Measuring Loyalty

Meeting both financial and CMR goals will require more than measuring lifetime value, more than tracking today’s typical metrics—satisfaction and defection. A McKinsey study furthers this point:

Despite all the money invested to promote loyalty among high-value customers, it is increasingly elusive in almost every industry.

A better appreciation of the underlying forces that influence the loyalty of customers—particularly their attitudes and changing needs—can help companies develop targeted efforts to correct any downward migration in their spending habits long before it leads them to defect. Such appreciation also helps companies improve their current efforts to encourage other customers to spend more. Our recent two-year study of the attitudes of 1,200 households about companies in 16 industries as diverse as airlines, banking and consumer products shows that this opportunity is surprisingly large. Improving the management of migration as a whole by focusing on not only defections, but also on smaller changes in customer spending, can have as much as ten times more value than preventing defections alone. Companies taking the approach we recommend have cut downward migration and defection by as much as 30 percent.^[6]

The McKinsey study reminds us that measuring degrees of loyalty is an evolving craft. Companies first tried to measure and manage their customers’ satisfaction in the early 1970s, on the theory that increasing it would help them prosper. In the 1980s, they began to measure their customers’ rate of defection and to investigate its root causes. McKinsey makes the point that these ideas are still important but, “They are not enough. Managing migration—from the satisfied customers who spend more to the downward migrators who spend less—is a crucial next step.”^[7]

The study goes on to say, “This step is so important because large amounts of value are at stake. Many more customers change their spending behavior than defect, so the former typically account for larger changes in value.” McKinsey cites the example of a retail bank where 5 percent of checking account customers defected annually, taking with them 10 percent of the bank’s checking accounts and 3 percent of its total balances. But every year, the 35 percent of customers who reduced their balances significantly cost the bank 24 percent of its total balances, whereas the 35 percent who increased their balances raised its total balances by 25 percent. This effect showed up in all sixteen industries studied and was dominant in two-thirds of them.^[8]

The McKinsey study backs up its argument with two more examples:

A local phone company found that more than 90 percent of its loyalty opportunities came from reaching out to customers dropping business features such as second lines and call waiting. A financial institution aimed all its loyalty efforts at increasing its customers’ satisfaction. It made major investments to cut down on service failures (such as unanswered phones) and reduced the number of closed accounts. But the effect on overall growth was marginal.^[9]

Relative Numbers

Brand futurist Nick Wreden makes the same point in his book, FusionBranding: Strategic Branding Models for the Customer Economy … and Beyond (Accountability Press, 2002), “People spend way too much time worrying about ‘absolute’ numbers, like lifetime value.

What they really should be looking at is ‘relative’ numbers—change over time. It is not nearly as important to know the absolute value of a customer as it is to know whether this value is rising or falling.” He calls this the “Customer LifeCycle,” and says, “Knowing and understanding the Customer LifeCycle is the most powerful marketing tool you can have.”^[10] It’s not enough to look at monthly or even weekly reports of customer status. Any one of these is no more than a snapshot in time. Wreden’s Customer LifeCycle is the measurement of trends that identify the satisfied customers spending more and the downward migrators spending less—the true measure of customer value.

Some Good Examples

Tesco Some companies realize the value of the customer relationship asset. Tesco, the largest supermarket chain—in fact, the largest retailer—in the U.K., has used its knowledge of over 5,000 separate customer needs segments to increase in-store product turnover 51 percent with a mere 15 percent increase in floor space. They have seen profits grow from $890 million in 1995 to $1.3 billion in 2000, while increasing market share from 13 percent to more than 17 percent. Back in 1995 a company called Dunn Humby helped Tesco develop its highly personalized loyalty program that now captures 80 percent of in-store transactions. Dunn Humby continues to manage the program for Tesco. Realizing the customer information managed by Dunn Humby is its most valuable asset, Tesco took a 53 percent stake in its data-mining partner in 2001.

Commerce Bank Since its founding in 1973, Commerce Bank in Cherry Hill, New Jersey, has been building customer relationships. The company hasn’t been cutting costs, hitting up customers for every sort of penny-ante fee, tolerating nasty employees, or greedily chasing after every possible loan. Commerce has invested in building customer relationships. Commerce welcomes customers as if it were a friendly retail business where you can even find a flesh-and-blood banker at 8:00 p.m. on Sunday. The result: The stock of Commerce Bank has returned an annualized 35 percent a year over the past decade.^[11] Are their customer relations a bankable asset? I’ll let you decide.

Sprint Newer businesses may be the first to accept customer relationships as an asset. The practice of evaluating a customer base is slowly taking hold at Sprint. Mike Nevels, CRM director at Sprint’s National Consumer Organization, was quoted, “Wall Street shareholders want to see customer growth in our PCS business, even though nobody asks about these numbers with our long-distance division. I think the metrics of success, to a degree, should be based on a business equation of customer profitability and value.”^{[12 ]}

Steve Skinner, president and CEO of Peppers and Rogers Group Inc., a management consulting firm dedicated to helping enterprises build and execute high-impact customer-based strategies, makes the case:

Careful valuation of a customer base gives the savvy CEO a new argument to take to Wall Street. Since customers, not products, make purchases and drive earnings, the most valuable thing any company creates is a customer. So it makes sense to track the value and predict the growth of this asset. If a CEO can articulate to the Street that the company’s existing customers can drive significant value going forward, the company is less dependent on customer acquisition and should earn a higher multiple.^[13]

A 2002 survey from PricewaterhouseCoopers showed that senior executives consider customer information and other nontraditional metrics when measuring a company’s success and value on Wall Street. Dr. Robert Eccles, PricewaterhouseCoopers Fellow, says, “While current financial results are very important, non-financial measures like customer satisfaction and product quality are also critical to how the markets value their company, since they are the leading indicators of bottom-line financial results.” Part of this process is to measure how much customers are worth based on their current value, future value, and defection rate, helping to turn “intangible assets” into revenue numbers for stockholders.^[14]

In May 2001, the Security and Exchange Commission (SEC) recommended companies report their “intangible assets” to shareholders, including the current and projected flow of future earnings (customer lifetime value) of an existing customer base.^[15] Whenever a company can show that its customer relationships can drive value going forward and make the company less dependent on new customer acquisition, the company’s stock should earn a higher multiple. Increased relationship value leads to increased shareholder value. Wall Street will care.

^[6]Stephanie Coyles and Timothy C. Gokey, “Customer Retention Is Not Enough,” The McKinsey Quarterly.com, 2002, Number 2, p. 1.

^[7]Ibid.

^[8]Ibid.

^[9]Ibid., pp. 2, 5.

^[10]Nick Wreden, FusionBranding: Strategic Branding Models for the Customer Economy … and Beyond (Atlanta: Accountability Press, 2002) as excerpted in Relationship Marketing Report, Volume IV Issue XII, p. 2.

^[11]Jeffrey Kosnett, “Ready for Long-Term Commitment?,” Investing Kiplinger’s, November 2001, p. 1.

^{[12 ]}Steve Skinner, “Sprint PCS Wireless Reports Customer Value to Shareholders,” INSIDE 1to1, January 19, 2002, p. 4.

^[13]Ibid.

^[14]“Looking Beyond the Numbers for Company Value,” [e-mail], October 19, 2002, p. 6.

^[15]Steve Skinner, “Sprint PCS Wireless Reports Customer Value to Shareholders,” INSIDE 1to1, January 19, 2002, p. 3.