Loyalty is a widely-used term, but it is difficult to quantify lifetime value and find the right balance between acquiring new customers and treating existing ones as long-term assets. By David Reed
Late in 2004, General Motors staged a car show in Las Vegas. Amid the usual glitz and glamour, the 100,000 consumers who attended were invited to use a software package to specify their ideal car. The system matched their answers to a model that was available for a test drive there and then.
So far, so ordinary, you might think. Except that only half of the recommended cars were GM models; potential customers could also test a BMW, DaimlerChrysler or some other competing model. The car manufacturer had become a car dealer.
If that seems a surprising move, then it shouldn’t. Instead, it is an appropriate reaction to the new realpolitik of the market. “You know customers will shop for other makes of car and find them. So why not be their trusted partner and be part of the process?” asks Don Peppers, founding partner of Peppers and Rogers Group.
He sees the GM exercise as an example of a significant shift taking place. “There is a trend towards treating customers as long-term assets,” says Peppers. For some organisations, this means giving up their existing business model in order to move into this new customer-centric space.
Peppers points to the decision taken by Blockbuster in early 2005 to stop charging for late fees. Under pressure from new, Web-based DVD rental companies, it allows customers to keep films longer, only charging a fee if the customer decides to keep the disk.
“That is a big step. Blockbuster got 15 per cent of its operating revenues from late fees. Some investors are urging them to rescind the policy, but our view is that it is in the company’s long-term interest to act in their customers’ long-term interest,” he says.
Examples of this kind of customer-first thinking are starting to emerge, and not just from the US. For some years, T-Mobile has been analysing its subscribers’ bills and recommending a different tariff if it would save them money.
Shift in business model
According to research carried out for Pitney Bowes, companies are spending the majority of their marketing budgets on customer retention, rather than acquisition. Based on responses from marketers in top 1,000 companies, 53 per cent of spending goes towards customers, rather than prospects.
The significance of that shift can be gauged from the split identified in the same survey in 2003, when only 43.5 per cent of marketing expenditure was for retention. Building loyalty, cross-selling and up-selling are being recognised as providers of higher returns on investment than cold prospecting.
“No business will survive without reaching out to new audiences,” says David Jefferies, marketing director of Pitney Bowes. “However, it is those companies excelling with their direct marketing communications to existing customers that stand to gain. Such a focus will do more than stem attrition – in a climate of mass competition, the rewards will be greater share of customer.”
The concept of customer lifetime value is widely used and almost casually quoted, but there is not much agreement on how to quantify it. “There is increased awareness of lifetime value, but how do you measure that? There are different costs associated. And how many businesses understand lifetime value?” asks Marc Nohr, managing partner of Kitcatt Nohr.
Famously, Frederic Reichheld calculated that it costs eight times more to acquire a new customer than to retain an existing one. It also demonstrated that a five per cent decrease in customer churn could yield profit increases of up to 125 per cent.
Duncan Kirkpatrick, senior consultant at customer insight agency Nunwood, says these findings need to be treated with caution. “It is a huge generalisation to say across all businesses that there will be the same ratio. That figure is an average – the actual one will be totally different depending on the industry, level of competition and economic climate,” he says.
In many sectors, there is more likely to be near parity between retention and acquisition costs. Kirkpatrick even points out that in the motor insurance industry, focusing on retention rather than prospecting would eventually lead to business failure. This is because in a highly-commoditised and price-sensitive market, consumers will leave regardless of any attempts to build loyalty.
“Insurers have conditioned consumers to churn and there is no way out,” he says of the price-led marketing which typifies the sector. “It is the prisoners’ dilemma. If they all acted together, they would be better off. But none of them do, so they are all worse off.”
The solution to working out how to assign budget is not all down to financial value, either. Norwich Union has been working with Nunwood to understand why 20 per cent of its customers defect each year. By modelling attitudinal data as well as behaviour, it is able to identify people most at risk of switching and focus offers on those worth keeping. Acquisition targets can then be set to replace defectors with new customers who are less likely to switch.
To achieve balance between the two objectives is not just about data analysis, however. There is a highly political dimension, which often gets in the way of its resolution. “In many instances, the way clients have divided their marketing departments is to have one lot do acquisition, and another retention. Acquisition uses advertising and sales promotion, while retention uses direct marketing,” says Douglas Moody-Stuart, associate director at The Marketing Store.
This has led to a mindset in which advertising and promotions create “acquisition traps” for prospects to fall into. This group then has to be converted by retention marketing, even though they may be just deal chasers.