How can you measure loyalty

Originally printed in MarketingNPV Journal vol. 2, issue 4, pages 4-9

Feature Story

How Can You Measure Loyalty?

AI
re these customers “loyal”?

You’re DuPont, and one of your
customers is a chemical engineer
a feeling? An attitude? Or is behavior
the only thing that counts?
Third, loyalty can be a strategy for
reducing ongoing expense. A company
that is retaining customers is one that
The key to loyalty measurement is hav- can, in theory, reduce its investment in
buying polymers from you under a
ing a very clear picture of the economic customer replacement. By closing the
master purchasing agreement. He
value you are trying to create. If there proverbial hole in the bottom of the
receives a volume-pricing discount.
is no expectation of superior economic bucket through which customers leak
This customer represents a lot of
value in either the short or long term, out, the company can improve prof-
revenue and repeat business for
then initiatives intended to inspire itability substantially. This was amply
you, but is he loyal?
customer loyalty can’t possibly pass demonstrated by Frederick Reichheld
I Pfizer relies on physicians to the basic business-case test. in his breakthrough 1996 study, The
prescribe its pharmaceuticals. One Loyalty Effect. It analyzed the bottom-line
doctor admits that, all other things value of an additional five percentage
being equal, she specifies Pfizer The Business Case points in retention rate, across a
drugs because she appreciates the for Loyalty variety of industries. [For an exclusive
educational seminars the company For most businesses, the promise interview with Reichheld on his
provides each spring in Florida. of customer loyalty implies potential current thinking, please see page 10.]
How loyal is she? economic value creation with
I A business traveler can buy coffee some combination of the following If you hear a lot of companies talking
anywhere but seeks out Starbucks five dimensions. about the importance of customer
in whichever city she finds herself retention, it’s because they have good
because she knows she can relax First, many companies invest dispro- reason. Competition in most industries
there. Can Starbucks assume it has portionately in customer acquisition is brutal. Customers are promiscuous.
created a loyal customer? at the beginning of the relationship, Couple these trends with the old-but-true
I An office manager gives Staples placing themselves in a negative saw that it costs more to acquire a
high customer-satisfaction scores economic position. The hope (a.k.a. customer than it does to retain one,
for breadth of merchandise, good “the plan”) is to pay off the initial and focusing your marketing efforts
pricing, and friendly service. He investment many times over through on existing customers makes sound
also carries one of Staples’ Business retaining customers and capturing the business sense. The more attractive and
Rewards cards. Can we assume lion’s share of their spending in the relevant your value proposition remains
he’s loyal? category year after year. to your customers, the less likely they
are to defect to the competition.
I Nike has strong repurchase rates
among amateur athletes who find Second, loyal customers may be
inclined to buy more types and more Fourth, customer loyalty can be
Nike shoes a better fit for wide
volume of products and services from associated with lower price elasticity
feet. Are these buyers loyal to the
you, thereby generating an enhanced and willingness on behalf of the
Nike brand?
return over the life of the relationship. customer to pay more for the privilege
Each of these scenarios describes a Estimate how much these customer of doing business with you. Higher
loyal customer. “Loyalty” comes in spend with you over their lifetimes, margins almost always drop to the
many forms. But should it be defined as and arrive at the financial benefit. bottom line.

