Wednesday, June 25, 2008

The Multi-dimensional Customer

As this series continues to probe into the area of multi-dimensional customer satisfaction, one of the first topics of concern is the multi-dimensional customer. In previous blogs measures were taken from purchasing, operations and management in many companies through a survey instrument. The average level of satisfaction was determined for respondents in each of these internal departments. When the averages for each group were determined, measured differences between the averages were noted and examined as a macro measure of the way in which different departments within the customer organizations perceived the products and services being provided. In that blog, no concern was given for the individual differences within a specific customer organization. This blog will look at the measures of satisfaction one customer-at-a- time.

Macro versus Micro

The previous blog provided a macro look (big picture) of the satisfaction level of different “kinds” of customers; such as, purchasing types, operations types and management types. In that way the survey could address issues that can best be resolved at the strategic level. For example, the previous blog indicated that satisfaction scores were lowest when reported by customer personnel in the operations area, If this situation is not consistent with the company strategy (e.g., we sell at the operations level), this measure provides the feedback to management that indicates selling at the operations level may be difficult since they seem least satisfied. Thus, the survey results provide a measure of the satisfaction level of different organizations with target customers and can be used to detect differences between the groups (purchasing, operations and management.
As a quick review, the macro measurement can be considered a strategic measurement because it measures (examines) satisfaction levels in areas addressed in the strategic plan of the company. As noted in the previous paragraph, if operations is the strategic area to sell to, then effort should be focused on activities that will assure the maximum perceived value and satisfaction in the operations area. When this measure indicates a level lower than planned or expected in this area, it can be a sign that the strategy is not being implemented to the extent expected by top management.

There is a tactical aspect to the measurement of satisfaction at multiple levels within the customer organizations. The tactical component can be considered the micro measurement since it measures satisfaction at multiple points within a single organization. The micro measurement provides the individual company personnel responsible for a customer with satisfaction measures at each level of the customer organization. Hence each customer can be managed individually from the measurements as well as the macro measurement for strategy.

Scenario 1 - The operations/purchasing problem

If there is a great negative difference between the satisfaction level of the operations/purchasing organization and other areas of the customer company, the difference may be an indication that there is an unresolved product or service problem within the customer organization that needs immediate attention. This scenario will manifest itself when the survey from the operations group or purchasing group indicates low satisfaction when compared with the satisfaction levels reported by other groups within the customer company. One way this occurs is when the operations group at the customer company is involved with the selection and/or purchase of equipment or services. There may be a short term requirement for answers to questions that relate to the product or service being provided. When the company is not available to respond quickly to the request for assistance, pressure is exerted on the customer’s operations group. This pressure may ultimately lead to sufficient stress within the operations organization to respond negatively to the survey. Thus, even though the current products and/or services are performing properly, the operations organization or the purchasing organization is losing confidence in the company which may lead to a deterioration of loyalty and ultimately the loss of the customer when the next purchase cycle occurs.

Scenario 2 - The operations problem

A large negative difference between satisfaction levels in the operations area and other areas of the customer company generally indicates product and/or service problems in the operations area that have not been communicated to the other areas. This may indicate that operations personnel do not communicate well with the other organizations or it may reflect the fact that the location of operations is sufficiently remote as to limit the amount of communication to other areas of the organization. One additional reason may be that operations personnel do not believe the problems to be sufficiently severe to warrant attention beyond their own organization. In my experience, operations personnel do not usually get other organizations involved until the problems begin to impact the performance of the operation. While the operations area may not make decisions about which company to purchase from, they do have influence. For this reason alone, low satisfaction scores from the operations area should be a “red flag” to the field organization to marshal the resources to get the problem resolved as expeditiously as possible.

Scenario 3 - The decision maker (management) problem

Similarly, if there is a large negative difference between the satisfaction level of the decision makers and other areas of the customer company, the difference may indicate a communications lapse within the customer organization. A problem may have been detected and corrected but only the problem detection was communicated to the decision makers; hence, they may not be aware that the problem has been successfully resolved. Experience has led me to the obvious conclusion that bad news travels fast and good news travels very slowly. Thus, the company may have spent a great deal of time and energy to respond to a problem that was escalated up the customer organization (perhaps to the point that a customer executive personally called an executive from the company). After having spent the time and energy, the company often will leave with the operations personnel very satisfied that the problem was addressed quickly and efficiently. They will say that the company did every thing correctly and that the problem was resolved. However, they may be hesitant to notify all the people who were contacted within their organization to get the problem resolved. They may not want the executives to find out that some of the “very serious” problem was the result of their mistakes. When this occurs, the executives are left with the belief that the products and/or services are less than adequate and that it took a great deal of effort on their part to get the problem resolved. The conclusion of the executives at the customer company is that they should reconsider vendors when the time comes to change (and they will NOT forget).


