A real loyalty program is not about how to satisfy all your customers but how many (and which) satisfied, profitable customers you keep. It also identifies the economic link between loyal customers, loyal employees and loyal shareholders. It recognises your customers as a core strategic asset of your business that should be managed. Your customer base:
- should be considered an asset
- can be measured and
- should be managed
True loyalty – what it is and what it isn't
We all know someone who is dedicated to a particular car, a brand of computer, flying with a particular airline. Depending on how outspoken the individual is, that opinion may be more or less explained but is still felt strongly.
Loyalty is not an attitude that your customers have but is behaviour – specifically repeat-purchase behaviour.
Loyalty management is all about managing customer behaviours not just what customers think. Why behaviour? Attitudes don't cause behaviour, rather the experience (good or bad) of a particular product will set up the context for future recollections of the use of that product. These recollections get reinforced by more experiences, shared experiences or learned experiences from others. Experience is the "take-away" of behaviour. Influencing attitude or measuring it doesn't count for much.
Businesses that have high levels of repeat purchase are more dependent upon loyal behaviour.
Effective loyalty programs change the loyalty profile of a customer base by rewarding purchase behaviour in a way that stimulates more of the same behaviour – more purchases. In this way a positive experience reinforces another positive experience.
How loyalty affects the value of the company
Most people agree that the value of a company is tied to it's ability to create earnings on a sustainable basis. The higher the volatility of earnings, generally the more risky a business is.
Since customers are the only source of sustainable cash flow, the more robust and reliable the customer base, the more reliable is the cash flow the lower the business risk. The more loyal the customer base, the more reliable and predictable their buying patterns, the more valuable the enterprise.
Defections of customers cost you money, because your older customers are generally more profitable than your newer ones. This is so because the older customers tend to make larger or more frequent purchases, can make quicker decisions about re-orders because they know what you offer, make referrals to others and will sometimes pay a price premium as they don't take advantage of sign-on bonuses and introductory discounts. Take a look at the following table showing the increase in net present value (NPV) with a 5 percent reduction in customer defections.
This estimate places the bottom line value of a 5 percent reduction in customer defections as worth between 25 percent and 95 percent from 30 percent for low loyalty (infrequent purchase) businesses such as cars, up to 95 percent for frequent re-purchase businesses such as long- distance telephone services, banking, advertising services and credit cards. This is calculated by comparing the net annual present value of the profit streams for the average customer life (ie: the lifetime value of a customer) of current defection rates with the NPV of the profit streams at 5 percent lower defection rates.
To determine the impact of customer defections on your business you need to quantify and profile the entire life cycle of the profits you earn from your customers. While today's bookkeeping systems are "trapped" in period accounting, you can borrow measures from traditional cost and financial accounting measures, by focusing on the significant differences between new and mature customers that affect the cash flows of your business.
Different products have different base levels of loyalty but all other things being equal, a loyal customer base will better withstand competitive pricing, promotion, distribution and other assaults than a non-loyal one. They also consume less cash in defensive retention costs.
The hierarchy of loyalty
Imagine a hierarchy of loyalty along a continuum from the least to the most loyal. Customers can occupy any level of this hierarchy and will generally act in a way that is more or less consistent with others who are on the same level.
Each step represents a higher plane of customer retention. Loyalty in our definition is not a merely an attitude but relates to an identifiable level of customer franchise or exclusivity. Determining where a customer (or group of customers) may sit reflects the recency (when the most recent purchase was made), frequency (how often purchases are made) and monetary value of actual purchase histories.
In an example noted by Wharton professor of marketing David Schmittlein, Merrill Lynch identifies "prime" customers by a combination of these factors. They noted that for a customer to be regarded as prime in each of the previous two years there was a 63 percent probability that they would again reach that status. If they were prime last year but not the year before, then they had a 46 percent probability of being prime this year. If they were not prime last year but they were the year before then the probability dropped to 14 percent. If they were not prime in both previous years the probability dropped to 6 percent. One can see the importance of recency as a factor as the likelihood of achieving prime status was three times higher (46 percent) if they were prime last year versus the year before (14 percent).
Loyalty personality types
While older customers are generally more valuable than newer ones (all other things being equal) we can go further. Here are some general descriptions of different levels of loyal behaviour.
The nihilist occupies the bottom step and may be thought of as both a destructive or potentially constructive one. A nihilist has defected from you and holds a passionate view about the product or service in question. He or she is most likely to have been a disenfranchised missionary. The chance exists to convert this person's passion into a positive force by redeeming the relationship in some way, by demonstrably going out of your way to recover this lost customer.