Copyright © 2005 MarketingNPV LLC www.MarketingNPV.com


And finally, loyalty can be equated and she gets a free trip to Florida
with the mother of all profitability each year — the economic relation-
engines — referrals. If loyal customers ship is vulnerable to a better deal.
are happy customers, then it’s likely If some other pharmaceutical
they are unpaid ambassadors for your manufacturer develops a better
company, spreading the word on how educational curriculum in a more
wonderful it is to do business with attractive warm weather location,
you. That saves you real money in it is likely the physician will
reduced customer acquisition costs. prescribe equivalent products from
the new company.
Four Types of Loyalty
There are four essential types of Transactional loyalty is easy to
loyalty, each with its own benefits, stimulate with promotions or
risks, and measurement approach. You rewards programs. But to the
may be able to distill your market into degree non-core components are
categories that align with these four used, “loyalty” can be difficult to
loyalty types. sustain at an acceptable profit level.
It’s also important to note that
1. CONTRACTUAL LOYALTY. When transactional loyalty can be achieved
relationship by allowing corporate solely due to customers’ perception
a customer purchases from you
buyers to place their orders online of the switching cost associated
through a formal agreement, you
24-7, buying under the terms with moving their business. With
have contractual loyalty. This is
defined in their contracts. However, financial services, consumers may
very common in business-to-busi-
the computers still have to match perceive a hassle in switching
ness situations. The DuPont example
the needs of the customers. banks for marginally superior
falls into the contractual loyalty
category. Contractual loyalty also value propositions.
applies to consumer situations like 2. TRANSACTIONAL LOYALTY. Repeat
subscriptions for newspapers and purchasing without any contractual 3. F UNCTIONAL LOYALTY. To the
magazines, or for cable, telephone, obligation can be called transac- functionally loyal customer, the
or broadband services. tional loyalty: The customer is in product’s very attributes are per-
the market for widgets, and you ceived as superior, thus preferable.
Contractual loyalty can be very sell widgets. Loyalty is based on One wireless phone company may
profitable when looked at on the factors such as price, value per- provide better reception near the
basis of the net present value of the ception, and convenience. The customer’s home, making for func-
contract. But it is often less prof- customer may find a better deal at tional loyalty. The Nike example
itable as contracts come up for any time, and if so, will switch also falls into this category; if you
renegotiation and competitors use without hesitation. have wide feet, you develop a very
aggressive promotional tactics to functional loyalty to shoes that fit.
steal your customers. Contractual The doctor giving her prescription-
loyalty also can instigate dissatis- writing business to Pfizer is an Functional loyalty is often the
faction. Customers may feel example of transactional loyalty. first hope of efforts to differentiate.
trapped in a business arrangement. She writes one prescription at a To the degree that you can offer
Dell uses its key account service time. Because the doctor’s loyalty customers something tangibly,
program, Premier.Dell.com, to add is affected by her value assessment palpably different yet relevant
value to the traditional contractual — the product costs her nothing, to the category purchase, you
continued>>>



continued from page 5
can lock up the portion of the Yet none of these descriptors has how sales reps manipulate the
market that prioritizes your proven sufficiently objective to span satisfaction scoring system. In a quiet
advantaged function. business units, channels, or customer moment during the new car delivery
touchpoints so as to create a consistent process, when one might reasonably
4. EMOTIONAL LOYALTY. This is the standard for managers to achieve. Nor expect the customer to be at the very
“feeling” part of loyalty, in which a has any been more than loosely peak of happiness, salespeople blithely
customer develops preferences for correlated to incremental profitability inform their customers of the impending
products or services based on their because few attributes are so distinct arrival of a J.D. Power satisfaction
appeal to the individual’s values, that they exceed the matching efforts of survey. Even if dealerships play it
ego, sensibilities, or other intangi- competitors. Nevertheless, the majority straight and work hard to meet
bles. Customers identify with the of mid-sized to large companies today customers’ needs, the manufacturers
brand, like the traveler searching have some sort of measurement system they represent have no better insight
for a Starbucks, because they seek for customer satisfaction, if for no into customer loyalty.
some nonfunctional benefit from other reason than to ensure continued
the association or experience. performance at or above their category’s That’s because functional satisfaction
Emotional loyalty is the Holy Grail competitive standard. doesn’t necessarily ensure that either
for many marketers — most often behavioral or emotional loyalty will
sought and least often attained. follow. Satisfaction rates among U.S.
Satisfaction = Loyalty? auto buyers are often reported in the
Satisfaction, though necessary, is an
upper 80th percentile range — this
One of the primary pluses of insufficient solo condition for loyalty.
past summer Toyota Motor Corp.
emotional loyalty is its ability to You can achieve high levels of satisfac-
topped the University of Michigan’s
withstand challenge to the economic tion yet not inspire any real loyalty.
American Consumer Satisfaction
or service relationship: Emotionally For an example, look no further than
Index with an 87 — but actual manu-
loyal customers will forgive minor your local car dealer. Automotive
facturer repurchase rates hover in the
errors in their experience and companies have been fast — and
30th to 40th percentile range. Dealer
maintain the relationship. Also, thorough — in their willingness to
loyalty is even worse, with only about
emotional loyalty often is associated embrace satisfaction metrics. But
20% of customers returning to the same
with price premiums in powerful anyone who has bought a car knows
dealer to purchase their next car. This
brands that have no discernable
differences in form, function, value,
or convenience.

