Mohit Sewak

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13 Dec

The Mismanagement of Customer Loyalty

Posted by Mohit Sewak Category: CRM, Consumer Behavior, Marketing, Research Review

The Mismanagement of Customer Loyalty

— By: - Werner Reinartz and V. Kumar —

In the article “Mismanagement of Customer Loyalty“, by Werner Reinartz and V. Kumar (HBR, July 2002), a U.S. high-tech corporate service provider was studied. After running a CRM scheme for five years, the company was able to determine the profitability of each of its accounts over time. About half of those customers who made regular purchases for at least two years-and were therefore designated as “loyal”-barely generated a profit. What we’ve found is that the relationship between loyalty and profitability is much weaker-and subtler-than the proponents of loyalty programs claim.

Following Hypothesis were tested: –

Claim 1: It costs less to serve loyal customers:

This is not true. In fact, the only strong correlation between customer longevity and costs that we found-in the high-tech corporate service provider-suggested those loyal and presumably experienced customers were actually more expensive to serve.

Claim 2: Loyal customers pay higher prices for the same bundle of goods:

It was found that the customers regularly guarantee greater frequency of purchase in return for lower prices.

Claim 3: Loyal customers market the company:

It has been proved that if managers are investing in a loyalty program for its supposed marketing benefits, then they are looking at a potentially misleading indicator.

Customers may well buy all their groceries at the same supermarket out of inertia and convenience.

Knowing When to Lose a Customer

The most common way to sort customers is to score them according to how often they make purchases and how much they spend. Many tools do that; one of the most familiar is called RFM (Recency, Frequency, and Monetary Value Analysis).

So just why is RFM such a poor way to measure loyalty?

One problem is that patterns of buying behavior for frequently bought goods are quite different than those for infrequently bought goods.

The second main drawback of scoring methods like RFM is that the monetary-value component is almost always based on revenue rather than profitability.

From Measurement to Management

After analyzing your customers’ profitability and the projected duration of their relationships, you can place each of them into one of four categories, as shown in the matrix “Choosing a Loyalty Strategy.”

Turning True Friends into True Believers:

In managing these true friends, the greatest trap is overkill. At the catalog company, for instance, we found that intensifying the level of contact through, for example, increased mailings were more likely to put off loyal and profitable customers than to increase sales. People flooded with mail may throw everything out without looking at it. Sent less mail, however, they are more likely to look at what they get.

Enjoying Butterflies:

The classic mistake made in managing these accounts is continuing to invest in them after their activity drops off. Any such efforts are almost invariably wasted; our research shows that attempts to convert butterflies into loyal customers are seldom successful – the conversion rate was 10% or lower.

Smoothing Barnacles:

The first step is to determine whether the problem is a small wallet size (the customers aren’t valuable to begin with and are not worth chasing) or a small share of the wallet (they could spend more and should be chased).

Then, a company can easily distinguish which loyal customers are potentially profitable and offer them products associated with those already purchased, as well as certain other items in seemingly unrelated categories. For instance, our corporate service provider might sell.