Customer Loyalty and Customer Lifetime Value

Customer loyalty and customer lifetime value are two different, yet related, areas of study. The purpose of this discussion is to outline each area and highlight how knowledge in both areas is necessary to better understand how to grow a company.  Companies are not static entities; they make business decisions in hopes to increase customer loyalty and grow their business. The key to business growth is to make decisions that will improve customer loyalty. Customer loyalty management is the practice of determining how to maximize customer loyalty. To understand how improvements in customer loyalty will improve business growth, we need to first understand the value of customers to the organization.

Customer Lifetime Value (CLV)
Customer lifetime value reflects the present total value of a customer to the company over his or her lifetime. The concept of CLV implies that each customer (or customer segment) differs with respect to their value to the company. When we discuss CLV, we typically refer to the value of a single customer, whether that customer represents the typical customer overall or the average customer within a customer segment (e.g., West coast customer vs. East coast customer).

The generic model of CLV can be broken down as a function of four elements:

• NC: Number of customers


• NP: Number of times the average customer make a purchase each year


• CL: Average customer life (in years)


• PPS: Average profit per sale (total sales revenue – costs)/number of sales

Using these elements, we can calculate the customer lifetime value for the entire customer base (or customer segment):
CLV = NC x NP x CL x PPS

Increasing the Lifetime Value of the Customers
Organizations, using this CLV model, can now view customers as assets with a specified value that, in turn, becomes the basis for making business decisions. The goal for management, then, is to maximize the CLV to the company. To increase the lifetime value of the customers, organizations can do one or more of the following four things:

• Increase size of the customer base (or customer segments)


• Increase the number of purchases customers makes


• Increase the average customer life


• Increase profits per sale

We see that higher CLV equates to greater financial growth with respect to profits and a greater likelihood of long-term business success. It is important to note that, because the CLV is a multiplicative function of four elements, a negative value of profits (costs are greater than revenue) results in a negative CLV no matter how large the other elements of the CLV become. Therefore, before trying to manage the loyalty of a particular customer segment, it is important to know if the customer segment is worth growing or even worth having. This step involves calculating the profits per sale.

Providing a value for profit is oftentimes game of guesswork due to the lack of understanding of costs associated with a given customer relationship. Costs may be difficult to quantify due to the lack of available data needed to make such precise calculations or costs may be overlooked due to a lack of understanding of the company resources necessary to maintain relationships with customers. The estimation procedure of the profit value should be transparent and shared across the organization to ensure assumptions about its calculation are reviewed by all interested parties.

While the concept of CLV has been traditionally applied in the sales/marketing field to understand the cost of attracting new customers, more comprehensive CLV models include costs associated with other phases of the customer lifecycle. Consider the customer lifecycle model in Figure 1. We see that a customers’ tenure with the company involves three general phases, attraction (marketing), acquisition (sales), and service (service). Within each customer lifecycle phase, company resources are required to maintain a relationship with customers. Accordingly, to get a more accurate estimation of the customer lifetime value, organizations are now including the costs to service the customers. Extending beyond the costs of attracting and acquiring customers, servicing costs expend organizational resources such as customer service staff costs and employee training costs, just to name a few. These service costs, along with sales/marketing costs, should be included in the estimation of profit per sale.





Figure 1. Customer Lifecycle

Once these costs associated with a given customer group can be established, the lifetime value of that customer group can be determined. While some customer segments could be very profitable, other customer segments might not be profitable at all.

Customer Loyalty Measurement
After identifying the extent to which a customer segment is profitable or not, the organization now must make a choice whether or not they want to invest in that customer segment to increase the lifetime value of the customers in that segment. Clearly, a customer segment that is costing more to maintain than the revenue it generates should raise red flags across the organization. In this situation, the organization can either attempt to decrease the costs of maintaining these relationships or simply attrite these relationships. For a customer segment that is profitable, the organization can determine how best to increase the lifetime value of that segment through loyalty management.

In the next step, the organization needs to understand how they can increase the lifetime value of the customers in the profitable customer segments. From the remaining elements of the CLV, the organization can improve the CLV by focusing on one or more of the customer-focused elements of the CLV model. Specifically, a company can increase the size of the customer base, increase the purchasing behaviors of the customer base, and increase the tenure of the customer base.Each of the customer-centric elements of the CLV correspond directly to each the three facets of customer loyalty identified through our research on customer loyalty. These three facets of customer loyalty include 1) Advocacy Loyalty, 2) Purchasing Loyalty and 3) Retention Loyalty.

