this kind result in a significant overinvestment in lapsed customers.

As the graph shows, the company started to incur losses on these customers after about 20 months. Many nonloyal customers can be very profitable initially, causing companies to chase after them in vain for future profits.


The Mismanagement of Customer Loyalty

Kumar report that there is little correlation between customer longevity and company profits. Long-time customers have expectations for and often receive more attentive service, greater discounts, and tend to be resistant to cost-cutting changes, such as moving from phone to Web communications. The authors suggest measurement tools to evaluate customer behaviors and strategic management tips to make customers more profitable. Kumar As valuable as segmentation is, even more valuable is correct identification at the individual level. At the corporate service provider, for example, we were able to predict how profitable and how loyal any particular customer would be with 30 percent more accuracy than we obtained using traditional methods like RFM [recency, frequency, and monetary value]. That kind of misinformation carries a high price. Our mail-order company, for instance, was sending mailings to people it should have ignored, ignoring people it should have been cultivating, and sending the wrong material to people.


Mismanagement of Customer Loyalty

They pay more than other customers, and attract new customers through word-of-mouth! Five years later, the company made disturbing discoveries: Half of its loyal customers barely generated a profit. And half of its most profitable customers bought high-margin products once—then disappeared. What happened?

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