The Financial Benefits of Customer Loyalty

 

Successful organisations have always understood the importance of providing a good level of service to existing profitable customers, in order to ensure that they do not defect to competitors. The current tough economic conditions mean there are not so many potential new customers around so building customer loyalty becomes even more of a focus.  Which is a challenge for many service operations, as the pressure to reduce costs can lead to a reduction in service levels and an increase in unhappy customers.

For those operating in a customer service environment, trying to justify maintaining or even improving the levels of customer service your team deliver, then “The Loyalty Effect” by Frederick Reichheld is a must read book.

I have always been a fan of the writings of Frederick Reichheld of Bain & Company and particularly “The Loyalty Effect”. Despite being written in the 1990’s before the Internet’s full impact had been felt, it highlights valuable lessons about the nature and benefits of loyalty amongst customers and employees which are equally valid today. Adding to the book’s credibility is that most of the examples of best practice organisations used are still alive and thriving more than 15 years on. 

For me the book’s biggest strength is its financial model on the potential benefits of retaining the right customers for a long time. This financial model can be a lifeline for hard pressed customer service managers trying to justify existing staffing levels. It offers a way of presenting the benefits of customer retention in a way that even a battle weary and hard-hearted financial director can appreciate.

I will explain my understanding of Reichheld’s basic model for the financial benefits of retaining customers.  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The diagram above shows that every new customer costs something for a business to acquire, whether it is advertising, handling a website enquiry or a face-to-face sales visit. Initial sales deliver a core profit which, depending on the industry, may or may not cover the initial costs of acquiring the customer. For car insurance or credit cards generally it will be some years before a new customer actually contributes a profit. For other industries the pay back may be much shorter or immediate.

For many service sectors the big benefits arise from keeping the customer loyal for many years. These benefits can be broken down into 5 areas. Apart from the base profit from the initial service offered, benefits can be obtained from:

• Sales growth: If a customer is impressed by your service they may place more of their custom with you eg they may visit your restaurant more frequently.
• Cost reductions: Existing customers understand the services you offer and don’t generally generate the same level of queries as a new customer. eg the initial administration overhead of opening an account is not incurred for repeat business. If customer loyalty is combined with employee loyalty then experienced delivery drivers will knows the best time to deliver to that customer, how to find them and where to park on repeat visits. The staff in my local Indian restaurant can write most of my order for food without me having to say anything so I take far less time to process than a new customer.
• Customer referrals: A happy and loyal customer can potentially refer you to others. In some markets such as selling life insurance this can be a key source of business leads.
• Price premium: Customers who value the service you provide are less likely to be price sensitive on individual lines.

This is a general model and the proportions of profit coming from the five elements will vary by market and over a period of years. However, it is a valuable exercise to consider each of the benefits in turn for your own market. It may well change your approach to dealing with customers. Reichheld makes the point that many companies do not immediately have to hand all the data to build this model for themselves. However, for those customer service managers with an entrepreneurial spirit, starting to gather this data may give you a weapon in the fight against budget cuts that will damage the business long-term.

 I have only been able to touch on Reichheld’s ideas here. To get a full view do take the time to read “The Loyalty Effect”.

 By Jon Davies| Righttrack’s Digital Marketing Manager

PS Also check out Righttrack’s Service Xtra offering