Tuesday, May 09, 2006

The Business Case for Loyalty

The key to loyalty measurement is having a very clear picture of the economic value you are trying to create. If there is no expectation of superior economic value in either the short or long term, then initiatives intended to inspire customer loyalty can't possibly pass the basic business-case test that returns must exceed investment.

For most businesses, the promise of customer loyalty implies potential economic value creation with some combination of the following five dimensions:

  • First, many companies invest disproportionately in customer acquisition at the beginning of the relationship, placing themselves in a negative economic position. The hope (a.k.a. "the plan") is to pay off the initial investment many times over through retaining customers and capturing the lion's share of their spending in the category year after year.

  • Second, loyal customers may be inclined to buy more types and more volume of products and services from you (cross-selling and up-selling), thereby generating an enhanced return over the life of the relationship.

  • Third, loyalty can be a strategy for reducing ongoing expense. A company that is retaining customers is one that can, in theory, reduce its investment in customer replacement. By closing the proverbial hole in the bottom of the bucket through which customers leak out, the company can improve profitability substantially. If you hear a lot of companies talking about the importance of customer retention, it's because they have good reason. Competition in most industries is brutal. Customers are promiscuous. Couple these trends with the old-but-true saw that it costs more to acquire a customer than it does to retain one, and focusing your marketing efforts on existing customers makes sound business sense. This was amply demonstrated by Frederick Reichheld in his breakthrough 1996 study, The Loyalty Effect. It analyzed the bottom-line value of an additional five percentage points in retention rate, across a variety of industries.

  • Fourth, customer loyalty can be associated with lower price elasticity. By trusting and engaging with your company and its offerings, customers may be willing to pay more for the privilege of doing business with you. And, higher margins almost always drop to the bottom line.

  • And finally, loyalty can be equated with the mother of all profitability engines — referrals. If loyal customers are happy customers, then it's likely they are unpaid ambassadors for your company, spreading the word on how wonderful it is to do business with you. That saves you real money in reduced customer acquisition costs.

To arrive at the financial benefit, you must be clear on which of the dimensions above your investments are designed to affect. Once you've made the investment decision, you should do the modeling and analysis required to measure how well the investments performed. Investing without goals and measurement leaves you vulnerable to questions that you cannot answer, undermining your credibility even if the results are ultimately positive.

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