Neutrals are those people who the classic advertising "awareness" campaign is aimed at. It is a long and expensive road to turn neutrals into customers, yet a large proportion of advertising budgets are spent to convert a tiny percentage of neutrals into triallers. It is more likely that neutrals (if they convert at all) will become prospects next.
Prospects have a recognised need or want for your offer. Effective advertising media selection should deliver predominantly prospects. They represent the largest volume of possible "new" customers that you will find. If your database operations have tracked the journey of your existing customers up the ladder over time, you should have a reasonably good idea of what these people read, listen to and watch. You should also have some sound demographics.
Probables may turn into customers given the chance to experience your offer (product or service) will respond to sample packs, free test drives, test flights and hands on product demonstrations where involvement can take place. Either that or they will seek out the opinion of someone knowledgeable especially in the case of a service, where trial of the service (like an airline or hospital) is difficult.
Your first opportunity to call someone a user is when they convert to becoming a tentative user or a trialler. The ease of becoming a trialler depends on the perception of risk and the counterbalancing switching costs incurred with trial. The most valuable customers begin life as tentative triallers because they are cautiously going through a discovery process. Rewarding, congratulating and assisting customers at this most early and unsteady stage of their loyalty ascent is the first point of a successful retention and upgrade strategy. It is also at this point where your database operations should capture as rich a picture of their behaviour as possible.
Successful triallers may graduate to become committed users, who will in all likelihood become your largest core of regular customers. These people may satisfy between a quarter to one half of their needs with use of your service. These are your quiet customers who will not do anything more then enter into a fair exchange: their custom for your offer. They will remain being a customer so long as their needs don't change and you don't break any implicit or explicit promises.
Advocates represent your unpaid sales force. They are influential opinion leaders who will, in certain circumstances, sell you and your offer to others in their circles of influence. They feel more than satisfied, they have a pride about their association with you. Perhaps using your offer suggests something about their status, their intelligence or discernment. In some way what your offer is doing is making them look good or feel good and they will repay you in kind – by bringing you more business.
Missionaries are the zealots who made the Apple Macintosh the only computer worth loving, the hogs who worship their Harley-Davidsons and the people who wouldn't dream of flying with anyone except Qantas or who would touch anything other than Foster's. These people are enthusiastic about their relationship with you and will feel hurt and disappointed if a friend misses out on an opportunity to buy your product. They will share your vision and passion if you let them in it. They'll be your most valuable source of new product ideas and your most vociferous critics if you fall short some way.
Firms consistently make the expensive mistake of devoting too large a proportion of their marketing budgets, seducing (new) people up the steps, without allocating sufficient resources to retain or maintain their relationships with those on the higher rungs, allowing too many to plunge downward. Knowing where the bulk of a customer base sits along the loyalty continuum may provide many insights into the stability of a business's revenue stream and how exposed a business may be to competition.
What is your company's loyalty profile?
By looking at the statistical distribution of customers along this hierarchy we can see a profile emerge. Depending on where the bulk of customers sit we can see a customers will react with a wide range of different responses to different circumstances. In other words the exposure of the company to competition, product failure and the likelihood of successful promotions will depend on the "loyalty profile" of the customer base.
a) is roughly a normal distribution and is what may be considered a well balanced customer base of triallers and missionaries with the bulk of customers being committed users and advocates.
b) may be a very effective "niche" provider with a small but fanatical customer base. Typically these products or services carry substantial emotional currency with advocates and missionaries taking the lion's share of the customer distribution. They may be product or service leaders in a particular category and customers have a strong sense of personal commitment.
c) may be an excellent profile for a new product or service that seeks to encourage trial, otherwise may be a profile may of a product with high attrition levels and few genuinely happy customers.
If this profile continues over time this suggests that the business will prove to be unstable, highly price sensitive and prone to brand switching from rival products and services. This type of profile would respond well to a concerted client retention program as a priority.
These profiles offer a way to make sense of movements in a customer base and determining whether a customer base is improving or deteriorating in value as an asset of the business. The more loyal a customer base is, the more valuable it is because it costs less to maintain and should be more stable over time. Similarly the closer a significant "skew" of non-customers is to the threshold (that separates a customer from a non-customer), the more valuable they are as a group of "near-customers" because conversion costs should be lower than people further away from the threshold. The closer they are then the easier it will be to stimulate trial.
Interpretation of these curves need to take into account both the type of product or service involved and it's maturity or stage of corporate life cycle.
