Peeling the Customer Loyalty Onion

by James T. Berger , February 2006

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As marketers seek to develop lasting relationships with customers and clients, the conventional wisdom focuses on developing these relationships through loyalty programs. The rationale is that marketers who invest in loyalty programs obtain their payback through repeat business. However, there is another theory that says customer loyalty programs are hardly the be all and end all and that customers view loyalty as a function of the “best value.”

As the loyalty onion is peeled, there are additional factors that come into play such as the need to meet customer expectations; the linkage between customer satisfaction and customer loyalty, and the challenges of measuring loyalty levels.

The Conventional Wisdom

The high priest of loyalty is Frederick Reichheld, a best-selling author, speaker and director emeritus of Bain & Company, a leading management consultant firm. Reichheld is founder of Bain’s Loyalty Practice area. After years of research, he concludes “loyalty pays.” He points to companies that focus on loyalty with envious industry leadership track records such as Harley-Davidson, eBay, Vangaurd and Northwestern Mutual.

Another key to the conventional wisdom involves an analysis of the costs of acquiring new customers versus the cost of keeping existing customers. It is also believed that acquiring new customers is typically far more expensive than maintaining existing relationships. Another tenant of the conventional wisdom is that customers tend to become more profitable the longer the relationship. Finally, loyalty customer are believed to provide an important by-product — the ability to generate positive references to new sources of business.

A Contradictory View

Michael Treacy, an internationally-known expert on corporate strategy and business process transformation, author and former MIT Sloan School of Management professor, takes another tact with respect to customer loyalty. Treacy believes customers are not loyal to suppliers. They are loyal to only one thing — the best value.

Treacy acknowledges that many corporations have invested in expensive loyalty programs, complicated customer relationship management schemes and lots of loyalty consulting advice to attract and retain customers. He believes that “results have been marginal at best. To keep your customers and gain new ones, you must understand the advantages that incumbency bestows and how to use those advantages to create powerful value that wins customers’ business again and again.”

Analysis of Expectations

Yet another factor in the analysis of customer loyalty is the role of customer expectations, according to data from the 2004 Customer loyalty Awards Survey, conducted by Brand Keys, New York. The survey, now in its eighth year, identifies the ways in which a consumer views a particular industry category, the brands within that industry, and most importantly, why people buy and continue to buy.

One of the metrics the study followed closely within the loyalty drivers is customer expectations. It found shifts in loyalty are often a result of increased expectations, and if these expectations are not property addressed by the brands, then consumers look elsewhere.

“Historically speaking, when customer expectations in crease, it’s a sign that customer needs are going unmet,” said Robert Passikoff, president of Brand Keys. “When customer needs are unmet, customers defect to brands that talk to them in believable ways and can fulfill the increased expectations.”

Satisfaction and Loyalty Linkage

Peeling the customer loyalty onion still deeper, the linkage between customer satisfaction and customer loyalty is examined. Walker Information, Inc., an Indianapolis research and consulting firm specializing in customer loyalty and retention, did a survey in 2002 of more than 2,200 information technology buyers.

The survey pointed out that consumer satisfaction alone isn’t enough to win repeat business in most cases. It further concludes that whether marketers are dealing with fickle customers or discriminating business-to-business buyers, marketers and vendors must go beyond quality products and effective selling techniques to earn loyalty. What really matters, according to the Walker survey, is building relationships and robust after-market support.

“Earning loyalty means establishing a high level of relationship…so that the customer will stick with your products and not be looking for an alternative,” said Jeff Marr, Walker vice president and survey leader. “It’s the entire brand experience that people look to when it comes time to make their next purchase. And that includes after-sales support as well as the core product offering.”

Butterflies, Strangers, True Friends and Barnacles

Werner Reinartz, an assistant professor of marketing at INSEAD, Fontainbleau, France, and V. Kumar, University of Connecticut School of Businesses professor, have created a rather interesting segmentation scheme to gauge customer loyalty. The variables are profitability and customer longevity. Highly profitable short term customers are classified as “butterflies.” Low-profitability short-term customers are labeled “strangers.” Highly profitable long-term customers are called “true friends” and low-profitability long-term customers are called “barnacles.”

Butterflies represent a good fit between the seller’s offerings and the customer’s needs and have a high profit potential. The action plan is to seek transactional satisfaction, milk the account as long as possible but know when to cease investing in the relationship and walk way. Strangers offer a poor fit between offering and need. In serving “strangers” the seller should make sure it makes profit from every transaction and make no investment in loyalty.

True Friends are the most valuable segment. They offer a good offerings/needs fit and high profit potential. In serving this segment, the marketer should communicate consistently but not too often and build attitudinal and behavioral loyalty. The goal is to please, nurture, defend and retain these customers. Finally, barnacles show a poor offerings/needs fit and offer low profit potential. Close analysis of size and share of wallet is needed and the company should focus on up-selling and cross-selling. If the size of wallet is small, the marketer should impose strict cost controls.

Need for Measurement

Reichheld advocates sophisticated ways to measure customer loyalty. He calls poor measurement a barrier to customer loyalty. “Retention data alone is not enough,” he says. “You need to ask customers if they would recommend the company to a friend or colleague, and your surveys must be constant and in real time.

“A lot of companies survey customers once or twice a year and they average the numbers across all products and locations….Satisfaction is not the right metric…and how can an average score once or twice a year be sufficient….The right way to gather and report loyalty feedback is to take it as seriously as your financial reporting,” according to Reichheld. “That means gathering and reporting at least monthly in a very granular fashion: every branch, every product.”

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Author
James T. Berger, Managing Editor of The Wiglaf Journal, specializes in both finance and marketing and has spent a number in both the investor relations field as well as an account manager and officer at several Chicago advertising agencies.

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