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.

5 comments:

Kate Nasser, The People-Skills Coach said...

Interesting research on customer loyalty and cost of serving customers. I will want to read your follow-up blogs to see where this goes.
Business owners and top leadership in large corporations always struggle with the question of value of customer loyalty. Please add me to your newsletter list if you have one.
Kate Nasser

John said...

This is a tantalizing piece of research but, I must say, not completely conclusive. Based on one source, it certainly leads us to questions a lot of the conventional wisdom and anecdotal information from the Customer Service and Marketing communities.
I would be very interested to see more empirical evidence on the cost of loyal customers and, perhaps even more tellingly, the actual return on investment for loyal customers versus new.
I would be grateful to be included in the distribution of your newsletter and will be following this thread with great interest.

michael nurse said...

While interesting, this research is unfortunately flawed from its underlying assumption. The researchers use longevity as a proxy for loyalty and longevity <> loyalty.

longevity could be an indication of convenience or lack of alternatives. For example, shoppers in a small town who have bought their groceries for years from the local grocer may (and usually do) switch to the shiny new and less expensive supermarket, wal-mart or club-store that gets built as their town becomes an exurb of the closest city. In a less drastic example, a supermarket might just be on the way home from work. But what happens if the customer moves or changes jobs? Or what happens if a competitor that is just out of the way of the customer's evening commute has a sale on enough items that are important to the customer that would save significant money?

Marieptfq said...

Interesting research on customer loyalty and cost of serving customers. I will want to read your follow-up blogs to see where this goes. Business owners and top leadership in large corporations always struggle with the question of value of customer loyalty. Please add me to your newsletter list if you have one. Kate Nasser

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