The micro measurement occurs for each customer company surveyed and hence becomes the unbiased feedback tool of the field organization. When used as a diagnostic tool, the multi dimensional survey for a customer becomes the roadmap to real customer management! Since there will be surveys for each area of a customer company, the account manager for the customer should use the information to direct the company personnel either directly or indirectly through the organizational structure. When company resources are used efficiently to manage customer problems, “fire-fighting” and other non-productive activities will diminish and profits will increase.

Tuesday, June 24, 2008

Similarities and Differences in Satisfaction within Companies

In my last blog I began a discussion on multi-dimensional customer satisfaction. The reason for offering up this topic now is my on-going concern that measurement of customer satisfaction today has changed so very little from the measurement ten to fifteen years ago even though there have been some great improvements in measurement. Some companies still rely on a single questionnaire mailed out at regular intervals to a specific individual in each of a selected number of customer organizations. While this process in and of itself is not incorrect, the conclusions and directions that may result as an outcome of the statistical results may be very misleading. In this case of a single questionnaire, it would be because the person completing the survey questionnaire may not be sufficiently familiar with the product and/or service to express the views of the company. Equally as important as the single view is the notion that one view may not adequately express the overall perception of the product and/or service. The strengths and weaknesses of the company performing the survey may vary from department to department within the company. The likelihood of capturing all of this information within a single survey is highly unlikely.

This blog will discuss some simple techniques for examining information from multiple sources within a customer company. In particular, the following paragraphs will describe the requirements for relating results from multiple departments of the customer, what statistical procedures can be used to detect real differences and how those differences might look on a graph or chart.

Requirements for Combining Data

Since satisfaction measurements are taken on an ordinal scale (which means only the order has value - the interval between intervals on the scale is undefined), and the responses are perceptual, absolute values are not available for comparison. It is relatively easy to compare weights of two or more food items since absolute values for 1 pound, 1 ounce, etc. are well defined. However, when it becomes necessary to compare the measure of customer satisfaction by two or more different individuals or groups, there is no absolute measure upon which to base the comparison. Thus, any measure must be on a relative scale and the scale must be the same for every individual or group. The scale used should be completely anchored in order to reduce variation.

Whenever possible the best way to compare results from different groups is to have each group answer the same question with the same wording and the same scale. Although there may be influence from the questionnaire (where the question was located), the same question with the same scale eliminates most of the difficulty. The other factors that may cause different responses such as knowledge of the product and/or service may not be known. When this situation occurs, the low cost solution is to ignore all these other factors, the high cost solution is to take the time and expense to measure them.

If the survey instrument has been properly developed, there will be common questions on each of the surveys so that comparison of results in areas of concern can be made.
The obvious response to the plan of having several survey instruments is to just send the same questionnaire to multiple persons within the customer company. This would be the best solution if the survey was sufficiently general so that each respondent could adequately respond to each question. However, the idea of asking customers questions is to evaluate the strategy and tactics of the company from the customer perspective. When the questions are reduced to a minimum set of general questions, the results have little or no information content with which to evaluate the strategy and tactics of the company performing the survey. Thus, surveys to different individuals within the customer organization should have unique questions specific to that organization along with some common questions from which to draw comparisons and a combined perspective of satisfaction.

Multiple Surveys - A Simple Example

In order to compare satisfaction levels within a company, the obvious step, as noted above, is to create surveys that can be sent to different organizations within the company. Since each organization will have different roles to play with regard to the product and/or service, questions appropriate for one organization may not be appropriate for another organization. However, in order to compare the perceptions of the different organizations there must be sufficient commonality of questions in each survey to allow for comparison of key factors within the survey.
The easiest common question to include on all surveys is the overall satisfaction question. Since this question is usually designed to perform multiple functions within the survey, one more use makes it that much more valuable. Consider for a moment the impact of having a measure of overall satisfaction from each organization for each of the customers you have surveyed. The results might appear as follows if a 10 point scale is used:
Purchasing – average satisfaction is 9.0
Operations – average satisfaction is 8.2
Management – average satisfaction is 6.5

While I don’t subscribe to the use of average satisfaction as a valid measure, I have used it in this case to demonstrate that differences may occur within an organization.

Although there may be many reasons for the differences between the three measures of overall satisfaction, first assume that the differences are statistically significant. That means that the differences are not the result of sampling error. (Many companies see every measured satisfaction difference as significant and immediately jump to conclusions that the difference is the result of something going on when often the reason for the difference is simply sampling error. From statistics sampling error arises because a sample result hardly ever exactly measures the population characteristic. Each time a sample is drawn from the population, a different sample result occurs. The nice thing about sampling is that the results from samples are generally normally distributed about the mean of the measure being taken so that as more samples are drawn, the population mean becomes bounded by the samples.

