It may sound like heresy, but the fact is that customer loyalty is not always a good thing. If, for example, you’re losing money in serving a particular set of customers, the last thing you want to do is invest in forging long-term relationships with them. And, if your customers’ loyalty is to old products and services, you may be lulled into a false sense of security that leaves you vulnerable to new competitive threats. A blind devotion to the concept of loyalty, like a blind devotion to chocolate cake or martinis, can be a dangerous thing.

That said, ignoring loyalty is even more dangerous. Companies that pay little or no attention to building loyalty among their customers (and, sad to say, most still fall into this category) are doomed to eventual decline. Either they will succumb to terminal customer churn or, more likely, they will lose their best customers to a nimble new competitor with a more compelling value proposition. We see such fates played out again and again in the business world, as once-prosperous companies give in to the “sin of success” and begin taking their market positions and customers for granted. Many of the original 1955 Fortune 500 companies – once the largest and most powerful beasts on the business planet – no longer exist. Once they had loyal customers – lots of them – and now they have none.

The Principles of Loyalty

Through our work helping companies build loyalty among their most profitable customer groups, we have identified four principles of loyalty that are applicable to virtually every company (see Exhibit 1). Each flies in the face of conventional thinking about the topic. The first principle focus on specific types of customers is controversial, as it forces a company to admit that some customers are more desirable than others. We have found that building loyalty among all customers is more often than not detrimental to the long-term health of an enterprise. After all, customers exhibit dramatic differences in their buying behavior and their cost-to-serve, leading to equally dramatic variations in the profitability they generate for a company. Building loyalty among non-profitable customers can thus undermine a company’s bottom line.

Moreover, trying to please the least profitable customers (who also tend to be the most demanding) can impede a company’s ability to serve its most profitable customers. Designing business systems to meet the needs of all the diverse customer types, for example, keeps enterprises from tailoring their products and services to the needs of the most attractive customers. Many banks that aim to provide top-notch digital, ATM, phone and branch services, for instance, cannot compete effectively with more focused competitors who master only one of these channels. The marketing advantage will always lie with the specialist. We have certainly seen this in the credit card business, where innovative specialists, like MBNA and Direct One have grabbed the most lucrative customers from traditional banks. Similarly, old-line department stores have found it extremely difficult to counter attacks from more narrowly focused specialty stores.

While the criteria for selecting which customers to target may vary, a company should focus on those it will be able to profitably satisfy and those who are constitutionally willing to be loyal. A mistake most brokerage houses have made is to target those who are the wealthiest and most active. Hence, they are all going after the same market, which is savvy enough to be loyal to none. Study after study pursues these “big ticket traders” with high revenue potential. However, the people in this segment are aware of their value and quite sophisticated in their ability to select investment opportunities. Furthermore, they enjoy the “game” of finding the best deal on every transaction. Loyalty carries little weight in their buying decisions.

That leads us to our second principle focus on creating value, not on reducing price. Though this may be counter-intuitive to some executives, who view discounting for one’s best customers as a part of doing business, the fact is that cheap prices alone will not provide a stable base upon which to build loyalty.

The problem is that discounting, in isolation, has negative ramifications. It suggests that prices have been set higher than value (and that the company knows it). It also suggests that the only reason for loyalty is, in essence, a bribe. All of this diminishes the perceived quality of the brand and sets up an industry dynamic wherein loyalty is bought and sold-as we see today in the telephone long distance market. In the current world of long distance, only a person who cares little about money would choose to be loyal to any firm. By switching regularly between competing carriers, even a frequent caller can show a positive cash flow by accepting the highest offer each month for switching or staying. No other industry has yet paid up to $100 cash to keep or entice a customer with no barrier to exit when the next offer comes a day or two later.

We saw further proof of this several years ago working for a leading Big 6 accounting firm. The issue was whether or not they should continue “buying business” in the audit practice. Clients wanted cheaper audits and the theory was that low-balling an account would get the firm into a relationship that would ultimately be profitable. Analysis showed that this strategy rarely paid off. Most of these clients continued to apply price pressure. Furthermore, client satisfaction studies for the same firm demonstrated that the more satisfied clients were actually paying higher hourly fees on average than less satisfied clients.

Far better, we have learned, is to provide other forms of value – perhaps in addition to pricing tactics. Innovations, particularly those offered only or first to valuable customers, are the best strategy. Bundling and co-branding can also enhance loyalty. There are many other routes to building value-based loyalty, including:

  • Using databases to acknowledge key events in the customer’s life, like their daughter’s  birthday, or to track and accommodate personal preferences
  • Providing special previews of new offerings
  • Creating customized packages of services that meet specific needs

Often, loyalty can be enhanced at little or no cost. For example, many marketers are seeking access to the high-end business market – a market held captive on planes and in hotels. These marketers could partner with hotels and airlines, allowing them to reward their best customers by giving them access to, perhaps even possession of, these new products. That’s a win-win.

