dealing with the issue of customer loyalty, a firm should try to forge as direct a connection as possible to loyalty's actual financial results. That is, we ought to be able to connect whatever strategies and tactics we employ to increase our customers' loyalty with their actual economic outcomes. The customer-strategy enterprise will want to quantify the benefit of a customer's increasing loyalty, and the most direct and unambiguous metric to deploy for this task is the customer's lifetime value, as described in Chapter 6.
CUSTOMER RETENTION AND ENTERPRISE PROFITABILITY
Enterprises strive to increase profitability without losing high-margin customers by increasing their customer retention rates or the percentage of customers who have met a specified number of repurchases over a finite period of time. A retained customer, however, is not necessarily an emotionally loyal customer. The customer may give business to a competing enterprise for many different reasons. As far back as the 1990s, Royal Bank of Canada (RBC) developed superior computing and database power, along with sophisticated statistical programs, to analyze customer information and test specific actions it should take with specific customers. Only then could the bank's frontline personnel deliver more effective personal contact and attention to individual customers.
A retained customer is not necessarily an emotionally loyal customer.
To learn the most about its customers, RBC has undertaken an intense, ongoing statistical analysis of them. It is always developing and refining the prototype for an algorithm to model the long-term lifetime values of its individual customers. Part of this effort includes a client-potential model that measures how growable certain kinds of customers are to the bank. The bank also analyzes a customer's vulnerability to attrition and tries to flag the most vulnerable before they defect, in order to take preventive action in a focused, effective way.
To expand share of customer, RBC also tries to predict statistically which additional services a customer might want to buy, and when. RBC not only makes different offers to different customers, but it also equips its sales and service people with detailed customer profiles. Thus, rather than providing a one-size-fits-all service, the bank's customer-contact people spend their time and energy making on-the-spot decisions based on each customer's individual situation and value.15 Note that this type of business practice not only benefits from individual customer interactions, but it also requires individual interactions to achieve the greatest success. As an RBC executive told the authors of this book, the bank discovered it “could lift contributions and penetration rates by up to 10% by virtue of the contact alone.”
In 1990, Fred Reichheld and W. Earl Sasser analyzed the profit per customer in different service areas, categorized by the number of years that a customer had been with a particular enterprise.16 In this groundbreaking study, they discovered that the longer a customer remains with an enterprise, the more profitable they become. (Several studies since then have indicated that relationship longevity is not a perfect predictor of profitability, but more often than not, the thesis has been supported by research.) Average profit from a first-year customer for the credit card industry was $30; for the industrial laundry industry, $144; for the industrial distribution industry, $45; and for the automobile servicing industry, $25. But those profits grow over time, the longer a customer does business with a company.
Four factors contribute to the underlying customer profit growth:
1 Profit derived from increased purchases. Customers grow larger over time and need to purchase in greater quantities.
2 Profit from reduced operating costs. As customers become more experienced, they make fewer demands on the supplier and fewer mistakes when involved in the operational processes, thus contributing to greater productivity for the seller and for themselves.
3 Profit from referrals to other customers. Less needs to be spent on advertising and promotion due to word-of-mouth recommendations from satisfied customers.
4 Profit from price premium. Customer acquisition can benefit from introductory promotional discounts, while long-term customers are more likely to pay regular prices. (But many companies have learned that if they advertise widely about a lower-price offer, they'd better be prepared to give it to current customers who want it too—or better yet, offer it without being asked.)
No matter what the industry, the longer an enterprise keeps a customer, the more value that customer can generate for shareholders.17 Reichheld and Sasser found in a classic study that for one auto service company, the expected profit from a fourth-year customer is more than triple the profit that same customer generates in the first year. Other industries studied showed similar positive results (see Exhibit 2.1).
No matter what the industry, the longer an enterprise keeps a customer, the more value that customer can generate for shareholders.
EXHIBIT 2.1 Profit One Customer Generates over Time
| Industry | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
|---|---|---|---|---|---|
| Credit Card | $30 | $42 | $44 | $49 | $55 |
| Industrial Laundry | $144 | $166 | $192 | $222 | $256 |
| Industrial Distribution | $45 | $99 | $123 | $144 | $168 |
| Auto Servicing | $25 | $35 | $70 | $88 | $88 |
Source: Frederick F. Reichheld and W. Earl Sasser Jr., “Zero Defections: Quality Comes to Services,” Harvard Business Review 68:5 (September–October 1990): 106.
Enterprises that build stronger individual customer relationships enhance customer loyalty, as they are providing each customer with what they need.18 Loyalty building requires the enterprise to emphasize the value of its products or services and to show that it is interested in building a relationship with the customer. The enterprise realizes that it must build a stable customer base rather than concentrate on single sales.19
A customer-strategy firm will want to reduce customer defections because they result in the loss of investments the firm has made in creating and developing customer relationships. Customers are the lifeblood of any business. They are, literally, the only source of its revenue.20 Loyal customers are more profitable because they likely buy more over time if they are satisfied. It costs less for the enterprise to serve retained customers over time because transactions with repeat customers become more routine. Loyal customers tend to refer other new