Loyalty and Satisfaction
Over the years, most companies have
Annual Customer Profit

acknowledged that happy customers
are more likely to be repeat customers
than unhappy ones. Owing to the
difficulty of defining “happy,” loyalty
indicators predominantly have been
linked to satisfaction measurement.
Some have even gone further, setting Y0 Y1 Y2 Y3 Y4 Y5 Y6 Y7
their sights on nothing less than
“delighting” customers or eliciting the
rare reaction of “wow.”
Acquisition Base Profit Revenue Growth Cost Savings Referrals Price Premiums



When paired with a strong rationale of
a functional, contractual, or transaction-
al nature, the combination works to
erect barriers to competition and
decrease price elasticity.
Annual Contribution

We know that the drivers of loyalty
are complex, and may be based on
different — but equally important —
factors like experiences, beliefs, prefer-
ences, or fit with one’s self image. But
if we are investing in improving our
products, services, or processes, we
need to link those investments to
P0 P1 P2 P3 P4 P5 P6
specific economic value creation. And
Employee Referral Customer Referral Customer Retention Customer Selection
because after-the-fact measurement
Efficiency Training Hiring
approaches may come far too late to
suggests that even though customers comparative purchase decisions at any eliminate bad investments or course-
may want different car experiences point in time, and past satisfaction is correct those with minor flaws, we
every three to five years, no one auto but an element of that perception, then need methods for forecasting the
manufacturer is meeting their needs. if company B offers me greater value, creation of economic value based on
Loyalty is low in the category, regard- all my satisfaction with company A changes we see early in the market
less of what satisfaction scores say. likely will not prevent my switching response cycle.
for greater relative value.
All this suggests that to successfully
To reinforce the point, a number of
measure loyalty, we need first to define
academic studies in recent years have So if you cannot rely on satisfaction
it in very specific terms that apply to
shown that satisfied customers don’t metrics to measure loyalty, what is
the desired business outcome. For
necessarily buy more or more often, in the solution?
example, a gasoline retailer might define
any category. Satisfaction as a proxy
loyalty as a high share of customer,
for loyalty is relative to each brand’s
position in the market at any given
How to Measure Loyalty measured in gallons purchased annually.
The overwhelming evidence today Because it has no idea of total
time. If we accept that the perception
points to the power of triangulation — consumption for each individual, the
of value most heavily influences
evidence of emo- retailer estimates share of customer by
tional loyalty cou- looking at total household consump-
pled with one or tion of gasoline across the country
Citi 42 6 14 16 2 4 5 more elements of and breaking it down into purchase
American Express 8 65 6 11 1 4 8 functional, transac- deciles. The marketer assumes, by
Wells Fargo 11 4 38 3 7 9 4 tional, or contractu- studying aggregate driving behaviors
Capital One 14 10 5 37 3 3 8 al loyalty. in miles per year and average fuel
Bank of America 4 4 10 2 55 1 10 Emotional loyalty economy, that the purchase patterns
Chase 6 14 4 6 7 45 2
overcomes prob- of drivers in the 7th decile represent
lems, sustains the the practical maximum annual
Discover 3 4 3 5 9 6 20
brand relationship, purchase volume for most households.
Citi American Wells Capital Bank of Chase Discover
Express Fargo One America and drives a desire (Customers in deciles 8, 9, and 10
After 3 years, 42% of Citi customers remain loyal; 6% switch to American Express; 14% switch to to repurchase. may be viewed as abnormally
Wells Fargo, and so forth. Numbers do not equal 100% due to options not shown.
continued>>>



continued from page 7
high-mileage/low-economy drivers).
Consequently, a customer purchasing
100% of the decile 7 consumption
Potential Customers Customers
level is believed to be directing a high – Opt-in
percentage of overall category business – Survey
Engaged Response
to the company and thereby judged to be – Cross-sell
very loyal (without indication of an emo- Purchase/ – Dialogue
Perceived Trial – Referral
tional connection to the marketer as yet).
Value
Perceived
“worth doing”
The retailer then collects self-reported Relevance
Awareness “for me”
survey data from customers in deciles
– accurate
4, 5, 6, and 7 about their perceptions of – salient
the brand and its quality, convenience,
value, etc. With this information, the Measure drop-out rates and causes
retailer can build predictive models to
Behavior tracking
estimate emotional factors’ impact on Perception tracking studies Experience perceptions
purchase behaviors and thereby evaluate Quality metrics
the potential return on spending more
to drive emotional brand loyalty vs.
investing in credit promotions, station
So the measure of true loyalty Transactionally loyal customers are
lighting, or premium item giveaways.
doesn’t rely on any single indicator characterized by patterns that can
but rather several, all pointing in a be teased out by data analytics,
Some marketers measure loyalty by
common direction. Here are a few such as:
engagement. They monitor the
we’ve compiled. • Changes in recency-frequency-
correlations between customers’ actual
monetary value by customer
purchase behaviors and the use of the
brand Web site, interactions with Indicators of Loyalty segment or cohort group
Each kind of loyalty — contractual, • Velocity of change in segment mobility
customer service channels, responses
transactional, emotional, and functional • Cross-category purchase behavior
to price increases or discounts, etc.
— is open to its own set of metrics. and trends
Engagement actions, taken by the
• Latency (gaps between transactions)
customer between purchase events,
Because contractually loyal customers • Frequency distribution of
are generally good leading indicators of
are buying under a purchase agreement, transaction value
the customers’ likeliness to repurchase
or purchase complementary products the agreement and its status need to
or services. This is the basis of the be measured. Ways to do this include: With the functionally loyal buyer, the
bundling model being pursued so • Share of market under contract key is to closely monitor the basis of the
vigorously by telecommunications • Frequency distribution of contract functional preference. Measurement
and cable companies today as they profitability approaches include:
fight to get their hooks into customers • Frequency distribution of customer • Top-of-mind awareness on key
by building high levels of engagement share of wallet functional dimensions
in the “stickiest” of services like • Contract renewal rates (perhaps by • Changes in perceptions of key
broadband access or digital entertain- inception date cohorts) functional attributes vs. those
ment. A customer who orders three • Incidence of contract expansion into of competitors
pay-per-view movies per month is far new product lines or business units • Willingness to recommend
more likely to stick around than one • Customer referral frequency • Price elasticity
who orders only sporadically. • Effective price changes at renewal



