Customer Relationship Management A Databased Approach

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Customer Relationship ManagementA Databased
Approach

• V. Kumar
• Werner J. Reinartz
• Instructors Presentation Slides

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Chapter Eight

• Designing Loyalty Programs

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Topics Discussed

• Satisfaction-loyalty-profit chain
• Loyalty programs
• Key objectives of Loyalty Programs
• Examples of Loyalty Programs
• Design Characteristics of Loyalty Programs
• Reward Structure

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Satisfaction-Loyalty-Profit Chain
Product
Performance
Customer
Retention /
Revenue /
Service
Performance
Satisfaction
Loyalty
Profit
Employee
Performance
Source Strengthening the satisfaction-profit
chain, Eugene W Anderson, Vikas Mittal. Journal
of Service Research, Nov 2000. Vol 3, Iss.2, p 107
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Results of Customer Satisfaction-Profit Link
Studies

• Direct link suggests, that as customers
  experience greater satisfaction with a firms
  offering, profits rise
• Improving customer satisfaction comes at a cost
  and once the cost of enhancing satisfaction is
  factored in, offering excessive satisfaction
  doesnt pay
• Marginal gains in satisfaction decrease, while
  the marginal expenses to achieve the growth in
  satisfaction increase
• There is an optimum satisfaction level for any
  firm, beyond which increasing satisfaction does
  not pay

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The link between Satisfaction and Retention
Source Strengthening the satisfaction-profit
chain, Eugene W Anderson, Vikas Mittal. Journal
of Service Research, Nov 2000. Vol 3, Iss.2, p 114
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The link between Satisfaction and Retention
(contd.)

• Link between satisfaction and retention is
  asymmetric
• Dissatisfaction has a greater impact on retention
  than satisfaction
• Even if the level of satisfaction is high,
  retention is not guaranteed
• If customers are dissatisfied, other products
  become more enticing
• The link is nonlinear in that the impact of
  satisfaction on retention is greater at the
  extremes
• The flat part of the curve in the middle has also
  been called the zone of indifference
• Factors like the aggressiveness of competition,
  degree of switching cost, and the level of
  perceived risk influence the shape of the curve
  and the position of the elbows

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The link between Satisfaction and Retention
Source Why satisfied customers defect, Jones,
Thomas O, Sasser, W Earl Jr. Harvard Business
Review. Boston Nov/Dec 1995. Vol. 73, Iss. 6
The figure shows the variability in the
relationship between satisfaction and retention
across industries. Loyalty was measured as the
customers stated intent to repurchase
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How Competitive Environment affects
Satisfaction-Loyalty Relationship Example

• In the very competitive automotive industry,
• Very high levels of satisfaction are necessary
  for a customer to repurchase the same brand again
• When utilising an airline
• Consumers may incur considerable switching costs
• This cost might increase due to bonus point
  build-up in frequent flyer programs and due to
  limited airline choice at any given airport
• Thus, consumers tend to re-patronize an airline
  even though their satisfaction might only be
  moderate

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The link between Loyalty and Profits

• Reichhelds hypotheses
• Long term customers spend more per period over
  time
• Cost less to serve per period over time
• Have greater propensity to generate word-of-mouth
• Pay a premium price when compared to that paid by
  short-term customers
• Does not hold true in a non-contractual
  relationship
• Revenue stream must be balanced by the cost of
  constantly sustaining the relationship and by
  fending off competitive attacks
• Efforts at increasing customer satisfaction and
  retention not only consume a firms resources but
  are subject to diminishing returns

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Lifetime Duration-Profitability Association

• Reinartz and Kumar Across the different firms,
• there is a segment of customers that is loyal but
  not very profitable
• (due to excessive resource allocation)
• there is a segment that generates very high
  profits although it has only a short tenure
• Since these short-term customers can be very
  profitable, it is clear that loyalty is not the
  only path to profitability

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Lifetime Duration-Profitability Association

• Overall trend shows a direct correlation
  between loyalty and
• profitability
• Outliers on the graph who generate high
  profits while not
• having high loyalty will outperform those
  customers who have a
• high level of loyalty but who are not very
  profitable

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Association of Profitability and Longevity of
Customers
Source The mismanagement of customer loyalty,
Werner Reinartz, V Kumar. Harvard Business Review
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Customer Loyalty

• Loyalty to a product or service by repeat
  purchases can be due to customers natural
  satisfaction and preference for the products
  features and benefits
• Loyalty can also be induced through marketing
  plans and programs from the firm
• Behavioral loyalty the observed action that
  customers have demonstrated towards a particular
  product or service
• Attitudinal loyalty the perceptions and
  attitudes that a customer has towards a
  particular product or service

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Loyalty Programs

• A marketing process that generates rewards to
• customers based on their repeat purchasing
• Consumers who enter a loyalty program are
  expected to transact more with the focal company,
  giving up the free choice they have otherwise
• In exchange for concentrating their purchases
  with the focal firm, they accumulate assets (for
  example, points)
• Points are exchanged for products and services,
  typically but not necessarily associated with the
  focal firm
• CRM tool used by marketers to identify, award,
  and retain profitable customers

