Shattering the Myths of Customer Loyalty

In a 1990 Harvard Business Review article, consultant Frederick Reichheld and Harvard professor W. Earl Sasser, Jr., captured the attention of the business community with the promise that "by reducing customer defection by a mere 5%, companies can boost profits by 25% to 85%." This enticing claim rocked the business world and jump-started the customer retention movement, in its infancy at the time.

Numerous additional HBR articles and over 40,000 books in the intervening 15 years have further promoted customer loyalty as an almost universal cure for the problems plaguing marketers today. The effect of the message is profound; a 2002 survey of global CEOs (conducted by the Conference Board) documented customer loyalty and retention to be the most important challenge that CEOs believed they faced -- surpassing stock performance or cost reduction! Because of this widespread acceptance, billions in corporate capital have been spent annually in pursuit of increased customer loyalty.

And why not? Isn't customer loyalty a worthwhile goal? The The simple answer is, "Yes, but..." And it's the "but" that is the problem, because most of what business leaders have been told about customer loyalty is just plain wrong. There wasn't a vast conspiracy perpetrated to mislead managers' belief in the benefits from customer loyalty; it has been a matter of a rudimentary understanding. The science investigating loyalty was embryonic and therefore incomplete. And incomplete frequently means wrong. Unfortunately, the messages of loyalty gurus with their half-truths and incomplete analyses have taken their toll: businesses have been crippled by false hopes and executives have been pilloried by their public dedication to delivering the over-promises of loyalty myths. It's time to set the record straight.

While we, too, have repeated many of the same myths, we noted in some of our consulting engagements that expected results from loyalty initiatives were not always achieved. These occasions motivated us to reexamine what we and the business community know about the laws of customer loyalty. Our study has benefited from work with hundreds of firms worldwide as well as the evolving insights of leading marketing scientists. As a result we have identified fifty-three commonly held beliefs about customer loyalty. We have been able to deflate each, showing them to be oversimplifications at best, and at worst, complete falsehoods. (See our book, Loyalty Myths, for a complete listing of all fifty-three myths.) Here we've listed six of the most commonly trusted loyalty myths and the recent research or faulty logic that exposes them as myths.

Loyalty Myth: Retaining 5% more of a company's customer will increase profits by 25% to 85%.

The underlying assumption of many of the myths of customer loyalty is the premise that retaining customers translates into increased profitability. Unfortunately, for most firms the foundation of this argument is shaky at best. Were one to accept Pareto's Principle, which suggests that "eighty percent of (a business's) revenues comes from twenty percent of (its) customers," then one would see the difficulty with the retention argument: not every customer positively contributes to profits.

The problem is even more serious than the 80/20 rule applied to revenue implies. Considering the profitability of individual customers for most firms, the results are significantly more extreme. Research in activity-based costing consistently shows that while revenues typically follow the 80/20 rule, profits are substantially more skewed; the most profitable 20% of customers contribute 150% to 300% of aggregate profits, the least profitable 20% of customers account for a 50% to 200% reduction in aggregate profits, while the middle 60% of customers neither add nor subtract from profits, simply breaking even.

It's absolutely critical to know a business's customers before launching a customer loyalty initiative, otherwise there is a strong likelihood that some of the wrong customers will be retained and some of the right customers will be overlooked and allowed to defect.

In order to expect such a high increase in profitability (25% to 85%), a company's profit percentage before launching the loyalty initiative would need to be extremely low. And the ability to generate additional profits by improving retention is highly contingent upon any firm's current retention rate. If we acknowledge that increasing the customer retention rate will be a costly proposition, this effort will likely experience diminishing returns (see figure 2). At some point, it will no longer be cost effective to dissuade additional defectors from defecting. The net result is that this myth is flawed from many perspectives.

Loyalty Myth: Most companies' databases are adequate for building loyalty.

Contrary to the ideal, most companies' information about their customers is in terrible shape! Some of the largest firms in the world have not assembled the personal identities and key contact information of their largest customers into one database. Instead, the information resides in the minds, drawers, or handheld PDAs of their sales representatives. Rarely is this critical information warehoused as logic would suggest and as loyalty needs dictate. Customer databases are a challenge rather than a facilitating factor in any loyalty initiative.

Loyalty Myth: Loyal customers help grow a business through positive word of mouth.

No doubt, in some business sectors customers do refer others, and these referrals can be a source of new customers. But there are natural boundaries to this behaviour. Most firms operate in categories with little perceived risk, minimal status conferral, and scant ego involvement associated with their products or services. For these firms, word of mouth is not a contributor. Word of mouth tends to be reserved for extraordinary products and services.

The degree of emotionality also affects referrals. Customers tend to speak about products and services and encounters with companies in one of two extreme conditions: extreme dissatisfaction or extreme satisfaction (delight). A reasonable amount of research tells us customers are far less likely to speak about positive experiences (which might attract new customers) than negative experiences (which might drive potential customers away). Word of mouth isn't the free advertising this myth perpetuates.

Loyalty Myth: Loyalty programmes will solve customer attrition problems.

This myth makes the critical basic assumption that the firm's product or service is not sub-par. Even if we assume that a well-designed and differentiated loyalty programme can enhance customer loyalty, a loyalty programme cannot compensate for an intrinsically bad product. If an airline consistently cancelled your flights, would the airline's award of frequent flyer miles really be a compelling retention mechanism?

Even with a parity product, far too many loyalty programmes become equivalent entries in a category mimic others rather than offering uniquely appealing rewards and appreciation. Loyalty programmes failing to offer customers real added value are a financial burden, not a competitive advantage. Tansas, a major grocery retailer in Turkey, examined the purchases made by members of its loyalty card programme and found they purchased no more nor shopped more frequently than non-members of the programme. To quote Servet Topaloglu, the company's CEO: "I knew that we had to give consumers a clear and differentiating reason to choose Tansas," which they achieved.

Loyalty Myth: Higher customer loyalty levels lead to higher market shares.

While it may seem counterintuitive, firms with the most loyal customers rarely have the largest market shares. Organizations we tend to associate with having fiercely loyal customers generally represent smaller, exclusive groups: Harley Davidson owners, Fender Stratocaster guitar owners, Edith Piaf fans, and so forth. As the size of a customer franchise increases, the associated loyalty declines to the norm. Loyalty and market share are not positively correlated.

Loyalty Myth: Satisfied employees create loyal customers.

The satisfaction mirror concept from the service-profit chain suggests that happy employees create happy customers, and vice versa. Unfortunately, numerous studies investigating the direction and magnitude of this association have generally failed to reveal consistent relationships. Some studies have shown a negative correlation between employee loyalty and customer loyalty, some a positive relationship, and a few have failed to show any relationship. More extensive studies that tracked employee satisfaction all the way to business results discovered some linkage, but the direction of the correlations are mixed. Employees should not be disregarded -- they need to be properly trained, well equipped, and made to feel appreciated -- but satisfaction (often operationalized as "Do you like your job?" and "Do you have a best friend at work?") is not the critical element.