Measuring emotional loyalty involves: metrics carefully but time them right, With those guidelines, it is critically
• Attitudinal surveys on key attributes too. With perceptual metrics such as important to continuously measure
– “like me” those collected in surveys, experience loyalty. Too many companies are still
– “a brand I can trust” has shown how the timing of the fielding monthly or quarterly surveys,
– “the right brand for the times” question can influence the result. Too then reading the results several weeks
• Competitive brand preference soon after the transaction the response after the data is aggregated. This
• Price insensitivity reflects the “honeymoon” when the makes it difficult to gauge the impact
• Problem tolerance consumer wants psychological rein- of any single or series of loyalty initia-
• Resistance to competitive offers forcement of his or her spending tives precisely: Too many variables
• Overall brand preference behavior. But too long after the may be present to tease out causality.
transaction, many of the discriminating Instead, the more effective approach is
details can be lost, resulting in mid-range to sample customers every day or at
Timing Is Everything scoring patterns. The goal is to pick a least every week and continuously
While marketers and managers place
time when the customer’s perspective read moving averages (of sufficient
high value on loyalty measurement,
will be fresh, but reflect consideration sample size). With time, you’ll be
it’s important to not only select the
of the experience vs. expectation. able to isolate the exact time when
customers’ perceptions or beliefs
changed and correlate that to both
behavior changes and the presence of
Recognizing that satisfaction is NOT a predictor of economically profitable behavior the loyalty stimulus.
(although dissatisfaction has been found to be highly predictive of negative economic
behaviors), many companies look to factors such as “likelihood to recommend,”
“likelihood to continue as a customer,” and “good value for the money” to triangulate The Bottom Line Is
on a customer’s loyalty. the Bottom Line
Ultimately, the objective of a loyalty
Using 1-to-5-point scales for each, with 1 being very low and 5 being extremely high, measurement process is to forecast
customers who rate the company as a 4 or 5 on each of the three dimensions are changes in customer profitability.
considered “loyal.” Those who rate the company high on any two dimensions but low Loyalty, properly measured, is a
on the third are assumed to be “vulnerable.” And customers rating the company low
leading indicator of future purchase
or neutral on two or more dimensions are assumed to be “neutral” — neither loyal
behavior, and thereby profitability. It’s
nor disloyal.
not about satisfaction, transaction
On a scale of 1 to 5, with 1 being the lowest and 5 being the highest, frequency, or favorable imagery. The
please rate us on each of the following: relationships between them drive
shareholder value. There are many
“Loyal” “Vulnerable” “Neutral”
ways to measure loyalty. The key is
Likelihood to refer a friend to us 4 2 2 to measure more, do it faster, and
connect your measurements to the
Likelihood to purchase from us again soon 5 4 3
economic outcomes of the organization.
Value you get for the money you spend with us 5 4 4 With a focused approach on the key
drivers of loyalty in your business —
contractual, transactional, emotional,
The simplicity of this approach can also be its downfall. Be careful to validate that or functional — and a set of metrics
these are the right questions for your business and that the results correlate to actual against each, you will manage
customer spending patterns with respect to longevity, frequency, or share of customer. customer loyalty in an efficient and
actionable way.


How can you measure loyalty

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