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A New Approach to Loyalty?

Published
  • November 21 2002, 1:00am EST
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In recent years, many companies have given customer loyalty a high priority on their list of business needs. Some companies have made it their highest priority. This has been a major driver of popular business strategies such as CRM, customer service, customer data warehouses and personalization. Now a recent article by Werner Reinartz and V. Kumar1 entitled "The Mismanagement of Customer Loyalty" has questioned these accepted beliefs. They studied four diverse companies by correlating length of relationship, cost of service, price, and profitability at the individual customer level. They also used quantitative research to study word-of-mouth marketing by loyal customers. Their findings contradict what they cite as four key accepted beliefs about the link between loyalty and profitability:

  • Loyalty and Cost of Service – There was no evidence that loyal customers are served at lower cost.
  • Loyalty and Price – There was no evidence that loyal customers pay a higher price.
  • Loyalty and Word-of-Mouth Marketing – There was little evidence that loyal customers benefit the company with recommendations to others.
  • Overall Loyalty and Profitability – The overall correlation between customer loyalty and customer profitability was between 0.20 and 0.45, a "weak to moderate" relationship.2

But as the title of the article makes clear, the key point is not that loyalty is unimportant. Loyalty is clearly important. Rather, the key point is that loyalty must be managed correctly. As Reinartz and Kumar put it, "No company should ever take for granted the idea that managing customers for loyalty is the same as managing them for profits."
Despite the pervasive talk about the importance of loyalty, it has not been my experience that real-life business strategies ever place that much over- emphasis on loyalty. But too often, loyalty is viewed as an overlay to the main business strategy, and is abandoned when financial pressures emerge. Clearly, mistakes are being made or the link between loyalty and profitability would be stronger than the dismal results previously cited.

Having established that current practices are inadequate, Reinartz and Kumar go on to suggest how loyalty management practices can be improved. I will summarize their suggestions in a few key points.

  • Customers can be classified based on their inherent loyalty and profitability. Companies must recognize the loyalty and profitability characteristics of each customer and market to them appropriately.
  • In many cases this means knowing when to accept that a customer relationship has ended, so that marketing dollars are not wasted on customers that aren’t coming back. Reinartz and Kumar cite "event history modeling" as one statistical technique that predicts which customers are unlikely to buy again. While this is just one of a number of techniques that I would put under the heading of "customer attrition analysis," it is especially useful for businesses that have complete purchase histories for their customers.
  • Also important is tracking customer behaviors besides loyalty that are drivers of profitability. Customers that always make small purchases or make large demand on customer service systems are not as valuable. (However, it must also be recognized that unprofitable customers are not always created by customer behavior. If a loyal customer is swamped with expensive direct mail and offered price discounts, this might make that customer unprofitable. But this is due to the company’s marketing behavior and does not represent the potential value of that customer.)
  • Beyond recognizing the inherent loyalty and profitability of customers, it is sometimes possible to influence customer behavior through up-selling, cross-selling and loyalty programs. Again, information and analysis are critical to success.

None of this comes as a revelation to people familiar with modern marketing practices. To answer the question posed in the title of this article, I don’t think that Reinartz and Kumar will initiate a "new approach" to loyalty. But it is still important to be told how far our current practices are from really good loyalty management. While there are surely some companies that have adopted a good balance of loyalty and profitability strategies, it appears that most have not gotten it right.

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