2.4. Ensuring Customer Loyalty

As we discussed, loyalty (retention) has long been known to have a significant impact on profit. Depending on the industry (and perhaps the statistician), it is somewhere between 5 and 17 times more costly to acquire a new customer than to keep the loyalty of a current one. The difference in revenue between the costs of selling to a new customer versus the cost of selling to an existing customer is pure profit.

2.4.1. Why Build Loyalty?

Frederick Reichheld of Bain & Company has studied the impact of loyalty on business profit extensively. He studied numerous industries (with both consumer and business end-customers) to understand the impact of customer loyalty on customer net present value.^[1]

^[1] Net Present Value (NPV) is a measure of profit that you expect to get from customers over a period of years stated as if you received it all today. It considers the time value of money, which states that a dollar you get today is worth more than a dollar you get in the future. NPV is a useful tool for consistently evaluating future profit. We'll look at it again in Chapter 17.

The Economics

Across all the industries studied, Reichheld found that a 5 percent increase in loyalty as measured by customer retention resulted in an increase in profits ranging from a minimum of 35 percent to a high of almost 100 percent. He found two reasons for this remarkable impact of a fairly small retention rate increase.

First, he studied the concept of changes in a company's customer “inventory.” (Parallel to product inventory, customer inventory includes the number and value of customers.) All companies want to increase their number of active customers. Companies are continually in the process of acquiring new customers. This growth in customer inventory is offset when customers leave you to buy from other vendors. No matter the size of your current customer inventory or your current growth rate, just increasing your retention rate by 5 percent will result in your customer inventory doubling in size every 14 years.

The second reason for the strong impact on profits stems from the fact that loyal customers buy more and cost less to serve. In the first year of the relationship (Year 0), many companies actually spend more to acquire the customer than the base or average profit they can expect to make from each customer. Each year thereafter, each customer contributes at least the base average profit. Over time, loyal customers begin contributing to profit in a number of different ways as illustrated in Figure 2-11.

As you can see, purchase levels often increase because customers are more willing to trust your reputation on items they haven't purchased from you before. Customers who know and understand your products and processes actually cost less to serve; they don't need as much help. Very loyal customers are likely to refer their friends and colleagues. And as a result of introductory offers and other discounts they are not eligible for, they may even pay higher prices.

Loyalty and the Internet

Some people believe the Internet has made loyalty obsolete. We've defined customer loyalty as an emotion that produces behavior that may not be (or may not appear to be) the most rational buying decision. Loyalty was important when customers didn't have enough information to make rational decisions and had to rely on companies they trusted to do the right things for them. Of course, for some customers, this is still true. Some customers will simply never be comfortable online and will always rely on some form of human communication. (We'll discuss the power of combining two touch points in Chapter 4.) Other customers will use the Internet just for the convenience of the online purchase transaction, but still will visit a retailer to gather information or make comparisons in person.

Other customers do use the Internet extensively to gather information so they can make truly informed and rational decisions. But loyalty still plays an important role in these situations. Even if your product, price, or operations are not quite equal to some competitors, loyal customers will not switch because they have an investment in the relationship. (It goes without saying that customers will not stay loyal if there are huge gaps between you and your competitors in the factors that form the total customer experience.) There is value to a customer in doing business with a trusted seller who already understands his situation and needs. Amazon.com will be a very interesting case to continue to watch. Amazon amassed a huge market share very quickly. By the loyalty measures of frequency and value of purchase (and even share of wallet), Amazon's customers have been extremely loyal. Will customers continue to be loyal now that Amazon has been forced to charge enough to cover all expenses? Is there enough value to customers in the relationship for Amazon to become profitable? The jury is still out.

Loyal customers continue to buy from you even when the product is not significantly different from, and may even cost more than, competitive products. Of course, the loyal decision may also be the most rational decision. Customers often become loyal because their experience over time has been that you have provided the best total value to them. For example, I prefer to buy HP toner for my printers even though it is more expensive than some other brands. I do this because I have been very happy with the results and believe this product produces higher quality documents. But I also have to confess that I even buy HP paper, and I'm not at all sure that it is much different from other manufacturers' paper!

How do we build loyalty? We do it by developing and using various tools and capabilities that help us deliver effective, coordinated, and positive interactions with our customers. Four elements make up the core of what it takes to build these tools and capabilities: information, process, technology and people. These four elements taken together will put your company in a position to effectively build customer loyalty. Choosing to pay more for paper that is probably no different from any other brand may appear irrational, but this type of behavior most often reflects the value of the relationship.

Building Loyalty

There are some misconceptions and partial truths about what it takes to create customer loyalty that produces the wonderful behavior of sticking with us over time and doing the following:

• Buying more

• Needing less expensive support (e.g., using online services)

• Referring friends

• Paying higher prices

We will discuss each of these partial truths so we understand what they can and can't do for us. We need to avoid depending on any one of them if we want to improve our chances of getting the full benefit of loyal customers.

Not Just Satisfying Customers

Many people equate customer satisfaction with customer loyalty. But satisfied customers are not necessarily loyal. In a Harvard Business Review article, Frederick Reichheld measured and showed the relationship between customer satisfaction and loyalty (see Figure 2-12).

We can learn several things from Reichheld's work. First, very dissatisfied customers (those who remain dissatisfied—we'll talk about that later) are never loyal. Not only will they not buy from you again, they are very likely to tell other people about their negative experience. These “terrorists” will actively hurt your reputation and your revenue.

However, it is important to understand that satisfaction alone is not enough to guarantee loyalty. Satisfaction and loyalty are independent factors. A customer can be very satisfied (4 or 5 out of 5) and still be indifferent as to which product he buys, shopping only for the best deal. Of course, some very satisfied customers are extremely loyal. Satisfaction is a necessary but not sufficient condition for customer loyalty.

Not Just Understanding Customers

Just as customers can be satisfied but not loyal, they can also be understood and still not loyal. Understanding customers in today's marketplace (where no one person really knows anyone personally) is largely based on collecting and analyzing information. But, in addition to understanding the customer, we must use the knowledge we gave gathered. We need tools and systems that let us access information and use it to deliver appropriate interactions based on what we know. Our people must be trained to do the right things for the customer based on having this knowledge.

Not Just Automating Processes and Customer Interactions

Loyalty is certainly not built on automating processes and interaction points alone. Automation can be a time and cost saver for companies. Many customers are choosing the flexibility and control they get over the web. But automated interactions can be pleasant or unpleasant; they can be appropriate to the customer or way off the mark. It takes more than flexibility, speed, and control to deliver positive relationships.

All These and More

By now, you realize that fostering loyalty is not just providing satisfaction or just knowing customers or just automating interactions that build loyalty. It is the sum total of the customer's experiences with our company's products, services, and people. The products and services developed and manufactured by the organization's back office have a major effect on loyalty, but we will focus on the front office functions of your organization: marketing, sales, customer service and product support, as well as any channel partner organizations that perform any of these functions for you. This is where we have the most cost-effective opportunity to impact customer loyalty.