“The Right Customers”

In today’s session, we saw the importance of focusing on the right customer. In the article of Reinartz, Werner and Kumar, you can read three claims about customer loyalty which the authors then contradict:

1. It costs less to serve loyal customers
* While in fact customers know their value to the company and often exploit it to get premium service or price discounts… They expect something in return for their loyalty!
2. Loyal customers pay higher prices for the same bundle of goods
* While Kumar shows us that customers regularly guarantee greater frequency of purchase in return for lower prices: a loyal customer is in fact more price sensitive than an occasional one…
3. Loyal customers market the company
* This only is true for certain kind of customers. Most companies measure loyalty purely on the basis of purchasing behavior: but they might buy a product due to inertia or convenience…

The third point points out the fact that a company should indicate what kind of customer a specific person is.
“The Right Customers” (Harvard business essentials) article stresses that not all customers are of equal economic value to a company. What one group creates in profits is frittered away in trying to serve another. Differences in profitability are a function of several factors: total revenues, profit margin on those revenues, the duration of the customer relationship, and the cost of acquiring, serving and retaining particular customers.

A problem is compounded when marketers spend more money trying to retain low-value customers: they confuse loyalty with profitability. So they spend too much money on activities aimed at retaining customers who contribute little to company profits. The economic value of an individual customer is the present value of the stream of cash flow generated by that individual minus the initial cost of acquiring that customer. The customer equity is the difference between the revenues a customer produces minus the costs of acquisition, retaining and developing that customer. The acquisition costs might be high, but if the company then retains the customer over many years, it might be rewarded. But some customers will generate a negative cash flow for a long time or even forever. This underscores the disparity of economic value among customers and the importance of knowing which ones provide the greatest and least value.

A company’s customer base is likely to follow a normal distribution around an average customer value. I used the article to show to a company what it can do to improve:

1. Stop doing business with people who persistently generate losses
* At some point, you must face the fact that some of the customers will not become profitable.  First investigate the customer’s situation. If the problem is financial incapacity (so a small size of the wallet according to Kumar), drop the customer.
But if the problem is that you are not getting enough share of the wallet, you need to make the relationship worthwhile:

2. Develop an economically sound plan for moving modestly profitable customers into the high-profit sector.
* Once you understand what customers want and are willing to pay for, you can create an offer they will find more attractive, perhaps by redesigning your current product or service. Another approach to work with marginally profitable customers is to work the cost side of the customer equity equation: find less costly ways to acquire and serve these customers.

3. Create a plan for retaining customers in the profitable sectors and developing their economic value even further
* You have to use some of the cash saves by eliminating uneconomic customers to cement and expand your relationship with profitable ones; they are the jewels in the crown.
Some further tips about the last improvement point (3):

1.) Quantify Defection
Estimate the rate of customer defection = turnover. (so count the number of customer defections (so customer you lose) over a period of time)
2.) Locate the epicenter of Defection
3.) Learn from Defectors and the Dissatisfied (so obtain feedback to help you when making choices about e.g. pricing, product, delivery etc).
4.) Neutralize the causes of Defection: this means eliminate reasons for customers to look elsewhere:
* Do not disappoint (keep it consistent and at expectations)
* Keep price reasonable
* Maintain a dialogue with customers (reward feedback)
* Keep looking for ways to surprise and delight your customers

Development means: expand the amount of profitable business you can conduct with current customers = expand your share of the wallet.
1) What customer information would you need to have before addressing new parts of the value chain?
2) How are customers currently handling those links, and through whom? Are they satisfied, or are they open to alternatives?
3) Do we currently have the competencies to serve those links? If not, would acquiring them be feasible and worth the costs?

So “The Right Customers” article also expresses some mismanagement of customer loyalty: a lot of managers are focusing on the wrong customers because they confuse loyalty with profitability. Using this article, a company will focus only on the right customer in the future!


One thought on ““The Right Customers””

  1. Thank you Larissa for posting this!! It is indeed a wonderful paper and a great fit to what we discussed today!! The fact that more studies comply with the idea that loyalty does not necessarily mean profitability, signals that there is a lot to investigate on finding the optimal budget allocation across different (loyal or less loyal) customers.

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