Wednesday, May 28, 2008

Loyalty Impact on Market Share

I have written a number of blogs about customer loyalty and retention in the last year. However, I have not taken the time to demonstrate how to measure the impact of improved retention on market share. The answer may seem obvious; namely, for every percentage point of improvement in customer retention, there should be a corresponding percentage improvement in market share. Wrong answer!
The fact is that unless your competition is also increasing their rate of customer retention, the impact of improved retention rates has a multiplying effect. I am going to demonstrate this effect by creating a simple market scenario and then examine several different cases to show how market share changes with changes in the rate of customer retention. The methodology is appropriate for service organizations, especially since customer retention is considered a major role of the service organization. This methodology provides the measurement of market share shift as a function of the improvement in the rate of customer retention (or reduction in the rate of customer defection).

Scenario: Consider a service market with three groups of competitors in the market. The first player is the manufacturer of the equipment. The second player is a large, national third party (independent) service (TPM) organization, and the last player is the group of all other servicers of the equipment. The manufacturer’s service organization maintains about 90 percent loyalty (that means that about 90 percent of the service customers continue to use the manufacturer’s service organization). When customers leave the manufacturer, half go to the large, national third party company and the other half go to smaller independent service organizations. The large, national third party maintains about 88 percent loyalty with about one third of those who leave returning to the manufacturer and the other two thirds going to other servicers. Finally, the group of all other servicers maintain about 86 percent loyalty with the remaining 14 percent who leave splitting evenly between the manufacturer and the TPM. In other words, 7 percent return to the manufacturer for service and 7 percent go to the large, national third party service organization.
Although these loyalty percentages may not be applicable to specific products, the methodology will apply for all areas and also when there are more than three players in a market. In fact, there is no limit to the number of players that can be analyzed. However, the more players there are in the market to be analyzed, the more data will be required to complete the analysis.

There are two types of analysis that can be made from this data. The first analysis, which will be included in this article, is the examination of the steady state market share that results from these loyalty percentages. (Steady state, as used in this article, will refer to the stable market that would result if there were no further competitive actions taken by any player in the market). The second analysis, which will be discussed in the next blog, will examine short term changes. The results of the steady state analysis for the scenario noted above indicates that the manufacturer will have a market share of about 35 percent, the large, national independent service organization will have a market share of about 33 percent, and the group of other servicers will have a market share of about 31 percent. This is interpreted as the ultimate market share that each player will get if there are no changes in the loyalty (or retention) from any of the three players.
Now that the steady state market share is known for each player, examine the impact of the manufacturer implementing a major program designed to increase customer loyalty. The program is sufficiently successful to improve the customer retention rate from 90 percent to 92 percent. At this point, neither the large, national third party service organization nor the group of other servicers do anything to increase loyalty (or to increase customer retention). The market share of each group now becomes 41 percent for the manufacturer, 30 percent for the large, national service organization, and 29 percent for the group of other servicers.

The following chart does not appear in the actual chart form. Please align to see results correctly.

Market Share (%)
Manufacturer TPM Other
Manufacturer with 90% Retention Rate 35.3 33.1 31.5
Manufacturer with 92% Retention Rate 40.6 30.4 29.0

In fact, the following chart shows how the manufacturer’s steady state (long term) market share changes as the retention rate changes over the range of 80 percent to 98percent.

The following chart does not appear in the actual chart form. Please align to see results correctly.

Steady State Market Share
Mfg retention Mfg TPM Other
0.98 73.2 13.7 13.1
0.96 57.7 21.6 20.6
0.94 47.7 26.8 25.5
0.92 40.6 30.4 29.0
0.90 35.3 33.1 31.5
0.88 31.3 35.2 33.5
0.86 28.1 36.8 35.1
0.84 25.5 38.2 36.4
0.82 23.3 39.3 37.4
0.80 21.5 40.2 38.3

From this chart the results are pretty amazing. The steady state market share for the manufacturer changes from a low of about 21.5 percent when the retention rate is 80 percent to an unbelievable high of about 73.2 percent when the retention rate is 98 percent. The rationale is simple; as the retention rate increases, it acts like a vacuum sweeper capturing new customers but allowing none to leave. Clearly, if a company could achieve a 100 percent retention rate, they would capture 100 percent market share in the long run. Similar results can be achieved by the TPM and the group of other servicers as they increase their rate of customer retention.

Although these results are dramatic, they will never be achieved. That is because they are steady state results. Thus they could only occur after a long period of time with no changes in the market - a condition that never happens. Nevertheless, the results have value for several reasons. The most important reason is that the results give an indication of the direction of market share based on your current level of customer retention. Secondly, the results can be used to evaluate different scenarios so that strategic plans can be translated into market share impact. Thirdly, market share impact can be assessed when your competition changes their customer retention levels. Fourthly, the steady state results provide a good snapshot that can be used as a point of reference. Lastly, steady state results are easier to understand than short term results that must be put in context of time period and other factors. The key point is that this is a planning model which shows the long term impact on market share which results from changes in the rate of customer retention.

Since this is a steady state model, initial conditions (initial market share) do not play a role. Even though the manufacturer may start out with 100 percent market share, it will have NO impact on the steady state market share that will occur as a result of customer retention rates. This is a very important point! Manufacturers usually start with 100 percent market share of the service business. If a manufacturer were to maintain 100 percent customer retention, there would never be any opportunity for competition for the service business. However, once the manufacturer drops below 100 percent customer retention, then the long term outcome will be the market share allocation resulting from the customer retention rates of the various companies that enter and compete in the market.

Another important point that needs to be mentioned is the information required to perform this analysis. As you may have noticed in the scenario at the beginning of this article, retention rates for all the companies in the market were known as well as the way customers were switching. These numbers are not the easiest to get, BUT, they are not impossible to acquire. Techniques are available to make these assessments (based on a statistical sample). As the size of the error in these estimates increases, the error in the market share measure also increases. (I will discuss errors for both the steady state model and the short term model as the concluding blog in the short series.)

While this is a very valuable tool for planning, it does not answer the many short term questions that may be asked. Questions you may want answered might include:
1. Given my current position in the market, what will happen in the next year to my market share if I can improve my customer retention rate x percentage points?
2. 1 just read that my major competitor has instituted a massive program to increase its customer retention rates. When and how much will that begin to impact my market share, and to what level must I raise my customer retention rate to maintain my market share against this competitor?
3. I would like to justify the cost of a new program that I believe will increase my
customer retention rate by x amount. What is the economic payoff, in terms of increased market share, that I can expect from this program?

In my next blog I will address these questions and show a few charts that indicate the rate at which market share changes in the short term.


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