Loyalty business model
Encyclopedia
The loyalty business model is a business model
used in strategic management
in which company resources are employed so as to increase the loyalty of customers and other stakeholders in the expectation that corporate objectives will be met or surpassed. A typical example of this type of model is: quality of product
or service leads to customer satisfaction, which leads to customer loyalty, which leads to profitability.
is first based on a recent experience of the product or service. This assessment depends on prior expectations of overall quality compared to the actual performance received. If the recent experience exceeds prior expectations, customer satisfaction is likely to be high. Customer satisfaction can also be high even with mediocre performance quality if the customer's expectations are low, or if the performance provides value (that is, it is priced low to reflect the mediocre quality). Likewise, a customer can be dissatisfied with the service encounter and still perceive the overall quality to be good. This occurs when a quality service is priced very high and the transaction provides little value.
This model then looks at the strength of the business relationship; it proposes that this strength is determined by the level of satisfaction with recent experience, overall perceptions of quality, customer commitment to the relationship, and bonds between the parties. Customers are said to have a "zone of tolerance" corresponding to a range of service quality between "barely adequate" and "exceptional." A single disappointing experience may not significantly reduce the strength of the business relationship if the customer's overall perception of quality remains high, if switching costs
are high, if there are few satisfactory alternatives, if they are committed to the relationship, and if there are bonds keeping them in the relationship. The existence of these bonds acts as an exit barrier. There are several types of bonds, including: legal bonds (contracts), technological bonds (shared technology), economic bonds (dependence), knowledge bonds, social bonds, cultural or ethnic bonds, ideological bonds, psychological bonds, geographical bonds, time bonds, and planning bonds.
This model then examines the link between relationship strength and customer loyalty. Customer loyalty is determined by three factors: relationship strength, perceived alternatives and critical episodes. The relationship can terminate if:
1) the customer moves away from the company's service area,
2) the customer no longer has a need for the company's products or services,
3) more suitable alternative providers become available,
4) the relationship strength has weakened,
5) the company handles a critical episode poorly,
6) unexplainable change of price of the service provided.
The final link in the model is the effect of customer loyalty on profitability. The fundamental assumption of all the loyalty models is that keeping existing customers is less expensive than acquiring new ones. It is claimed by Reichheld
and Sasser (1990) that a 5% improvement in customer retention
can cause an increase in profitability between 25% and 85% (in terms of net present value
) depending upon the industry. However, Carrol and Reichheld (1992) dispute these calculations, claiming that they result from faulty cross-sectional analysis.
According to Buchanan and Gilles (1990), the increased profitability associated with customer retention efforts occurs because:
For this final link to hold, the relationship must be profitable. Striving to maintain the loyalty of unprofitable customers is not a viable business model. That is why it is important for marketers to assess the profitability of each of its clients (or types of clients), and terminate those relationships that are not profitable. In order to do this, each customer's "relationship costs" are compared to their "relationship revenue." A useful calculation for this is the patronage concentration ratio
. This calculation is hindered by the difficulty in allocating costs to individual relationships and the ambiguity regarding relationship cost drivers.
Fredrick Reichheld (1996) expanded the loyalty business model beyond customers and employees. He looked at the benefits of obtaining the loyalty of suppliers, employees, bankers, customers, distributors, shareholders, and the board of directors.
All historical trends for different segmentations and their standard of living may also be very helpful in developing customer retention strategy. Lifestyle is also a very powerful tool, can be used for better customer retention and to know his/her needs in better way.
Business model
A business model describes the rationale of how an organization creates, delivers, and captures value...
used in strategic management
Strategic management
Strategic management is a field that deals with the major intended and emergent initiatives taken by general managers on behalf of owners, involving utilization of resources, to enhance the performance of firms in their external environments...
in which company resources are employed so as to increase the loyalty of customers and other stakeholders in the expectation that corporate objectives will be met or surpassed. A typical example of this type of model is: quality of product
Product (business)
In general, the product is defined as a "thing produced by labor or effort" or the "result of an act or a process", and stems from the verb produce, from the Latin prōdūce ' lead or bring forth'. Since 1575, the word "product" has referred to anything produced...
or service leads to customer satisfaction, which leads to customer loyalty, which leads to profitability.
