Tuesday, January 26, 2010

Do Loyal Customers Really Market the Company?

This is a continuation analysis of the research by Werner Reinartz and V. Kumar. Details of the research can be found in the two preceding blogs. The final claim that the researchers examine is that loyal customers market the company more than the non-loyal customers.

The idea that loyal customers are "apostles" as described by the NPS philosophy, is one that is believed by many to be "gospel" (sorry about that pun). Often companies use this concept to justify loyalty investments believing that loyal customers are similar to sales people but with more gravitas. Hence, this is probably one of the most important claims to examine because of its financial impact.

The researchers found that "the link between customer longevity and the propensity to market by word-of-mouth was not that strong." To measure the passive word-of-mouth, the customers were asked whether they would name the company when asked to recommend a company. This was followed by asking whether they ever spontaneously told friends and/or family about positive experiences with the company. Then the customer was called and asked if they felt loyal to the company, how satisfied they were and would they consider changing to another company. The researchers also measured how often, how much and how many different items were purchased to determine a quantitative measure of loyalty using the RFM measure.

The results from the survey indicated that customers who exhibited high levels of both behavioral and attitudinal loyalty were 44% more likely to be active marketers and 26% more likely to be passive word-of-mouth marketers. However, the researchers concluded that loyalty cannot be based purely on the basis of purchasing behaviour. They believe that measures should include the attitudinal survey as well.

Their final conclusion was that companies need to judge customers by more than just their actions. The attitude of the customer maybe the strongest influence in word-of-mouth marketing.

The bottom line is that loyal customers do indeed market the company but maybe not market as dramatically as expected. The apostles may be a little more blurry and difficult to define than we imagined and not as easily identified.

Monday, January 25, 2010

Do Loyal Customers Pay More?

This is a continuation of the research by Werner Reinartz and V. Kumar where they dispel some of the claims usually attributed to the actions of loyal customers. Recall that they surveyed approximately 16,000 customers from four different companies. To get more detail, check with the two previous blogs.

The second claim they refute is that loyal customers are willing to pay higher prices because the cost of switching to another supplier is too expensive and therefore they are willing to pay higher prices. I will add some personal experience to this claim. When I last worked in industry serving as Director of Planning for a large multi-division corporation, we had customers who asked us to increase our prices so they could justify replacing equipment sooner. While my example does not directly support the claims of Reinartz and Kumar, it does point out that companies do not always seek the lowest prices for various reasons.

The evidence from their surveys indicated that long-term customers paid lower prices than newer customers. There prices were between 5 and 7% lower depending on the product. They found no evidence that loyal customers paid higher prices in the consumer business. In the mail-order business, the loyal customers paid 9% less than recent customers for one product category. At the French grocery chain there was no significant difference in the prices in any category for loyal customers. At the brokerage house all customers were charged the same fee.

The conclusion of the researchers as a result of their surveys was that a loyal customer is actually more price sensitive than the occasional customer. The researchers also suggest that loyal customers may strongly resent companies that try to profit from their loyalty. The survey results seem to suggest that consumers at all levels believe that loyal customers deserve lower prices.

As the Internet continues to influence the marketplace, it is becoming more and more obvious that companies cannot get away with price differentiation between customer groups for long.

The bottom line is that all evidence shows that loyal customers expect lower prices and generally get it. The cost of switching suppliers is no longer a factor in the equation of pricing.

Saturday, January 9, 2010

Does It Cost Less to Serve Loyal Customers?

This is a continuation of the two previous blogs and is based on the article titled "The Mismanagement of Customer Loyalty" in the Harvard Business Review by Werner Reinartz and V. Kumar. The first claim they examine (that is normally assumed valid for loyal customers) is that it costs less to serve loyal customers.

Recall that this research is based on examining the buying habits of 16,000 customers in four companies in four different industries over a four year period. The four companies are in retail grocery (French), corporate service provider (US), direct brokerage firm (German) and a mail order company (US). The logic that is most often presented as the basis that loyal customers cost less is:
1. Upfront costs of acquiring loyal customers is amortized over a large number of transactions.
2. Loyal customers need less hand-holding and it is cheaper to deal with them.
3. Loyal customers are more familiar with a company's processes and can resolve more problems on-line without needing the direct intervention of a technical assistant.

These researchers found that "in none of the four companies we tracked were long-standing customers consistently cheaper to manage than short-term customers." In the case of the corporate service provider the loyal customers were actually more expensive to serve. They point out that the corporate service provider provided dedicated sales and service teams. One of the observations that they made was that small disparity between the cost-to-sales ratio for recent and long-time customers.

While this research is not comprehensive in terms of being representative of the industries it studied or industry taken as a whole, it appears to be well planned and comprehensive in terms of a reasonable time frame to test this claim that loyal customers cost less to serve. Of equal importance is the fact that they got very similar results in very disparate industries. It is likely that there are companies and industries that do have lower costs from loyal customers than they do from recent customers.