Data for the chart above was created by taking all the responses from the Purchasing Department and computing an average satisfaction. Similarly, average satisfaction responses were computed for Operations and Management. Thus, the chart indicates the average differences for different groups of customers for the sample. (A second chart, to be discussed later, will examine the differences between each measure within a specific customer and accumulate those differences on a chart.)
The results from the chart above indicate that the differences noted between Purchasing, Operations and Management are not the result of sampling error.

Therefore, there must be some other factors influencing the differences. One simple possibility is that the sales organization has an excellent relationship with the purchasing departments and has developed very positive relationships over time and hence the high average satisfaction level from purchasing personnel within the customer companies sampled. The Management personnel seem to rate their overall satisfaction lower than the other two groups. This might be interpreted to mean that management personnel might mean that the contacts with Management personnel have not developed strong relationships. The statistics indicate that Operations personnel are, on average, scoring satisfaction lower than purchasing personnel. Since this is a pattern for the entire sample response to the survey, it may indicate a need to train sales and service personnel to spend more time with customer personnel in Operations and Management in order to discover possible reasons for the difference in overall satisfaction scores.

The difference between the average satisfaction for Operations and the other departments should also be evaluated. Survey results from the previous chart indicate that satisfaction levels are generally lower for Operations and Management than for Purchasing.

So What

Now that there is statistical evidence that Purchasing, Operations and Management have different perceptions of overall satisfaction what is the next step. The first point is that this is news. Whereas a single measure would have never uncovered this difference, there is now a measure which allows a further step into understanding what is going on within your customer organizations.
The second point is that each of these measures can prioritize where to invest additional resources to provide the greatest improvement in customer perceptions of your company. From the simple example, Management appears to be the best candidate for application of resources. While there may be extenuating circumstances that may direct the efforts into other areas, the statistical results provide signposts of this possible opportunity.

In my next blog I will analyze the measure of differences within individual customers and discuss how to interpret the results. The key will be on how to combine individual differences to get macro measures of the entire customer base along with the micro measures of individual customers.

Wednesday, June 18, 2008

Multidimensional Customer Satisfaction - Part 1

As I continue to read about customer satisfaction, I am realizing how little progress is being made. I still see measurements that are the same as they were ten and even fifteen years ago. For this reason, I am going to spend several blogs looking at customer satisfaction from the perspective of a multi-dimensional measurement.


I first measured customer satisfaction while working at AM International (the old Addressograph Multigraph Corporation) in 1980. At that time the service division supported ten different product divisions. The purpose of a customer satisfaction survey was purely defensive because the service division was being blamed for lack of product sales, as I recall. We decided to ask the customers how we were doing rather than count on the product divisions to relate their customer perspectives. As it turned out, and perhaps why I appreciate customer satisfaction measurement so much, the survey validated what we believed to be true; namely, the service organization was doing a fine job and the real problem was that the sales organization was acting more like order takers than salesmen. Since then I have become a true believer that the customer is the best person to ‘tell it like it is.’
Furthermore, a survey gets past the anecdotal argument where one anecdote is offered to counter another anecdote that presents the opposite point of view. The survey provides a statistical basis that infers the perspective and preferences of the entire customer base when the survey has been properly performed. However, as I have assisted more and more companies to measure customer satisfaction, I have learned what now appears to be the obvious. I have learned that customer satisfaction in the industrial/commercial world is not sufficiently measured with a single survey to an individual.

Single versus Multidimensional

The single survey to an individual in a corporation will measure that person’s perspective of the company being surveyed. The question is whether that single perspective is an accurate representation of the perspective of others within the corporation. Of course the second question is whether the person surveyed is qualified to respond. With the exception of the retail market, most companies in the business-to-business (B2B) industry do business with other companies with the implication that no one person accurately reflects the perspective of the company.
There have been a number of books written in recent years on B2B marketing. These books point out the great difference between marketing to the consumer and marketing to commercial and industrial concerns. One of the major points they make is that a company is not just a single individual and the selling process can consist of selling to a number of people within the company. In fact, many companies have teams that are used to select and evaluate vendors. Members of the team might include personnel from the quality organization, engineering, operations, and finance as well as purchasing.

While the decision to choose a particular vendor may reside within a single individual, corporations today are using teams to perform evaluations and make decision recommendations. Hence there is the need to make multiple measurements to accurately assess the satisfaction level of the ‘corporation.”