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Key Objectives of Loyalty Programs

• Building true (attitudinal behavioral) loyalty
• Efficiency profits
• Effectiveness profits
• Value alignment

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Building True Loyalty
loyalty

• Encompasses both attitudinal and behavioral
  components of loyalty
• Greater commitment to the product or organization
  through the building of true loyalty
• Function of true value provided to the customers
• Involves degree of involvement in the product
  category, visibility of the product when using
  it, or value expressive nature of the product
• Goal of many customer clubs
• Difficult in the case of a low involvement
  category e.g. grocery shopping

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CRM at Work Supermarkets - Difficulty in
Building True Loyalty

• Despite spending hundreds of millions of pounds
  on price-cutting campaigns and loyalty card
  schemes, supermarkets
• have only persuaded a small minority of shoppers
  to stay loyal
• According to a report from Mintel Research
• Only 15 of all grocery shoppers are completely
  loyal to the store where they do their main
  grocery shopping
• 29 use one other store
• 22 use two others
• Men are more likely than women to be loyal to a
  single store
• 46 of men shop in just one or two main stores

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Efficiency Profits

• Profits that result from a change in customers
  buying
• behavior due to the loyalty program
• Change in buying behavior can be measured, in
• Basket size
• Purchase frequency acceleration
• Price sensitivity
• Share of category requirements (SCR) or
  share-of-wallet
• Retention
• Lifetime duration
• Measured in terms of the immediate profit
  consequences as compared to profit consequences
  without loyalty programs net of the LP cost

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Effectiveness Profits

• Measured in terms of the long-term profit
  consequences realized through better learning
  about customer preferences over time
• Allows sustainable value creation for customers
  through customization of products or
  communication
• Most likely to generate sustainable competitive
  advantage since it produces the highest profits
  in the long run
• The strategy of using a LP to learn about
  customer preferences may result in impressive
  gains for both customers and organizations
• Customers get more of what they truly want, and
  firms are safe in terms of not having to engage
  in a costly mass marketing exercise

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Value Alignment

• Goal of aligning the cost to serve a particular
• customer with the value he/she brings to the
  firm
• Allows firms to serve their most valuable
  customers in the best manner
• The goal of value alignment is particularly
  critical when there is great heterogeneity in the
  customers value and in the cost to serve the
  customer
• Example the airline business, the hospitality
  industry and the financial services industry

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Revenue and Profitability of Customers
Example of a firm with a highly heterogeneous
customer base
-Tier A represents 71 of the customer
base, Tier B 42 and Tier C the remaining 27.
- More than a quarter of the customers are
unprofitable and need to be subsidized by the
highly profitable ones
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Examples of LPs

• Frequent-Buyer programs
• City Bagels, a sandwich retail chain offers every
  10th sandwich free for customers who have nine
  stamps from previous purchases
• Volkswagen Club and Card
• Customers collect points from Volkswagen (VW) for
  servicing their car or buying accessories and
  from partners of car rental companies and tour
  operators
• The points can be redeemed for dealer services,
  price reductions on car purchases, and catalog
  merchandise
• Star Alliance Frequent Flyer Program
• Any flight on any Star Alliance airline counts
  towards a members frequent flyer program

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Examples of LPs (contd.)

• Webmiles.de
• Webmiles allows its members to collect and redeem
  assets in a network of retail partners. Thus, the
  retailers become members in Webmiles partner
  network
• Webmiles manages the program and the
  communication with more than 1 million customers
• Neimann Marcus
• Offers its LP InCircles to all customers. Using
  a shopping card, customers accumulate points that
  can be redeemed for exclusive rewards
• Buitoni Pasta Club
• Buitoni offers a platform for exchange among
  pasta enthusiasts sharing recipes, cooking
  experiences, and testing innovative product
  concepts. The club offers an opportunity for
  Buitoni to get closer to heavy end-users

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Loyalty Programs Membership Growth
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CRM at Work Frequent Flyer Programs

• American Airlines, United, Continental, and USAir
  multiply miles flown by a customer by a
  coefficient derived from the type of seat class
  that customer has paid for
• Passengers who are willing to pay to upgrade to
  business or 1st class will, in turn, earn more
  miles and thus be rewarded sooner and more often
• Southwests reward program is based on the number
  of flights that an individual takes. Every eight
  round trip flights are worth one free round trip
  flight
• Southwest rewards customers who fly 50 round trip
  flights in a year with a free companion pass for
  the next year
• Southwest captures the business of high value
  customers who fly at least once a week, on an
  average
• By reducing the role of the middleman, Southwest
  is able to capture revenue
• Result Southwest has been the only major airline
  that has had a positive net income since the year
  2000

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Design Characteristics of Loyalty Programs

• Reward structure
• Hard vs. soft rewards
• Product proposition support (Choice of rewards)
• Aspirational value of reward
• Rate of rewards
• Tiering of rewards
• Timing of rewards
• Sponsorship (existence of partner network,
  network externalities)
• Single vs. multiform LP
• Within sector vs. across sector LP
• Ownership (focal firm vs. other firm)

LP
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Reward Structure

• Hard vs. soft rewards
• Financial or tangible rewards (hard rewards) and
  those based on psychological or emotional
  benefits (soft rewards)
• Hard rewards price reductions, promotions, free
  products and preferred treatment
• Soft rewards psychological benefit of having
  special status in addition to receiving preferred
  customer service

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Reward Structure (contd.)