These loyalty curves are dynamic, should vary over time and will reflect changes in the mood of the customer base. If metrics are in place to monitor movements in the base then they should serve as an effective feedback mechanism and tool for retaining customers. They capture and summarise the behaviour of the customer base, which carries implications for marketing strategy formulation.
Customer loyalty – a self-sustaining virtuous cycle
Companies can achieve more substantial profit by pursuing employee loyalty to support customer loyalty. An active strategy of "conserving" quality customers, who consume value-added or value rich services from enterprises and pay a premium in return, serviced by high quality long-term committed employees who add significantly to the client relationship and are rewarded at a premium level accordingly. The entire approach is self supporting.
Why customer satisfaction is not the same as customer loyalty
Satisfaction matters, but it's an unreliable measure. Between 60 percent and 80 percent of customers who defect to a competitor said they were satisfied or very satisfied on a satisfaction survey just prior to the defection. This suggests that effective loyalty measures can't just focus on attitudes, but only actual repeat buying behaviour which is the only meaningful measure of customer satisfaction.4Conventional wisdom in the field of consumer behaviour has been turned on it's head, making obsolete the old view that consumer attitudes led to buying behaviour. We now suspect that experience drawn from behaviour leads to attitudes that support or erode future behaviour.As we've pointed out, a general retention program alone is not the answer as you could spend significant resources satisfying the wrong customers.
So, to make sense of such an intangible concept as customer loyalty, a model is useful to help conceptualise loyalty. The hierarchy of loyalty model is useful, simple and now practical because flexible database technologies are available to capture customer behaviour making modelling of the hierarchy possible.
Introducing a loyalty, benefits or reward program
If your marketing manager proposes a loyalty program, you should spend some time asking yourself (and your manager) three questions.
1. Which of our customers are profitable?
2. How much are our profitable customers worth over their life of using our product?
3. Will the proposed loyalty program help with the retention of these and the culling of others?
Some of the programs you'll see in the market today really aren't loyalty programs. You could describe them as one of the following;
Benefits programs - programs that predominantly bundle groups of merchants in points schemes, trading credits for discounted or free merchandise to all comers based on reaching hurdle rates of spending
Retention programs - programs that will reward any customer who reaches a certain level of spending, or revives lower levels of spending from older customers
Loyalty programs - integrated programs that identify the incremental profit contribution, quantify the lifetime value of customers and develop customised promotions to retain and develop the most valuable customers. These also integrate with creating programs to enhance staff loyalty.
Points-based benefits systems are not true loyalty schemes ... they're benefits bundling programs that appeal to a particular segment of the market who like collecting points. They will commit a group of customers to shorten their list of competitive options because they want to "fill their book" of points and squeeze more benefit out of the purchase but these customers may not stick around once the program ends. The benefits don't reinforce the product because they have nothing to do with the underlying value delivered by the product you make and sell. They don't reinforce the purchase much because the reward offered is divorced from the sale – paid so much later (if ever) that many people will have forgotten what they did to earn the reward.
Worse still, after months or more of incremental effort that customers spend on amassing points they often find that the effort didn't deliver the value they expected. Their disappointment then reflects not just on the scheme itself but on the underlying product.
For rewards to be effective in reinforcing a loyalty program, they need to fulfill six elements; being:
Identifiable cash value - deliver something of tangible value to the customer
Choice - provide the customer a range of rewards that are attractive
Aspirational value - a reward that is appealing and compelling
Relevance - to your product and service as well as to the customer reinforcing the core value proposition
Convenience - deliver this value within a short time frame and require little or no incremental effort by the recipient to collect the reward
Data - accurate information about the behaviour of your customers
Conclusion
While benefits programs and retention campaigns abound, the decision to introduce a loyalty program is really a question of fundamental business philosophy, not a short-term promotional tactic. The benefits are profound and far-reaching but require a significant commitment of management time and financial resources. So returning the question posed at the beginning of this article, when question arises of a new loyalty program, be prepared for a long term implementation.
* Anthony Surtees is managing director, ITN Communications Pty Ltd
Disclaimer
The purpose of this database is to provide a full-text record of all articles that have appeared in the CDJ since February 1997. It is aimed to assist in the research and reference process. The database has a full-text index and will enable articles to be easily retrieved.It should be noted that information contained in this database is in pre-publication format only - IT IS NOT THE FINAL PRINTED VERSION OF THE CDJ - therefore there might be slight discrepancies between the contents of this database and the printed CDJ.