Consider a client of mine in recent years. This client sold and serviced large computer systems. The purchase decision was typically made by a “decision maker.” The computer system was usually managed by a “system administrator.” The computer system was used by many “end users’ because of its size and speed. If the computer company were to use the single measurement approach to capture customer satisfaction, which “person” do you survey?

The answer most survey organizations would give is to survey the decision maker because that is where the decision will come from the next time a purchase is to be made. “As long as the decision maker is happy, I’m happy” is a quote that is made by the naive. While the decision maker may be happy at the time of the survey, that does not guarantee that he will be either a loyal customer or even that he will be satisfied at the time of the next purchase. Some reasons why the decision maker alone may not be appropriate are:
1. The decision maker may be far removed from the operation and may not be aware of the positive or negative perception toward the computer that is present within the organization.
2. The decision maker may not even wish to be informed until the next time a decision is to be made.
3. The decision maker may be a decision maker in name only.

Meanwhile, the relationship between the computer company and the other groups within the user company is being established.

As it turned out, the users in most of the companies that used this computer were extremely influential and could effectively direct the decision maker according to their wishes so that a measurement of satisfaction from the decision maker was of little value with respect to satisfaction and loyalty. The real point of this example is that all three groups of individuals were important. Perceived problems from any one of the groups would have some effect on the outcome of the next purchase. Thus, it was necessary to know where each group stood with respect to the satisfaction with the computer system.

What is missing in the single measurement

The single measurement of customer satisfaction within a company misses two very important components; namely, the perception of each group within the user company that has any interaction with the product or service provided, the potential differences in satisfaction between the various groups, and the real level of loyalty that is being created within the user company as a result of the perceptions of the various groups.

I believe that these measures are even more important than any single measurement because the ultimate objective is customer retention which can only be derived from loyalty. Since loyalty will only be developed from the combined levels of satisfaction in each group, the key is to be able to derive the combined loyalty factor.

In my next blog in this series I will focus on how the similarities and differences of the measurements of the different groups within the user company. If you are still using the single measurement method for customer satisfaction, you may want to rethink your position - especially if your products and/or services are being sold to corporations rather than individuals.

Tuesday, June 10, 2008

The Economics of Improved Customer Retention

This blog will answer the third question posed in the first blog in this series about relating customer retention to market share. In the two preceding blogs I answered the first two questions relating to the short term impact of improved customer retention and combating improved customer retention by competitors. The value of this blog is the presentation of a methodology for translating improvements in customer retention to market share and then into budget impact. I have found that management can be very supportive of programs when the programs are self funding. Thus, if it can be shown to management that a specific customer retention program creates additional revenue that exceeds the cost of the retention program, there is a high likelihood that it will be approved.

Perhaps the easiest way to describe the process of translating improved customer retention into budget impact is by outlining the process step-by-step.

Step 1 - Define the customer retention improvement program elements

It is easy to say you have a customer retention improvement program. It is quite another matter to demonstrate to a critical management team that the program actually works. I hope you will recall an earlier blog of mine that described customers as either “nice” customers or other customers. The point was that “nice” customers can be fatal to your business because they take whatever you give them and if they don’t like it they just go away without telling you why. They are too “nice” to want to tell you that you did not provide them with the level of service they needed or expected. It will be very difficult to develop a customer retention program that will be able to measure any impact on the “nice” customers.

On the other hand, you may recall a more recent blog where I mentioned that one of the most important measurement systems you have is the one that tracks the effectiveness of complaint resolution. This measurement indicates how well you resolve customer complaints (from those customers willing to complain; that is, those who are NOT “nice” customers). These customers are the best candidates for customer retention. There have been numerous studies (some by me for specific clients) that indicate a customer who complains and whose complaint is resolved quickly and satisfactorily are more satisfied (and loyal) than customers who do not experience any problems. Thus, the complaint resolution system is a critical element in any program to improve customer retention. For more detail on other elements to improve customer retention, refer to my previous series of blogs on customer retention.

Step 2 - Define the measurement for customer retention

A good measure of the health of a service organization is customer retention. Those service organizations with a high percentage of service contracts or loyal customers find it easy to measure customer retention by simply examining the percent of service contracts renewed or the frequency of purchase. For those organizations without a large contract base or a small customer base, the measurement of customer retention is a little more difficult - but NOT impossible. In each of my series of blogs I have stressed the importance of staying close to your customers. If you have been following my advice you know who your customers are and how they are doing (with respect to the products and services you offer). For those in this category, the measurement of customer retention is simple.

If you are the category of those who have “too many” customers to stay close to, this measurement is going to be very difficult. In the course of my consulting practice I have found many companies who think they know their customers until it comes time to contact them. For these companies the customer data base turns out to contain 5% to 15% of names who are no longer customers (gone out of business, switched to a competitor, moved to a new location, etc.). There will be a great deal more effort required by companies in this category to get a reasonable estimate of their customer retention. (This is the subject for another entire blog).