• Product proposition support
• Reward directly supports the firms product
  proposition
• Example The US Bagel franchise Finagle-A-Bagel
  has a LP that allows participants to redeem their
  accumulated bonus points for the firms own
  products sandwiches and drinks
• Allows LP member to redeem points for products
  that are completely unrelated to the focal firms
  offering
• Example British Petroleums LP users may redeem
  points from their gasoline-related purchases for
  merchandise such as first-aid kits, photographic
  films, coffee mugs, and Barbie dolls

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Reward Structure (contd.)

• Aspirational value of reward
• Consumers prefer hedonic goods as opposed to
  utilitarian goods when receiving a gift or a LP
  reward
• Mercedes Benzs LP makes it possible to transform
  points against a flight in a MIG 29 combat
  aircraft
• Neimann Marcus, the US luxury retail chain, gives
  out each year a new list of wow and cool
  rewards. These unique rewards include a world
  famous photographer to come to a customers home
  for taking pictures

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Reward Structure (contd.)

• Rate of rewards
• Ratio of reward value (in monetary terms) over
  transaction volume (in monetary terms)
• How much a consumer is getting in return for
  concentrating his or her purchases
• Tiering of rewards
• Rewards based on asset accumulation response
  function - how assets or rewards are accumulated
  as a function of spending behavior

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Change in Cumulative Spending with Two Different
Response Functions
In case 1, the buyer receives the same amount of
rewards per spent, regardless of the spending
level In case 2, the buyer receives a larger
amount of rewards per spent, with increasing
spending level. Here, the program is relatively
more attractive for buyers who are high spenders.
Many airline programs follow this pattern
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Reward Programs in the Gaming Industry

• Harrahs Entertainment Three-tiered loyalty
  program - Total Rewards.

• The tiered structure offers different levels of
  reward services and privileges to customers of
  differing tiers
• Reward ranging from cash back at slots/tables to
  complimentary offers for shows, meals, and hotel
  stays at any Harrahs location.
• Members also can draw benefits from Harrahs
  alliance with partner firms such as Sony, Royal
  Caribbean, and Warner Brothers

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CRM at Work Bloomingdales Rewards Plus Program

• Increasing levels of rewards to customers based
  upon their annual spending level
• First tier Premier Insider- all members that
  sign up for a Bloomingdales credit card
• Second tier Premier Plus Insider- members who
  spend more than 1000 annually
• Third tier Ultimate Premier Insider customers
  who spend over 2500 each year at Bloomingdales

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Reward Structure (contd.)

• Timing of Rewards
• Determined by minimum redemption rules, type of
  reward given out, and reward rate
• Longer the timing to build up to a certain reward
  level, the greater the breakage (the amount of
  rewards that are never redeemed)
• Lock-in effect - firm creates redemption rules
  that favor long accumulation periods, thereby
  impacting customer retention
• Customers build up assets that function as
  switching cost

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LPs Based on Sponsorship

• Single vs. multi-firm LP
• Single LPs that reflect only the transactions
  with its own customers
• Multi-firm LP member may also accumulate assets
  at organizations associated with the focal firms
  LP
• Within sector/across sector
• Supply side dimension of multi-firm LP
  design-degree of cross sector partners
• Example for within sector The STAR Alliance of
  SAS, Lufthansa, United Airlines, Varig
• Example for across sector The LP of AOL and
  American Airlines, with its 2000 or so partners,
  spans many different industries
• Ownership
• For multiform LPs, the ownership dimension
  characterizes who owns the LP within the network
  whether it is the focal firm, a partner firm or a
  firm whose sole purpose is to manage a LP

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Summary

• Satisfaction-profit-chain (SPC) needs to be
  implemented at a disaggregate level or individual
  level than aggregate, firm-level
• Link between satisfaction and retention is
  asymmetric, i.e., dissatisfaction has a greater
  impact on retention than satisfaction, and
  nonlinear
• Reinartz and Kumar demonstrated that loyalty is
  not the only path to profitability
• The success or failure of a loyalty program (LP),
  whether contractual or motivated through
  incentives, is determined by profitability from
  the customer
• Most companies need to revisit their business
  model
• to reflect on the impact of Loyalty Programs on
  their bottom line
• to determine how customer service initiatives add
  value to future revenue streams