The E-Business Software Weekly is a series profiling trends and developments in software and applications that support e-business, the Internet, and other electronic communication channels. Look for a new story each week in this space.
Valuing Customer Loyalty
Most adults over age 40 remember the once-ubiquitous phenomenon of S&H Green Stamps. Distributed primarily during the 1960s, the multi-denominational stamps came as a lagniappe with merchandise purchased at thousands of retailers, from gas stations to grocery stores. Consumers collected the green-colored stamps in paper albums and, once the albums were full, could redeem them for a variety of prizes available from a special S&H catalog. For a generation not yet jaded by all manner of advertising gimmickry, S&H Green Stamps were fun to collect and a great way to earn prizes. In reality, they constituted one of the first and most successful customer loyalty programs.
So influential was the S&H Green Stamps program, in fact, that its underlying "rewards" philosophy over time came to pervade almost all forms of product and service retailing. From grocery store "club cards" to book stores' "frequent reader" programs to the venerable airline "frequent flyer" programs, a wide range of companies now promise their customers special benefits for becoming and remaining customers. Although many of these loyalty programs are designed in part to collect information on customer preferences and purchases so as to improve merchandise selection and better target the companies' advertising, all such programs have one overriding purpose: to deepen customers' commitment to the company or organization.
Today, few goals are more critical to corporate well-being. As Thomas M. Siebel, CEO of customer relationship management leader Siebel Systems, writes in his new book "Taking Care of eBusiness" (profiled in an earlier column), "loyal customers have always been important to an organization's long-term success." But, he notes, "due to the heightened competition of today's environment, customer loyalty is arguably more important-and more threatened-than ever before. Virtually every organization today faces growing assaults on its customer base by competitors. At the same time, organizations are stepping up their efforts to compete for the same new customers; this drives up the cost of acquiring customers while simultaneously diminishing the effectiveness of those acquisition efforts."
The Power of Customer Loyalty
Facing these challenges, companies from essentially every industry are discovering that enhanced customer loyalty pays off-and handsomely. Frederick Reichheld and his colleagues at management consultant Bain & Company determined in a recent study that, across industries, a 5% increase in customer retention could increase an organization's profitability by as much as 25% to 100%. Correspondingly, a company whose customer retention rate fell by 5% could experience a 50% or more decline in its bottom line. A July 2001 survey by New York-based market research firm Jupiter Media Metrix came to a similar conclusion, finding that companies accurately identifying loyal customers could increase average customer order size by up to 60% and reduce customer acquisition costs by 27%.
Although it may seem intuitive, it is worth asking how enhanced customer loyalty can have such dramatic effects. Both Thomas Siebel of Siebel Systems and Frederick Reichheld, author of "The Loyalty Effect," suggest that five key forces are at work:
The rate at which an organization retains customers significantly affects how much it must spend to acquire new customers. As Siebel points out, "Given that it can cost five to twelve times more to acquire a new customer than to keep an existing customer, there are sizable bottom-line benefits" whenever a company is able to hold on to its existing customers.
Typically, loyal customers spend more over time than do occasional customers. A Jupiter study at the height of the Internet boom, for instance, uncovered a key secret to dot-com success: while nearly 70% of Amazon's purchases were made by repeat customers, the percentage of repeat-customer purchases at soon-to-fail dot-coms was hovering near 30%.
Loyal customers generally cost less to serve. Being more familiar with a company's products and policies, loyal customers will need to ask fewer questions than new customers will, and each customer contact with a loyal customer, on average, will be briefer. Studies have shown that, at financial services firms, this cost difference can be as high as 10 to 1.
For nearly all companies, loyal customers are an important source of referrals. And because personal referrals tend to be one of the most credible forms of marketing, these referrals often generate immediate signups-dramatically reducing the cost of customer acquisition.
Loyal customers are generally less price sensitive than occasional customers. Occasional and first-time customers typically purchase merchandise based primarily on product-centric features, like price, whereas loyal customers tend to buy based more on brand (which is merely their accumulation of experiences with a particular company), making them less sensitive to price discounts from less-well-known competitors.
The Role of E-Business
Factors such as those enumerated above make it clear that the degree of loyalty that a company elicits from its customers is likely to be a key factor in its profitability. "Loyal customers are generally an organization's best customers," emphasizes Tom Siebel, "because their preferences are best suited to an organization's offerings..." Hence, "organizations that understand the economic benefits of loyal customers treat them like gold and continually try to learn more about them."