From the queuing analysis, the decision of exactly how many additional personnel to add must be made. With the results from the complaint system, consider the situation where the addition of two additional personnel to the phone system would have provided wait times acceptable to half of those that defected. Thus, the implication is that 15 rather than 30 would have defected if the additional personnel were available. When this is translated back into the retention calculation, the implication is that the defection rate would have been 8% rather than the 10% calculated.

To put the improved customer retention program into economic perspective, the new retention rate now needs to be translated into improved market share which is the next step.

Step 3 - Translate new retention rate into new market share

The calculations that were presented in the second blog in this series will be used for this example. In the second blog, I posed a manufacturer with a 90% retention rate (as noted above) and provided a table which indicated the rate of growth of market share when the customer retention rate improved by 2%. The table from that blog is reproduced below for convenience.
Months Manufacturer
1 0.353
2 0.360
3 0.366
4 0.372
5 0.376
6 0.380
7 0.384
8 0.387
9 0.389
10 0.391
11 0.393
12 0.395
13 0.396

The chart indicates that as soon as the new personnel are in place and customer defections resulting from waiting too long on the phone are addressed, market share should steadily increase to a new steady state of 39.6% which is approximately 4% higher than before the initiation of the new retention program.

Step 4 - Translate new market share into revenue

For the case where the service market is $100 million per year, the increase in revenue to the manufacturer as a result of the improved customer retention is shown in the following table.
current mkt improved mkt Incremental
revenue revenue 1/12 of annual increase
1 $35.3 million $36.0 million $58,000
2 $35.3 million $36.6 million $108,000
3 $35.3 million $37.2 million $158,000
4 $35.3 million $37.6 million $192,000
5 $35.3 million $38.0 million $225,000
6 $35.3 million $38.4 million $258,000
7 $35.3 million $38.7 million $283,000
8 $35.3 million $38.9 million $300,000
9 $35.3 million $39.1 million $317,000
10 $35.3 million $39.3 million $333,000
11 $35.3 million $39.5 million $350,000
12 $35.3 million $39.6 million $358,000

The total incremental revenue for the 12 month period is $2,940,000 (the sum of the incremental revenues for the twelve months). Even if this were a $10,000,000 service market, the incremental revenues would be $294,000 for the year.

The question you might ask is why not just compute the incremental revenue from saving the 15 customers. For this example ($100 million market with about 35% market share and each customer contributing about the same revenue) the computed savings is only about $700,000. The key point is that the direct computation only considers the customers measured whereas the proposed analysis looks at these customers as representative of the entire market and provides the extrapolation for entire market. The proposed method indicates a return more than 4 times greater than the direct computation.

Step 5 - Compute the bottom line impact

The last step is to translate the number of additional personnel into a budget impact which will show the cost of hiring, training, additional phone lines (if required), and on-going expenses for maintaining a larger staff and compute the return on the investment to the company. Once again, assume the following costs are associated with each of the items listed:
Start-up Costs (one time costs)
I. Hiring costs for two incremental personnel $10,000
2. Training for two personnel 5,000
3. Additional phone system hardware 1,000
4. Additional furniture, etc. 5.000
Total Start-up costs = $21,000
On-going Costs (recurring costs)
1. Personnel (2 @$30,000/year) $60,000
2. Benefits (35%) 21,000
3. G&A (7%) 4,200
4. Phone lines 12.000
Total On-going costs = $97,000/year

Thus, the total cost for the first year is $118,000 and $97,000 for each succeeding year (plus inflation). These costs will begin to be incurred before the incremental market share (and revenue) begin and will show reduced profits until the personnel are in place and the impact of their presence is detected by the customers. However, based on the magnitude of the impact, the costs will be recovered well within the first year for the $100 million market and will be recovered within two years for the smaller $10 million market.

The one caveat to this analysis is that it has been made under the assumption that the competition is not also improving their customer retention levels at the same time. Of course, the calculations will be different for every combination of retention rate and market size; however, this methodology will work as long as the short term (1 year) size of the market is relatively stable.

One final caution: When markets are very unstable (rapidly growing or declining) this methodology is only a rough approximation at best.

Saturday, June 7, 2008

Combating Improved Customer Retention by Competitors

The current literature is filled with blogs about customer loyalty and customer
retention. As companies begin to understand the implications of these concepts
the notion of investing in customer retention becomes appealing. The good news is that companies are beginning to invest in customer retention programs. The bad news is that many companies don’t know what or how to measure retention or to understand, interpret and analyze the results. For those companies in the same market as those investing in customer retention they also need to invest in customer retention programs if they intend to hold their position in the market. The point is that customer retention criteria and measurements are vastly different from customer satisfaction measures.

