| How
to build customer retention |
How to retain consumer
customers
By Arthur Middleton Hughes
One basic objective of database marketing is finding ways of improving the customer retention rate. A key contribution of Frederick Reichheld in his wonderful book, The Loyalty Effect, was his recognition of the importance of employee loyalty to customer loyalty. He pointed out that many, if not most, customers are loyal not to the brand or the firm, but to the people who serve them at the firm. When you lose employees, you often lose customers as well. Any marketing program aimed at customer retention must begin with looking at employee satisfaction and retention. The problem is that employee retention throughout a company is seldom something that the marketing department can influence directly. It they want to retain customers, however, marketers must recognize that customer loyalty and employee loyalty are usually tightly linked.
Acquiring the right customers
Given that loyal customers are better to have and more profitable than others, what can you do about it? Until ReichheldŐs book came along, there was one universal answer: figure out who the loyal customers are, and treat them well. Provide things like: gold cards, PresidentŐs clubs, advisory panels, member nights, special toll free phone lines, and hundreds of special services that will encourage these loyal people to stick around for a long time.
There is nothing in ReichheldŐs book that disagrees with these recommendations. But there is little to support them, either. Reichheld simply changed the subject. The route to loyalty, he explained, is to recruit loyal people to begin with. ŇSome customers are inherently predictable and loyal, no matter what company theyŐre doing business with. They simply prefer stable, long-term relationships.Ó
His book provides dozens of examples of companies who have figured out the characteristics of their loyal customers. They have developed simple rules that aid them in attracting the right kind of customer, and avoiding the wrong kinds. Some of his examples:
˘ An insurance company discovered that, for them, married people were more loyal than singles. Mid-westerners were more loyal than Easterners. Homeowners were more loyal than renters. Once they found this out, they used the knowledge to guide their acquisition strategy.
˘ MBNA discovered that people reached through an affinity group-- such as doctors, dentists, nurses, teachers and engineers-- were more loyal credit card holders than people reached through general direct mail campaigns.
˘ Many companies used their databases to learn that customers attracted by low-ball discount offers were more likely to disappear than customers attracted using non-discounted offers. They tended to leave as soon as the competition made them an even lower ball offer. Were they different people, or had the offer made them think of the companyŐs products in terms of price, rather than value? Who knows? It really doesnŐt matter. Discounting is not a profitable long range strategy.
Reichheld pointed out that satisfaction scores may be worthless as a means of measuring customer loyalty. In the automobile industry, American cars typically have satisfaction scores in the 90%, but the repurchase rates hover around 35%. Repurchase is the best indicator of loyalty, he concluded.
The importance of sales commissions.
An important part of employee loyalty is the employee
compensation system. Reichheld pointed out that ŇThere is always a tension
between commission sales and customer loyalty because a sales force paid on
commission and hell-bent on customer volume generally finds that the easiest
prospects to sell are the ones whose loyalty is lowÓ. In many industries the acquisition process has become so
costly that customers who defect after the first year are unprofitable. A way
has to be found to recruit the right kind of customers: loyal customers who
last several years. It is possible that this can be done only by modifying the
way customers are acquired in the first place, and the way they are maintained
during the first couple of years.
Insurance Illustration
LetŐs apply the loyalty principle to life insurance. First year attrition in life insurance is usually high. In some companies, a life insurance agent receives a large commission on the initial sale, and reduced commissions on the next few yearsŐ premiums. LetŐs see how we could increase customer loyalty by changing the commission structure for the agent. Suppose, initially, that agents get a commission of 40% of the first yearŐs premium and 4% of the premiums paid in the second and third years. Here is an illustration of the resulting lifetime value:
In this example, 35% of the customers defect after the first year. Administrative costs are 20% the first year, and 15% each subsequent year. The profit to the company in the first year is zero. The lifetime value of newly acquired customers in the third year is $660. With this system, we are down to less than half of the originally acquired 400,000 customers in the third year. Future profits have to come from this group.
LetŐs look at this picture and see how we could improve customer loyalty. Customers respond to contacts with agents. In this picture, the agent gets most of his commission in the first year. The agent receives about $200 in the first year for signing up a new customer. Commissions in the next two years are about $40 per retained customer per year. If the agent is aggressive, in the second and third years he is busy hustling up more business @ $200 each, rather than spending a lot of time communicating with his existing customers in the next two years @ $40 each (at least half of which will come in without any significant effort on his part). The way he sees it, one hour spent on new business pays him five times as much as an hour spent with a prior year customer-- and he is right.
Suppose we were to change the commission structure. We will offer agents 20% on the initial sale and 20% on each of the next two years premiums. The effect of the new commission structure is to get agents to focus more on customer retention and loyalty. Customers respond to communications. There is no question that the retention rate will increase. Why does it increase? For two reasons. 1) The agent will consciously or unconsciously recruit people who will last for two or more years. 2) Once customers have taken out a policy, the agent will contact them frequently to make sure that they do not defect. Here we show the retention rate increasing by 5 basis points in each of the three years. As a result, the insurance company has 210,000 premium paying customers remaining from the original 400,000 in the third year, rather than the 182,000 resulting from the old system. How have the insurance agents made out?
As you can see by this chart, the agentŐs revenue per newly acquired customer has grown by $192. In the following chart, total company profits have increased from $290 million to $324 million.
Why did the retention rate go up? Because the agent realized that the second and third year premiums were vital to his success as an agent, and his ability to maintain his standard of living. Under the new system, agents will both seek out loyal customers to begin with, and maintain active contact with customers. The change for agents who already have a 40/4/4 system may be difficult. You might start by using the new system for new agents, rather than old veterans.
What we have been showing here is that there are many ways to boost retention. One way may be the change the agent compensation scheme.
Arthur Middleton Hughes is Vice President of The Database Marketing Institute. Ltd. (Arthur.hughes@dbmarketing.com) which provides strategic advice on relationship marketing. Arthur is also Senior Strategist at e-Dialog.com (ahughes@e-Dialog.com) which provides precision e-mail marketing services for major corporations worldwide. Arthur is the author of Strategic Database Marketing 3rd ed. (McGraw Hill 2006). You may reach Arthur at (954) 767-4558 .
The articles on this web site are available to the general public to read, enjoy and for limited business use. If you want to reprint more than one or two of them for resale or use in a business or educational environment, send an email to Arthur Hughes at arthur.hughes@dbmarketing.com. He will give you permission by return email. The cost, depending on the number of copies you want to reprint, is very inexpensive.