Business Model and Customer Lifetime Value
Customer surveys can result in hundreds of thousands of data points for large organizations. Consider one high-tech company who surveys their customer base bi-annually with a survey that contains roughly 50 questions (both loyalty questions and business attribute questions). Given a sample size of 14,000 respondents per survey period, this company has 1.4 million pieces of customer feedback data annually with which to help them manage their customer relationship! While most companies might not have the magnitude of customer feedback data as this company, even smaller amounts of data (20,000 data points from 20 questions and 1000 respondents) can overwhelm a company trying to use their data intelligently to manage their customer relationships.

Business Model. To help us understand how to use the data, we can employ models to help us put the data in context. There are many different types of models regarding customer satisfaction and loyalty (ACSI, 2008; Heskett, Sasser & Schlesinger, 1997) but they all have basic elements in common. A basic model incorporating common elements of each of these models appears in Figure 2.






Figure 2. Marketing/Sales/Service Business Model and the Relationship among Key Organizational Variables
(Adapted from Heskett, Sasser & Schlesinger, 1997 and ACSI, 2008)


This business model illustrates the interrelatedness of the organizational variables that ultimately impact the company’s financial performance. Empirical research shows that business growth is stimulated primarily by customer loyalty. Loyalty is a direct result of customer satisfaction, and satisfaction is largely influenced by the value of services provided to customers. Value is created by satisfied, loyal, and productive employees. Employee satisfaction, in turn, is impacted by the business strategies and internal systems that enable employees to deliver results to customers. Partners also provide products and services to joint customers and help to impact customer loyalty to the partnering company.

Customer Lifetime Value. Older models examining the relationships among organizational variables, whether purposefully or not, do not make the distinction among the different facets of customer loyalty. The distinction of the facets of customer loyalty goes beyond recent thinking regarding the simplistic notion that customer relationship management can be effectively conducted with a single loyalty item.

Increasing the lifetime value of customers requires the management of all three types of loyalty in the customer base (or segment). By measuring each type of customer loyalty, executives can more effectively manage their customer relationships by examining each type of loyalty. Loyalty management allows companies to address customer growth, purchase behavior, and customer retention. To improve the CLV, business decisions can now be targeted to address specific types of loyalty concerns.

Customer Feedback Programs Best Practices: An Empirical Investigation

Improving the customer relationship is seen as the key to improving business performance (Ang & Buttle, 2006; Reinartz, Krafft & Hoyer, 2004). In the course of this endeavor, popular business strategies emerged that have shined a spotlight on the importance of understanding customers’ attitudes, expectations and preferences. Customer-centric business strategies, such as CRM (customer relationship management) and CEM (customer experience management), focus on managing customers’ attitudes about their experience, fueling the proliferation of customer feedback programs (CFPs).

Customer feedback programs (CFPs) reflect a variety of types of customer programs where formal customer data are collected on customers’ perceptions and satisfaction programs, customer advocacy programs and customer loyalty programs. This study was designed to identify best practices regarding customer feedback programs.

A web-based survey was used to collect information from 112 customer feedback professionals on their company’s CFP. Survey administration was conducted using a Web-based survey tool provided by GMI (Global Market Insite, Inc.). Respondents were provided by CustomerThink.com and through the author’s professional network.

CFP Best Practices

Widely used (adopted by 80% or more) CFP business practices by Loyalty Leaders (companies whose industry percentile ranking of customer loyalty was 70% or higher) are located in the top half of Table 1 (in descending order of adoption rate).



Additionally, customer loyalty percentile rankings and satisfaction with CFP in managing customer relationships were compared for companies who adopted a specific CFP business practice and companies who did not. Results (see Table 1) showed that companies who adopted specific CFP business practices, compared to companies who did not adopt the business practices, had higher customer loyalty percentile rankings (17% difference) in their industry and higher satisfaction with CFP in managing customer relationships (1.5 difference on a 0 to 10 scale).

Applied research helps companies gain superior customer insight through in-depth customer-centric research. This research extends well beyond the information that is gained from the typical reporting tools offered through survey vendors. Applied research can take the general form of linking operational metrics to customer feedback data. Additionally, research can also take the form of linking other constituent’s attitudinal data (e.g., employee, partner) with customer feedback data. Companies that conduct this sort of in-depth research gain the knowledge of how to better integrate the customer feedback into daily processes.

Executive support and use of customer feedback data as well as communication of the program goals and the customer feedback results helps embed the customer-centric culture into the company milieu. Executive use of customer feedback in setting strategic goals helps keep the company customer-focused from the top. Additionally, using the customer feedback in executive dashboards and for executive compensation solidifies the importance of customers as a key business metric. Sharing of the customer feedback results (as well as results of applied research) throughout the company helps ensure all employees are aligned with top management’s view regarding the importance of the customer in daily operations.