Now that we are into the real market war of battling for market share, I will examine the impact of changes in retention by a competitor and what it will take to protect or recover market share attacked by the competitor. This blog will continue with the same scenario as the first two blogs where a service market for a product is composed of three competitors. The three competitors are the manufacturer, a large, national third party maintainer (TPM), and all other service organizations considered as a single competitor.

The combat between competitors for market share is probably the classic problem in American business. Each competitor in a specific market is trying to take (and keep) customers from its competitors. The well known and well documented war between Pepsi and Coke is perhaps the most widely discussed. (See the book Pepsi Sneezed’).

Case 1 - Manufacturer increases retention rate from 90% to 92%

For this blog I will use the data from the first blog on market share where I illustrated that when the manufacturer had a 90% retention rate, the large, national third party maintainer had an 88% retention rate and the other servicers had an 86% retention rate this led to a steady state condition of market shares which were 35%, 33% and 32% respectively. It was further shown that if only the manufacturer increased the retention rate of its customers, the steady state market share would shift to 40.6%, 30.4% and 29.0% respectively for the three competitors when no other changes in retention rates had occurred.

The question for the third party maintainer is what retention rate must it obtain in order to preserve his 33% market share or to grow beyond that share when the manufacturer has increased its retention rate to 92%. It is clear that the TPM must increase retention rate just to hold current market share. The good news for the TPM is that not all the market share to be gained by the manufacturer will come from the TPM; some will come from other service organizations. Similarly, when the TPM increases its retention rate, not all of the market share gain will be at the expense of the manufacturer. The following chart indicates the long term market share that will be achieved by the TPM for various retention rates when the manufacturer has increased its retention rate to 92%.

TPM retention rate versus market share
Retention Rate 0.88 0.885 0.89 .895 .90
Market Share 0.304 0.314 0.323 0.333 0.344

From this chart it is clear that the TPM must increase the retention rate from 88% to about 89.5% just to maintain the original market share of 33.1%. The loss of market share will be from the other service organizations rather than the TPM. If the TPM intends to grow market share ahead of the manufacturer, the TPM must increase customer retention rates two percent in order to get about one percent long term growth in market share (33.1% to 34.4%).

It is not always obvious that one or more competitors are attempting to increase customer retention rates, some signs may be missed. Lower service contract prices induce customers to renew contracts (discounts have the same effect) and keep them from defecting to competitors. Similarly, offering service contracts with longer duration will minimize customer defection. (Sears used the phrase ‘buy tomorrow’s service at today’s prices” as a way to encourage service contract renewal).
A complementary tactic for growing market share is to attack competitive weaknesses to encourage defections. In Southern California there is a real battle going on between banks. One tactic used by a smaller bank is to advertise personal service (get to know your banker) because the larger banks have a high turnover as a consequence of mergers. For the hardware service business, a tactic that might encourage defection could be to guarantee parts delivery within a specified time (if not received in time, the price of the part would be reduced by x%). Federal Express has a policy that reduces (or eliminates) payment if the package is not delivered on time. In any service industry, it generally takes setting a new standard for the level of service to create a sufficient force in the market to encourage defection from competitors. The exception to this rule occurs when the market is sufficiently fragmented (ill defined) to preclude adequate information being available to potential customers about competitive offerings.

Case 2 - TPM increases retention rate from 88% to 90%

Again, assume that the manufacturer has a 90% retention rate, the TPM has an 88% retention rate and the other servicers have an 86% retention rate; the market share of each is about 35%, 33% and 32% respectively. Now consider the case where the TPM increases the retention rate of its customers from 88% to 90%, the market share would shift to 33% for the manufacturer, 37% for the TPM and 30% for the other service companies when no other changes in retention rates occur.

The question for the manufacturer is what retention rate must be obtained in order to preserve a 35.4% market share or to grow beyond that share when the TPM has increased its retention rate to 90%. It is clear that the manufacturer must increase its retention rate just to hold its current market share. The good news for the manufacturer (as it was for the TPM) is that not all the market share to be gained by the TPM will come from the manufacturer. Some of the gain will come from the other service organizations. The following chart indicates the long term market share that will be achieved by the manufacturer for various retention rates when the TPM has increased its retention rate to 90%.