The service quality model
A model by Kaj Storbacka, Tore Strandvik, and Christian Grönroos (1994), the service quality model, is more detailed than the basic loyalty business model but arrives at the same conclusion. In it, customer satisfactionCustomer satisfaction
Customer satisfaction, a term frequently used in marketing, is a measure of how products and services supplied by a company meet or surpass customer expectation...
is first based on a recent experience of the product or service. This assessment depends on prior expectations of overall quality compared to the actual performance received. If the recent experience exceeds prior expectations, customer satisfaction is likely to be high. Customer satisfaction can also be high even with mediocre performance quality if the customer's expectations are low, or if the performance provides value (that is, it is priced low to reflect the mediocre quality). Likewise, a customer can be dissatisfied with the service encounter and still perceive the overall quality to be good. This occurs when a quality service is priced very high and the transaction provides little value.
This model then looks at the strength of the business relationship; it proposes that this strength is determined by the level of satisfaction with recent experience, overall perceptions of quality, customer commitment to the relationship, and bonds between the parties. Customers are said to have a "zone of tolerance" corresponding to a range of service quality between "barely adequate" and "exceptional." A single disappointing experience may not significantly reduce the strength of the business relationship if the customer's overall perception of quality remains high, if switching costs
Switching barriers
Switching barriers or switching costs are terms used in microeconomics, strategic management, and marketing to describe any impediment to a customer's changing of suppliers....
are high, if there are few satisfactory alternatives, if they are committed to the relationship, and if there are bonds keeping them in the relationship. The existence of these bonds acts as an exit barrier. There are several types of bonds, including: legal bonds (contracts), technological bonds (shared technology), economic bonds (dependence), knowledge bonds, social bonds, cultural or ethnic bonds, ideological bonds, psychological bonds, geographical bonds, time bonds, and planning bonds.
This model then examines the link between relationship strength and customer loyalty. Customer loyalty is determined by three factors: relationship strength, perceived alternatives and critical episodes. The relationship can terminate if:
1) the customer moves away from the company's service area,
2) the customer no longer has a need for the company's products or services,
3) more suitable alternative providers become available,
4) the relationship strength has weakened,
5) the company handles a critical episode poorly,
6) unexplainable change of price of the service provided.
The final link in the model is the effect of customer loyalty on profitability. The fundamental assumption of all the loyalty models is that keeping existing customers is less expensive than acquiring new ones. It is claimed by Reichheld
Fred Reichheld
Frederick F. Reichheld is a United States business author and business strategist best known for his research and writing on the loyalty business model and Loyalty Marketing. His books include The Loyalty Effect , Loyalty Rules! , and The Ultimate Question: Driving Good Profits and True Growth...
and Sasser (1990) that a 5% improvement in customer retention
Customer retention
Customer Retention is the activity that a selling organization undertakes in order to reduce customer defections. Successful customer retention starts with the first contact an organisation has with a customer and continues throughout the entire lifetime of a relationship...
can cause an increase in profitability between 25% and 85% (in terms of net present value
Net present value
In finance, the net present value or net present worth of a time series of cash flows, both incoming and outgoing, is defined as the sum of the present values of the individual cash flows of the same entity...
) depending upon the industry. However, Carrol and Reichheld (1992) dispute these calculations, claiming that they result from faulty cross-sectional analysis.
According to Buchanan and Gilles (1990), the increased profitability associated with customer retention efforts occurs because:
- The cost of acquisition occurs only at the beginning of a relationship: the longer the relationship, the lower the amortized costAmortization (business)In business, amortization refers to spreading payments over multiple periods. The term is used for two separate processes: amortization of loans and amortization of intangible assets.-Amortization of loans:...
