Back to basics as loyalty marketing comes full circle

The principles of loyalty marketing are not as cast-iron as was once thought.

Let’s rewind ten years to Fred Reichheld’s first seminal writings on loyalty. Companies need to focus on customer retention for five main reasons, he argued. First, acquiring customers is an expensive business, so the more you keep, the less you need to spend. Second, the longer a customer stays with you, the more profitable he becomes. Third, established customers have a lower cost to serve. Fourth, they provide more word-of-mouth recommendations to other customers. And fifth, as loyal customers, they are less price sensitive.

Very alluring, but is it true? Not according to a growing body of evidence. Take assertion number one. Customer acquisition is an expensive business, but comparing acquisition costs to retention costs is a bit like comparing chalk with cheese: you could argue that every penny a company spends is on retention marketing – providing value to existing customers. If you separate out spends in one, particular “marketing” bucket, your analysis will be skewed. Besides, the more you spend on specific initiatives focused on customer retention, the less true the original proposition becomes.

Second, it’s not necessarily true that profitability increases with longevity. In fact, as banks know very well, many long-term customers are extremely unprofitable. According to research by Insead marketing professor Werner Reinartz across four industries (retail, mail order, hi-tech and financial services) three years ago, some of the most profitable customers simply “blow in” to buy many high-margin products and then stop buying, while many “loyal” customers are barely profitable. Some companies identified these “butterflies” as customers with potentially high lifetime values and then showered them with retention marketing programmes – to zero effect. The more these butterflies were marketed to, the less profitable they became. They had already moved on.

Hello big spenders

Separate research by South Bank University professor Andrew Ehrenberg also disputes the link between loyalty (this time defined in terms of share of customer spending) and profitability. Statistically speaking, he argues that loyal customers tend to be low-spending customers. They are not particularly active, tending to buy just one or two brands infrequently. High-spending customers tend to have much larger brand repertoires that are purchased more frequently, so their total spend per brand is also higher.

So what about assertion number three: lower cost to serve? Reinartz’s research simply found “no evidence” for this assertion. In fact, the only statistical correlation he found (in hi-tech) pointed to the opposite. The more loyal customers were, the more demanding they became.

Enter benefit number four: word-of-mouth recommendation. Well, according to recent empirical research by Robert East, professor of consumer behaviour at Kingston University, across 15 categories (including cars, primary schools, credit cards, car insurance, home insurance, ISPs and mobile air time), the longer customers stay with a company, the less likely they are to recommend its services. East’s explanation for this surprise finding is simple: salience. Long-established relationships don’t remain top of mind. It’s novelty that sparks attention. In most cases, says East, “new customers act as the best advocates for the brand” (though rarely used services such as car servicing and fast-changing markets such as ladies’ fashion stay top of mind longer).

Which gets us to point five: greater willingness to pay brand premium. Again, the evidence seems to be “Not true”. According to Reinartz’s research, the more customers learn about companies’ systems, the more adept they become at squeezing better value from them. Besides, “customers seem to strongly resent companies that try to profit from loyalty”.

So where does this leave us? One lesson is that marketing is a horses for courses game. Loyalty is a factor… in some categories in some circumstances. It’s the specific facts about specific customer segments that matter. As East pleads: “We need more evidence-based marketing.”

More generally, the case for a specific focus on retention or loyalty marketing is often doubtful. As Reinartz puts it: “The relationship between loyalty and profitability is much weaker and subtler” than often suggested. Even if it is empirically true that some loyal customers are more profitable (or that greater retention would be more profitable), a specific activity called “loyalty marketing” may not be the best way to improve the situation: the distinction between acquisition and retention marketing is often extremely unclear. For instance, some of the most profitable uses of loyalty data are for acquisition purposes (Tesco’s move into financial services). In the mobile phone industry, churn rates are horrendous. But is that proof of the need for better retention marketing or simply a reflection of the nature of acquisition strategies, which seem designed to appeal to promiscuous customers? And in mature markets, what does advertising really do? Attract new customers? Or help keep existing ones?

A friendly word of mouth

Recently, Reichheld started distancing himself from his earlier research, arguing instead that there is just one number any company needs to know: customers’ willingness to recommend products or services to a friend.

There are a couple of interesting things about this. First, as a concept, it’s potentially as loose and woolly as loyalty and satisfaction. Does willingness to recommend mean the customer is willing to say “It’s OK” or “Wow! It’s absolutely wonderful”? Are we talking about prompted or unprompted recommendations? And is this “one number” really possible to identify by asking a customer whether he is prepared to recommend or not in a survey? (According to East’s research, most recommendations occur naturally in conversation, prompted by the listener’s “felt need” for the information, not by the teller’s enthusiasm or interest in the product.)

Second, willingness to recommend has got nothing to do with longevity, lifetime value, behavioural data or any of the usual details of loyalty marketing. It’s a different ball game.

Third, as Reichheld observes, “willingness to recommend” tends to be a by-product of the customer’s overall experience of the company. The best way to improve willingness to recommend is to improve service, provide better value and so on.

Hang on a second. Isn’t that where we started from?

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