The combination of a rigorous applied customer-centric research program, top executive support and use of customer feedback results, and the communication of program goals and results are key ingredients to a successful customer feedback program.

You can find the free executive summary here. For more information about the study, please contact Bob Hayes at Business Over Broadway.

Net Promoter Debate: The Measurement and Meaning of Customer Loyalty (Free White Paper)

The Net Promoter Score (NPS) is used by many of today’s top businesses to monitor and manage customer relationships. Fred Reichheld and his co-developers of the NPS say that a single survey question, “How likely are you to recommend Company Name to a friend or colleague?”, on which the NPS is based, is the only loyalty metric companies need to grow their company. Despite its widespread adoption by such companies as General Electric, Intuit, T-Mobile, Charles Schwab, and Enterprise, the NPS is now at the center of a debate regarding its merits.

I have conducted some research on the Net Promoter Score (NPS). Turns out, the claims of the NPS developers are grossly overstated and misleading. I have summarized my findings (along with the current research on the topic) in a free white paper. You can download a free copy of the white paper by clicking the link below.

Free white paper on NPS debate

Bob

Customer Loyalty and Goal Setting

All companies who use customer loyalty surveys strive to see increases in their customer loyalty scores. Improving customer loyalty has been shown to have a positive impact on business results and long-term business success. Toward that end, executives implement various company-wide improvements in hopes that improvements in customer loyalty scores will follow.

One common method for improving performance is goal setting. There is a plethora of research on the effectiveness of goal setting in improving performance. In the area of customer satisfaction, what typically occurs is that management sees that their customer loyalty score is 7.0 (on a 0-10 scale) at the start of the year. They then set a customer loyalty goal of 8.0 for the end of the fiscal year. What happens at the end of the year? The score remains about 7.0. While their intentions are good, management does not see the increases in loyalty scores that they set out to attain. What went wrong? How can this company effectively use goal setting to improve their customer loyalty scores?

Here are a few characteristics of goals that improve the probability that goals will improve performance:

Specific. Goals need to be specific and clearly define what behaviors/actions are going to be taken to achieve the goal and in what time-frame or frequency these behaviors/actions should take place. For example, a goal stating, “Decrease the number of contacts with the company a customer needs to resolve an issue” does little to help employees focus their efforts because there is no mention of a rate/frequency associated with the decrease. A better goal would be, “Resolve customer issues in three or fewer contacts.”

Measurable. A measurement system needs to be in place to track/monitor progress toward the goal. The measurement system is used to determine whether the goal has been achieved and provides a feedback loop to the employees who are achieving the goal.

A common problem with using customer loyalty scores as the metric to track or monitor improvements is that satisfaction goals are still vague with respect to what the employees can actually do to impact satisfaction/loyalty scores. Telling the technical support department that the company’s customer loyalty goal is 8.0 provides no input on how that employee can affect that score. A better measure for the technical support department would be “satisfaction with technical support” or other technical support questions on the survey (e.g., “technical support responsiveness,” technical support availability”). We know that satisfaction with technical support is positively related to customer loyalty. Using these survey questions for goal setting has a greater impact on changing their behaviors compared to using vague loyalty questions. Because satisfaction with technical support is related to customer loyalty, improvements in technical support satisfaction should lead to improvements in loyalty scores.

An even better measure would be to use operational metrics for goal setting. The company must first identify the key operational metrics that are statistically related to customer satisfaction/loyalty. This process involves in-depth research via linkage analysis (e.g., linking satisfaction scores with operational measures such as hold time, turnaround time, and number of transfers) but the payoffs are great; once identified, the customer-centric operational metrics can be used for purposes of goal setting.

Difficult but attainable. Research has shown that difficult goals lead to better performance compared to goals that are easy. Difficult goals focus attention to the problem at hand. Avoid setting goals, however, that are too difficult and, consequently, not achievable. One way to set difficult and attainable goals is to use historical performance data to determine the likelihood of achieving different performance levels.

Relevant. Goals for the employees should be appropriate for the employees’ role; can the employee impact the goal? Additionally, the goal should be relevant to both the employee and the organization. Holding employees to be responsible for goals that are outside of their control (e.g., technical support representatives being responsible for product quality) is unfair and can lead to low morale.

Accepted (or mutually set). For goal setting to increase performance, employees should be allowed to participate in setting their goals. Goals that are not accepted by the recipient are not likely to be internalized and motivating. A good approach would be to get employees involved early in the process of goal setting. Let them help in identifying the problem, selecting (or understanding) the key measures to track, and setting the goal.