The economics of relationship marketing

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The economics of relationship marketing

• Customer loyalty and profitability
• Customer loyalty and customer satisfaction
• Customer acquisition vs customer retention
• Calculating customer profitability
• Using customer profitability to guide marketing
  actions

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Just a Quotation...

• It has always been incredible to me how
  insensitive companies can be to customers. Most
  of them dont seem to understand that their
  future business depends on having the same
  customer come back again and again.
• (W.H. Davidow, 1986, Marketing High Technology)
  

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Two kinds of profit

• Virtuous profit the result of creating value,
  sharing value and building the assets of the
  business
• Destructive profit comes from exploiting assets,
  destructing a firms true value
• A firms income and profits may be impressive in
  both cases, but you can tell the difference by
  analyzing customer loyalty!

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From loyalty to profits
profit margin
40 20 0 -20
80 85 90 95 100
customer retention
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Loyalty effect no. 1

• As customers get more loyal, you keep more
  customers per time period, so that you end up
  with more customers

x new customers
customer base
y defecting customers
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Loyalty effect no. 2
price premium referrals cost savings revenue
growth base profit

• As customers get more loyal, the customers
  become more profitable

annual customer profit
0
1 2 3 4 5
acquisition cost
year
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The elements of profit (1)

• Acquisition cost
• advertising
• direct mail campaign
• commission on sales to new customers
• sales force overhead
• wining and dining with potential customers
• often the acquisition costs are higher than
  management expected!
• Base profit
• price minus costs

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The elements of profit (2)

• Revenue growth
• customers buy more over time
• very difficult to measure requires tracking
  customer cohorts over time (instead of simple
  cross-section analysis!)
• Operating costs
• better knowledge about customers increases
  productivity
• particularly strong effects in retailing and
  distribution (better forecasting and inventory
  management)

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The elements of profit (3)

• Referrals
• satisfied customers are good advocates
• especially important when the product is
  difficult to try out
• new customers that are acquired on the strength
  of a personal recommendation are more profitable
  and stay longer
• Price premium
• partly because new customers get special
  discounts
• more important old customers place more value on
  the relationship and are willing to pay higher
  prices

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How to measure loyalty?

• The best measure of loyalty is share of purchases
  in a product category
• Since this information is usually not available
  at the level of the individual consumer, firms
  can use three indicators
• intent to repurchase (usually overstates true
  loyalty)
• primary behavior (e.g. recency, frequency,
  amount, longevity)
• secondary behavior (e.g. willingness to recommend
  the product to others)

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What about customer satisfaction?

• Customer satisfaction is one of the most used,
  but also most unreliable measures
• In many firms, measuring customer satisfaction
  has become an end (instead of a means towards
  more profit)
• Customer satisfaction surveys are often poorly
  conceived and conducted
• they measure the wrong activities
• they measure the wrong customers
• they are easy to manipulate
• they dont provide the right kind of information
• customers get tired of them

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Satisfaction vs loyalty

• If a customer indicates that he is satisfied
  with your product, that does not mean that he is
  also loyal!

electricity
high
airline
hospital
loyalty
computer
car
low
satisfaction
completely dissatisfied
completely satisfied
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Some questions

• How do you measure customer satisfaction?
• How do you interpret the findings from customer
  satisfaction studies?
• How do you translate the findings to strategies
  to improve the firms profits?

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So what to do?

• Analyze failures (e.g. customer defections)
  track the quality of departures
• Losing a customer is a perfect opportunity to
• identify root causes of problems
• identify business practices that need to be fixed
• win the customer back and create a better
  relationship
• Dont leave it to outsiders (research firms), but
  involve your own managers
• Tie bonuses to the reduction of defections

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Acquisition vs retention

• The appropriate criterion to evaluate new
  initiatives is whether it will grow our customer
  equity
• Customer equity captures the net value of the
  relationship with a customer
• Customer acquisition and retention are two very
  different activities
• The optimal budgets for both activities are NOT
  related (unless the total budget is limited)

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Measuring customer equity (1)

• Customer equity represents the net value of a
  customer relationship (life time value)
• calculate total purchases per year
• multiply that by the products margin
• discount the total cash flow to get their net
  present value
• calculate the total costs for developing the
  relationship and retaining the customer
• discount the total costs to get their net present
  value
• deduct the costs of acquisition

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Measuring customer equity (2)

• At which level do you define customers?
• Just existing or also prospective customers?
• How do you determine which customers are
  active?
• Do you calculate per product or total
  relationship?
• How do you forecast future profit?
• How do you deal with one-time purchases?
• Do you also look at total profit per customer per
  product category (allows you to calculate share
  of profits)?
• For what period do you make the calculations?
• How do you allocate variable and acquisition
  costs?

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Strategic use of customer equity measures

• Choosing target segments
• only most profitable customers
• several segments with varying levels of
  profitability
• Allocating resources among segments
• allows you to maximize the return on marketing
  investments
• requires information about customer
  responsiveness
• also take into account the degree to which
  customers can be replaced
• Ethical issues
• increasing differences between service levels
  (consumer apartheid?)
• often not noticeable for customers invasion of
  privacy?