Manufacturer retention rate versus market share
Retention Rate 0.90 0.905 0.91 0.915 0.92
Market Share 0.331 0.342 0.354 0.368 0.382

As can be seen from the table, the manufacturer must increase retention rate by 1% in order to maintain long term market share of 35.3% that was realized when the TPM only had an 88% retention rate. When the manufacturer also increases retention rates, the loss of market share will be from the other service organizations rather than from the manufacturer. Recall that the table of market share versus retention is very non-linear, especially at high retention rates. This non linearity helps reduce the amount of increase in retention rate necessary for the manufacturer to maintain its market share. if the manufacturer intends to grow market share in the face of the TPM pursuing increased market share, the manufacturer needs only to increase customer retention rates an additional one half percent to get a market share increase of almost 1.5%!

As I noted previously, the market share values in this blog are steady state shares which are best used for planning purposes only. Thus, the market share numbers presented for various retention rates would only be achieved after a period of time with no intervening changes in retention rates by any of the competitors in the market. However, the results do provide some insight into the market. For example, as a competitor increases its retention rate, not all the loss of market share comes from only one competitor. In general, the distribution of market share loss will be proportional to the way in which the other competitors lose business to the one gaining share. If one competitor gets twice as many customers from one competitor as another, the loss of market share will be in approximately the same proportion.
Further, when a smaller competitor increases retention rates, it takes a smaller percent improvement in retention rates for the larger competitors to maintain market share than the percent increase in retention rate generated by the smaller competitor.

I will address the last question that was stated in the first blog in my next blog so that I can conclude this brief series with a few blogs discussing the implications of growing market share.

Thursday, June 5, 2008

Measuring the Short Term Impact of Customer Retention

As you will recall from my previous blog, I plan to extend the implication of customer retention on market share from the long term solution to the short term solution. As I pointed out in my last blog, the long term solution is good for planning purposes but does not accurately describe the short term effects on market share and may not be the best way to assess the value of a specific retention improvement program.

As I have discussed this topic with friends and colleagues I have received a great deal of support. They have all acknowledged that there is an obvious relationship between customer retention and market share. My analysis indicates the relationship is non-linear and hence may have a very dramatic effect on market share under certain combinations of conditions. This insight is what has led to this series of blogs.

There are two very different perspectives that can benefit from this analysis. The first perspective is from the point of view of the manufacturer. If the manufacturer has a strategy to develop its service business, it becomes imperative that the manufacturer put programs in place to create and maintain a high level of customer retention. For more detail on building and maintaining high levels of customer retention refer to my four part series on customer retention in the previous months.
The second perspective is from the point of view of an independent service organization (ISO). The independent service organization has the same need as the manufacturer to create and maintain a high level of customer retention. Unlike the manufacturer, the ISO does not begin with 100% of the customer base for a product. To the contrary, the ISO begins with 0% of the customer base and must attract customers away from the manufacturer. At the same time, the ISO attracts customers from the manufacturer, it needs to protect against customer defections.
In the past, ISOs have used price as the lure to get customers away from the manufacturer. While this may still be true to some extent, more ISOs are using multi-vendor service as the lure today.

As an aside, the point of looking at these two perspectives is to note that ISOs have a more difficult time building and maintaining market share since they must protect their base from defection while simultaneously attracting new customers at the same time. The manufacturer generally needs only to concentrate on customer retention. The importance of building market share is that market leaders get to establish pricing levels and also benefit from economies of scale that generally go with volume operations. While history indicates that services pricing levels have been the purview of the manufacturer, with multi-vendor service the market share leader may be an ISO that may have the clout of setting pricing guidelines for the industry.

I will continue the scenario of the manufacturer, the large, national third party maintenance organization (TPM) and smaller third party service companies each competing for a share of a particular product market discussed in the previous blog. For this blog, it will be assumed that the manufacturer has recently announced a new product. All three service organizations (manufacturer, TPM, and the smaller service companies) have the general ability to service the new product but only the manufacturer has the parts and will perform service exclusively during the warranty period. If the manufacturer maintains the same 90% loyalty (retention rate) for the new product as it has for other products, the TPM maintains an 88% loyalty, and the other smaller service companies maintain 86% loyalty, the question is, “how will the market share for the service of this product change over time” (Note: these loyalty figures remain the same as the previous blog in order to provide continuity.)
The effect of market share erosion from the manufacturer is shown in the table below. Note the three levels of market share erosion for a manufacturer. They are labeled 98, 90 and 80 respectively to indicate the market share erosion for customer retention rates of 98, 90 and 80 percent.
Market share
98 90 80
1 1 1 1
2 0.980 0.900 0.800
3 0.962 0.815 0.651
4 0.944 0.744 0.540
5 0.929 0.684 0.457
6 0.914 0.633 0.396
7 0.900 0.590 0.350
8 0.888 0.553 0.315
9 0.876 0.522 0.290
10 0.865 0.496 0.271
11 0.856 0.474 0.257
12 0.846 0.456 0.246
13 0.838 0.440 0.238
14 0.830 0.427 0.232
15 0.823 0.415 0.228
16 0.816 0.406 0.224
17 0.810 0.398 0.222
18 0.804 0.391 0.220
19 0.799 0.385 0.219
20 0.794 0.380 0.218
21 0.789 0.376 0.217
22 0.785 0.373 0.216
23 0.781 0.370 0.216
24 0.777 0.367 0.216
25 0.774 0.365 0.215
26 0.771 0.363 0.215