But Siebel cautions that organizations "should not automatically conclude that every long-term customer is a high-value customer; it is possible, in fact common, that some loyal customers actually cost the organization more than they are worth." The research conducted by Frederick Reichheld and his colleagues for "The Loyalty Effect" determined that, on average, 20% to 30% of customers acquired will wind up costing a company more than the company receives in benefits. In banking, as many as 50% of the customers will have a negative lifetime value.
If companies could identify these negative-return customers from the outset, they would clearly save their shareholders a lot of money. But they usually cannot: it is typically very difficult, if not impossible, to predict at the beginning of a relationship which customers will be high-value customers and which will be low-value ones. And it's not always easy even to identify high-value customers in the middle of an ongoing relationship. Siebel explains that, although customer loyalty programs "typically produce positive results, organizations widely recognize that, in the past, those efforts generally have been suboptimal, due to organizations' limited ability to record, track, and monitor the precise outcome of every customer interaction."
Generating this kind of information is the primary purpose of e-business systems. Because such systems can capture the details of each customer interaction, they can be used to build up quite robust customer profiles that reveal key customer preferences and other marketing-relevant data-all essential factors in understanding and enhancing customer loyalty. Equally vital, e-business systems can be used to deploy this information at the precise time it is needed-for instance, during a customer telephone inquiry. As such, e-business systems can help companies, meaningfully and in real-time, to distinguish between high-value and low-value customers, and so make it possible to implement customer loyalty programs that strengthen customer loyalty in a highly cost-effective fashion.
Enhancing Customer Loyalty Programs
Putting in place an e-business system to capture, categorize, and store for ready retrieval each instance of contact with a customer is the first and most necessary step for establishing an effective customer loyalty effort. But it is only the first step. In addition, companies seeking to drive up the returns from their customer loyalty programs also must:
Ensure that they are measuring the "right" things. Unfortunately, even among firms with sophisticated customer management systems, this does not always happen. In its study cited earlier, for instance, Jupiter Media Metrix discovered that 45% of online shoppers chose e-commerce Web sites based primarily on word-of-mouth recommendations, yet only 7% of surveyed e-commerce firms could ascertain whether new e-customers had reached their Web site because of a referral.
Use the data intelligently. Even when a company records and stores all of the relevant customer measures, it still may fail to appropriately use the resulting data as the basis for its customer assessments. Consider, for example, the results of a survey by RONIN Corporation, a financial services research firm, of more than 340 executives from international financial service companies. The RONIN researchers found that, despite the importance of customer satisfaction in the financial services sector, just 28% of insurance executives and 25% of bankers employed customer satisfaction survey data in constructing their analyses of the profitability and success of their products.
Act on the information so developed. The data resulting from customer loyalty measurements and analyses can be enormously helpful, but only if they form the basis for corporate action-a role well-suited to e-business systems. Says Tom Siebel: "Properly understood and deployed, e-business enables the organization to leverage the information and communications technologies, build effective processes, and empower its people," all focused on achieving three key action-oriented objectives: (1) identifying and selecting those customers who are most likely to become loyal, profitable customers; (2) acquiring as many of those customers as possible at an acceptable cost; and (3) retaining as close to 100% of these customers as reasonably achievable.
Be willing to make the tough decisions. Studies reported by Frederick Reichheld in "The Loyalty Effect" indicate that, in many sectors, profits are concentrated among a small number of customers. In the local telephone service sector, for instance, the most valuable 10% of the customers often produce as much as 10 times as much profits as the least valuable 10%. And in some financial services firms, 20% of the customers were found to be responsible for 170% of the firms' profits-meaning that these customers were subsidizing losses incurred by the remaining 80%. Facing these unfavorable economics, companies may need to either reallocate resources among customer groups or else devise cost-efficient ways of turning less valuable customers into more valuable ones.
Customer Loyalty and Corporate Survival
Given the imperative that companies face today in striving to enhance customer loyalty, it is not surprising that the customer loyalty sector has become big business. For example, a January 2001 survey of 821 business decision-makers by Harris Interactive, the New York-based survey research firm, discovered that virtually all surveyed companies were increasing their customer loyalty spending, and that 42% of the firms were planning to spend upwards of $3 million each on e-marketplace investments designed primarily to boost customer loyalty.
Even in large firms, this is a lot of money. But for small and midsize enterprises, it could spell the difference between survival and demise. To ensure that their customer loyalty investments promote the former rather than the latter, customer-focused companies need to do more than muscle up their customer loyalty programs. They also need to make sure they are doing so in the most effective, cost-efficient ways.
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