The importance of building a positive value perception underlies the third principle: focus on building loyalty, not just reducing churn. One can reduce churn fairly simply. Focusing wholly on churn typically leads to a series of costly, last-ditch efforts to stop customers as they are about to walk out the door – efforts that typically amount to “too little, too late.” The better approach is to understand the underlying drivers of loyalty and use that understanding to preempt churn by reinforcing loyalty at critical junctures throughout the customer’s life cycle. Discounts, presents and timely interventions all work but only until a competitor tries again. The best defense is to win both hearts and minds. This requires an emotional connection with customers through communications and a reward/thank you after behavior rather than an incentive at the front-end to induce it.

Finally, loyalty programs, like quality programs, are not free. Each program and initiative must be rigorously tested to ensure that it is working and paying off. The fourth principle-systematically prioritize efforts based on ROI (and other set criteria) – is the logical conclusion of our initial point. Loyalty is not a good idea if it means keeping unprofitable customers longer. It is a necessity if it means – as it should – developing and retaining a profitable group of customers.

While each enterprise is unique, the process of developing a loyalty program can be generalized (see Exhibit 2). The first step is diagnostic and contains two equally important interrelated elements:

  • Identify the key drivers/causes of both customer retention and customer defection
  • Identify customer segments that can be profitably served

Each of these diagnostics must be based on research – and, in the case of the drivers of defections, this must be blind research in which the client is not identified. Relying on what customers told the sales team is not enough. Too often, companies believe what they want to about why customers don’t return and don’t have the vaguest idea about what truly motivates their most loyal customers.

The segmentation effort must encompass customer attitudes, behaviors and demographics and, if such databases exist, it should be tied to actual customer history. Only by looking at both rational factors and emotional factors can segments be constructed that both describe and (at least partially) explain behavior. The segments must then be carefully analyzed from an economic perspective to determine reliable estimates of their profitability over time.

Key outputs for this step are a “knowledge book,” which summarizes what has been learned historically (and from any fresh research) as well as a set of hypotheses about potential loyalty programs. Once segments and motivations have been identified, the enterprise must hypothesize how to combine the learning – that is, develop hypotheses about what program(s) will improve the loyalty of which profitable segments.

In the second step, these ideas are triaged and those deemed most promising are fully fleshed out and then refined. It is important in this stage to ensure that all the ideas are practical (i.e. can be implemented) and that the juice appears worth the squeeze (i.e. the potential impact is relatively large with incremental revenues exceeding program costs).

The next step is to test the potential programs. This requires careful design with explicit criteria and measurements, both of revenues and costs.

The final step is to implement the program(s) while continuing to rigorously measure the impact. It is vital that feedback mechanisms be built in with the flexibility to amend/enhance the program as it continues. It is also critical that marketing and communications to customers are part of what is tested and monitored over time.

Getting Beyond the Hype

Now that loyalty has become a flavor-of-the-day management issue, many companies will inevitably launch new programs. As they do, managers should be aware of the pitfalls that can thwart success. The major barrier is an inability to recognize that different customer segments have different values and therefore must be served differentially. As noted, these differences usually manifest themselves as different wants and needs both on the left-brain (e.g. product features) and the right-brain (e.g. emotional connection) sides. The key is to communicate appropriately to each valuable segment. Given today’s sophisticated marketing tools (e.g. database modeling, interactivity, etc.), this is now technically feasible, which makes loyalty programs potentially far more powerful than before the days of database manipulation and mining and before the possibility of individualized messaging.

Even after a targeted approach is taken, marketers must avoid these potholes:

  • Not focusing on the future, serving only today’s needs instead of anticipating what key customer segments will want in the future.
  • Failing to connect acquisition efforts with loyalty programs. A key sign of danger is if those involved in acquisition are organizationally distinct from the loyalty team.
  • Failing to measure properly and comprehensively. A company shouldn’t just look at customers’ tenure or at their short-term revenues or even their profitability. In fact, each program should assess the proper weighting of at least four dimensions of loyalty:
    • Length (e.g. tenure)
    • Depth (e.g. amount of spending)
    • Breadth (e.g. number of accounts, services used)
    • Width (e.g. other household members, referrals)

Making loyalty more than a fad requires doing it right from the start – in-depth analytics, followed by alignment and dedication. Like any initiative that requires major change to be effective, it requires the continuing commitment of top management.

In closing, keep in mind these perspectives from two thought leaders:

“There is only one valid definition of business purpose: to create a satisfied customer.”

- PETER DRUCKER

“The purpose of a business is to create and keep a customer.”

- TED LEVITT