The bottom line is that many companies assume that their loyal customers are more profitable without taking the time to add all the many benefits that they offer the loyal customers. If they would take the time to analyze the true costs of serving loyal customers versus recent customers, they might find that while a loyal customer offers the potential of a long-term revenue stream, the cost of maintaining that stream may exceed the profit derived from the products and services being provided.

As a closing note I have had several comments regarding the study with some suggesting the study is flawed. Since I am not privy to the details of the study I cannot provide assurance one way or the other about its accuracy. One comment appeared to suggested that loyalty and longevity were not the same. While I agree with the semantics, I cannot fathom how one can describe loyalty without including a time component.

Tuesday, January 5, 2010

Some Different Measures of Loyalty

Before I continue my discussion of the previous blog and the research by Werner Reinartz and V. Kumar I think it is necessary to properly define loyalty. The tool that these researchers used was REM which stands for recency, frequency and monetary value. There is also a consultant (the service wiseguy) who uses referrals in his calculation of customer loyalty. The loyalty factors he uses in his calculation of the value of customer loyalty are retention, repeat business and referrals. One of the most popular measures of loyalty that is in use today is NPS, Net Promoter Score. Since this is the one that appears to be the most often used in the market today, the following information provides some background on NPS.

Fred Reichheld in his book "The Loyalty Effect" provided some interesting background on the subject of loyalty when he referred to a book,"The Philosophy of Loyalty", written in 1908 by Josiah Royce, a professor of philosophy at Harvard. According to Professor Royce loyalty per se cannot be judged as good or bad; it is the principles one is loyal to that can and should be judged. And it is devotion to those principles that tells us when and if the time has come to end our loyalty to an individual or group. While this definition does little to lead us to a mathematical model for loyalty, it does offer logic that suggests that mathematics may not be the only criterion to measure loyalty.

Of course we can always go back to the dictionary definition that defines loyalty as faithful to one's allegiance. However, this simple definition does not carry the necessary depth to explain the intricate relationships between companies and their customers.

Mr. Reichheld offers some economic effects that he believes is derived from loyalty. The five effects that he offers as a natural consequence of loyalty are:
1. Revenues and market share grow as the best customers are swept into the company's business, building repeat sales and referrals.
2. Sustainable growth enables the firm to attract and retain the best employees.
3. Loyal long-term employees learn on the job how to reduce costs and improve quality, which further enriches the customer value proposition and generates superior productivity.
4. Spiraling productivity coupled with the increased efficiency of dealing with loyal customers generates the kind of cost advantage that is very difficult for competitors to match.
5. Loyal investors behave like partners.

These five effects are countered in the article by Reinartz and Kumar. I will discuss these effects in the next blogs. Meanwhile, the bottom line is that there appears to be no one measure of loyalty that everyone can agree on. I think we can take as the bottom line that mathematics is not sufficient to describe customer loyalty.

I am sure I have omitted a number of other measures and descriptions of loyalty that may be more useful than these. I apologize for the omissions and am willing to consider any that come to my attention.

Saturday, January 2, 2010

Is Loyalty Really Profitable?

I found a very interesting article by Werner Reainartz and V. Kumar in the Harvard Business Review issue of July 2002. I don't know how I missed it. The article is titled "the Mismanagement of Customer Loyalty" and the results of their research is based on a survey 16,000 individuals over a four-year period. Their research was based on the databases of four companies in four different industries; namely, a high-tech corporate service provider, a large mail-order company, a French retail food business and a German direct brokerage house.

To quote the authors findings "Specifically, we discovered little or no evidence to suggest that customers who purchase steadily from a company overtime are necessarily cheaper to serve, less price sensitive, or particularly effective at bringing in new business."

They chose to look at the relationship between customer longevity and the companies' profits. If there was a relationship, there should be a positive correlation between these two variables (relationship and profits). If the variables were perfectly tied together (profits came from loyal customers), then the correlation between the two should be 1.0. This would mean that marketing could accurately predict sales from loyal customers based on their longevity. However what they found was the following:
1. the grocery retailer showed a correlation of 0.45,
2. the corporate service provider showed a correlation of 0.30,
3. the direct brokerage firm showed a correlation of 0.29, and
4. the mail-order company showed a correlation of 0.20.

A brief statistics lesson might make the point more clearly. A correlation of 0.45 means that about 20% (0.45 times 0.45) of the movement (increase or decrease) in sales is due to longevity so that about 80% of the change in sales is due to some other factors. When the correlation is 0.20, the movement in sales due to longevity is about 4% with other factors accounting for 96% of the change. In other words, with such low correlations, it is unlikely that marketing could forecast sales based on the loyalty of their customers.

These researchers then tested three claims which are usually assumed by those who espouse loyalty as a key profit generator:
Claim 1. It costs less to serve loyal customers,
Claim 2. Loyal customers pay higher prices for the same bundle of goods, and
Claim 3. Loyal customers market the company.

I will address each of these three loyalty claims in future blogs since they are pivotal in making the case for loyalty. For now the bottom line is that we can no longer state that customer loyalty is any guarantee of increased profitability. In fact, we might find that there are loyal customers who are NOT profitable.

web visitor stats
OptiPlex 755 Desktops