Customer Relationship Management A Databased Approach

1. Customer Relationship ManagementA Databased Approach V. Kumar Werner J. Reinartz Instructor’s Presentation Slides

2. Chapter Eight Designing Loyalty Programs

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

4. s L P Satisfaction-Loyalty-Profit Chain Product Performance Customer Retention / Revenue / Service Satisfaction Loyalty Profit Performance 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

5. Results of Customer Satisfaction-Profit Link Studies • Direct link suggests, that as customers experience greater satisfaction with a firm’s offering, profits rise • Improving customer satisfaction comes at a cost and once the cost of enhancing satisfaction is factored in, offering “excessive satisfaction” doesn’t 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

6. 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

7. 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

8. 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 customer’s stated intent to repurchase

9. 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

10. The link between Loyalty and Profits • Reichheld’s 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 firm’s resources but are subject to diminishing returns

11. 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

12. High Lifetime Profit Low Low High Loyalty 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

13. Association of Profitability and Longevity of Customers Source: “The mismanagement of customer loyalty”, Werner Reinartz, V Kumar. Harvard Business Review

14. Customer Loyalty • Loyalty to a product or service by repeat purchases can be due to customer’s 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

15. 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

16. Key Objectives of Loyalty Programs • Building true (attitudinal & behavioral) loyalty • Efficiency profits • Effectiveness profits • Value alignment

17. BuildingTrue 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

18. 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

19. Efficiency Profits • Profits that result from a change in customer’s 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

20. 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

21. 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 customer’s value and in the cost to serve the customer Example: the airline business, the hospitality industry and the financial services industry

22. 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

23. 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

24. 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

25. Loyalty Programs Membership Growth

26. 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 • Southwest’s 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

27. 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

28. 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

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

30. 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 Benz’s 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 customer’s home for taking pictures

31. 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

32. 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

33. Reward Programs in the Gaming Industry • Harrah’s 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 Harrah’s location. • Members also can draw benefits from Harrah’s alliance with partner firms such as Sony, Royal Caribbean, and Warner Brothers

34. 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

35. 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

36. 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 firm’s 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

37. 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