The time scale is noted only as periods of time. For the hardware service industry this scale would most likely be in months since customers defect from one servicer to another at the end of the warranty period or end of a contract (if they have a contract). Thus, for the example described, manufacturers with retention rates of 90% and 80% will be near their steady state market share (noted in my blog last month as 35.3% and 21.5%, respectively) within about two years. On the other hand, when the retention rate is at 98%, the market share of the manufacturer is still about 5% above the steady state market share. This implies that the higher the customer retention rate for the manufacturer, the longer it takes to reach the steady state market share. In other words, as retention rate increases for the manufacturer, steady state market share conditions take longer to occur.

The data in the table above are appropriate for new product introductions but are not appropriate for service of existing products. The first question asked in my last blog was: “given my current market position (market share), what will happen in the next year to my market share if I can improve my customer retention rate x percentage points?”

Obviously, since there are many scenarios (different levels of market share and different increases in customer retention rate); only two scenarios will be considered to demonstrate the concept. The first is from the manufacturer’s perspective. For this case, assume the same scenario noted above; namely, 90% retention for the manufacturer, 88% retention for the TPM and 86% for all other service organizations. Further, consider the market in steady state (market shares of 35.3% for the manufacturer, 33.1% for the national TPM and 31.5% for all other service organizations). Now, the manufacturer institutes a customer retention program that increases customer retention rates from the current level of 90 to 92%. The following table indicates the change in market share for the manufacturer for the next year following implementation of the program.
Months Manufacturer
1 0.353
2 0.360
3 0.366
4 0.372
5 0.376
6 0.380
7 0.384
8 0.387
9 0.389
10 0.391
11 0.393
12 0.395
13 0.396

Note that the change in market share during the ensuing twelve month period is about four percent. Thus, the payoff for the improved customer retention program of two percent, from 90% to 92% is four market share points. When the size of the market is known, this can be translated directly into revenue dollars and with further refinement into profit dollars.

As an example, if the service market for a given product is known to be ten million dollars (based on the number of pieces of equipment in the market), a four percent improvement in market share is worth $400,000 in revenue. If the service organization is working at a 25% margin level, this translates into $100,000 in increased profits once the new level of market share is reached. In fact, additional profits will accrue as the market share increases. So long as the cost of the customer retention improvement program is less than the increase in profit (over some specified time interval - such as two years), it makes economic sense to implement the program. The subtle implication to this situation is that the increase in customer retention, which leads to increased market share, also leads to increased activity for the organization. Thus, the concern is that the organization must be prepared to handle the increased workload and staff accordingly to maintain the increased level of customer retention.

The second scenario is from the TPM’s perspective. For this case assume the same scenario noted above; namely, 90% retention for the manufacturer, 88% retention for the TPM and 86% for all other service organizations. Further, consider the market in steady state (market shares of 35.3% for the manufacturer, 33.1% for the national TPM and 31.5% for all other service organizations). Now, the TPM institutes a customer retention program that increases customer retention rates from the current level of 88% to 90%. The following table indicates the change in market share for the TPM for the next year following implementation of the program.
Months TPM
1 0.332
2 0.338
3 0.344
4 0.348
5 0.352
6 0.356
7 0.358
8 0.360
9 0.362
10 0.364
11 0.365
12 0.367
13 0.367

As you can see, the change in market share during the ensuing twelve month period is about three and one half percent. Thus, the payoff for the improved customer retention program of two percent from 88% to 90% is three and one half market share points. The gain is slightly less than the manufacturer since the TPM had a smaller market share initially. When the size of the market is known, this can be translated directly into revenue dollars and with further refinement into profit dollars in the same manner as the analysis for the manufacturer.

Once again it must be clearly understood that these results are based on a change in only one of competitors in the market. When the other competitors see the change occurring, it is likely they will institute some kind of program to reduce the market share growth. The key point to get from this blog is that IMPROVEMENTS IN CUSTOMER RETENTION BEGIN PAYING OFF IMMEDIATELY. It does not take long for customer retention improvement programs to pay for themselves since they begin increasing market share almost soon as the first customer is preserved that would have otherwise defected.
I will continue this analysis for the other two questions noted in last blog next.

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