Especially service providers invest a lot of money in customer loyalty programs, assuming that long-term customers are good for the company. Because of that myth, customer churn and customer retention have become key performance indicators with service providers; budgets and resources are allocated based on those figures and most marketing campaigns are set with the goal to keep customers as long as possible with the company’s services. This paradigm is so strong and unchallenged, it seems worthwhile to have a look at how well all this loyalty money is really spent.
While it is certainly important to keep paying customers that contribute revenues to your company, this post focuses on the profitability that long-term customers generate compared to not so loyal customers. We also look at this mainly for settings where a service provider has many, comparably small customers. Obviously, customer loyalty has a different importance in high-tech companies where you have only a few but large customers that provide substantial revenue contribution. But even there it is important to look at customer profitability and not only revenue.
Loyal customers are supposed to be less expensive to serve and to have a lower price sensitivity, which means that prices can be raised on them more easily without compromising on demand. As I outlined in one of my previous posts, customer retention costs are usually higher than initial acquisition costs. Retention costs therefore need to be compensated by high, regular revenue and sufficient gross margins per sales in order to ensure overall customer profitability.
There has been some excellent marketing research on the topic. For example, Werner Reinartz and V. Kumar (“The Mismanagement of Customer Loyalty”, Harvard Business Review, July 2002) investigated the link between customer loyalty and profitability in four example companies. The result of their study was that the link between customer loyalty and profitability is very weak. The picture below shows the relations between profitability and loyalty, clearly showing that long-term customers can have both high and low profitability, the same as short-term customers.
The study also showed that the assumed smaller price sensitivity does not exist with long-lasting customers. These customers often use their bargaining power to pay even lower prices than short-term customers, also resulting in lower margins per transaction.
I assume why companies still focus on keeping their customers as long as possible is the following:
- It is more comfortable for the sales force. Dealing with customers that you already know is easier than hunting for new customers, which involves a lot of uncertainty and risk.
- Especially service providers invest a lot of upfront money in acquiring new customers, e.g. free hardware, free months of service (used to be very popular for DSL), however have comparably small marginal costs for delivering their service. Therefore, a certain revenue contribution over time is required in order to compensate for the initial costs. What service providers often neglect is, that these high acquisition costs are not really a prerequisite to win new customers and that overall margin counts, not only margin on service delivery.
- Especially the telecommunications industry is fixated on churn rate as a key performance indicator and not profits per customer or for the company. That seems to justify overly investing in customer retention and loyalty initiatives.
With this knowledge in mind, take a look at your loyalty programs and their real impact on profitability. Try to monitor profitability per customer, invest in your customers more carefully based on their duration/profit ratio, and get rid of customer retention as the key metric to measure your company performance.
References:
The Mismanagement of Customer Loyalty, Werner Reinartz and V. Kumar, Harvard Business Review, July 2002
Getting the Most out of All Your Customers, Jacquelyn S. Thomas, Werner Reinartz, and V. Kumar, Harvard Business Review, July-Aug. 2004
© Stephan Hesslich