. - Account maintenance costs decline as a percentage of total costs (or as a percentage of revenue).
- Long term customers tend to be less inclined to switch and also tend to be less price sensitive. This can result in stable unit sales volume and increases in dollar-sales volume.
- Long term customers may initiate free word of mouthWord of mouthWord of mouth, or viva voce, is the passing of information from person to person by oral communication. Storytelling is the oldest form of word-of-mouth communication where one person tells others of something, whether a real event or something made up. Oral tradition is cultural material and...
promotions and referrals. - Long term customers are more likely to purchase ancillary products and high-marginProfit marginProfit margin, net margin, net profit margin or net profit ratio all refer to a measure of profitability. It is calculated by finding the net profit as a percentage of the revenue.Net profit Margin = x100...
supplemental products. - Long term customers tend to be satisfied with their relationship with the company and are less likely to switch to competitors, making market entry or competitors' market share gains difficult.
- Regular customers tend to be less expensive to service because they are familiar with the processes involved, require less "education," and are consistent in their order placement.
- Increased customer retention and loyalty makes the employees' jobs easier and more satisfying. In turn, happy employees feed back into higher customer satisfaction in a virtuous circleVirtuous circle and vicious circleA virtuous circle and a vicious circle are economic terms. They refer to a complex of events that reinforces itself through a feedback loop. A virtuous circle has favorable results, while a vicious circle has detrimental results...
.
For this final link to hold, the relationship must be profitable. Striving to maintain the loyalty of unprofitable customers is not a viable business model. That is why it is important for marketers to assess the profitability of each of its clients (or types of clients), and terminate those relationships that are not profitable. In order to do this, each customer's "relationship costs" are compared to their "relationship revenue." A useful calculation for this is the patronage concentration ratio
Patronage concentration
Patronage concentration is a term used in marketing. It is the share of an individual consumer's expenditures in an industry that is spent at one company...
. This calculation is hindered by the difficulty in allocating costs to individual relationships and the ambiguity regarding relationship cost drivers.
Expanded models
Schlesinger and Heskett (1991) added employee loyalty to the basic customer loyalty model. They developed the concepts of "cycle of success" and "cycle of failure". In the cycle of success, an investment in your employees’ ability to provide superior service to customers can be seen as a virtuous circle. Effort spent in selecting and training employees and creating a corporate culture in which they are empowered can lead to increased employee satisfaction and employee competence. This will likely result in superior service delivery and customer satisfaction. This in turn will create customer loyalty, improved sales levels, and higher profit margins. Some of these profits can be reinvested in employee development thereby initiating another iteration of a virtuous cycle.Fredrick Reichheld (1996) expanded the loyalty business model beyond customers and employees. He looked at the benefits of obtaining the loyalty of suppliers, employees, bankers, customers, distributors, shareholders, and the board of directors.
Data collection
Typically, loyalty data is being collected by multi-item measurement scales administered in questionnaires. However, other approaches sometimes seem more viable if managers want to know the extent of loyalty for an entire data warehouse. This approach is described in Buckinx, Verstraeten & Van den Poel (2006).All historical trends for different segmentations and their standard of living may also be very helpful in developing customer retention strategy. Lifestyle is also a very powerful tool, can be used for better customer retention and to know his/her needs in better way.
See also
- Loyalty marketingLoyalty marketingLoyalty marketing is an approach to marketing, based on strategic management, in which a company focuses on growing and retaining existing customers through incentives...
- Business modelBusiness modelA business model describes the rationale of how an organization creates, delivers, and captures value...
- Customer loyalty programs
- Strategic managementStrategic managementStrategic management is a field that deals with the major intended and emergent initiatives taken by general managers on behalf of owners, involving utilization of resources, to enhance the performance of firms in their external environments...
- Relationship marketingRelationship marketingRelationship marketing was first defined as a form of marketing developed from direct response marketing campaigns which emphasizes customer retention and satisfaction, rather than a dominant focus on sales transactions....
- Net Promoter Score
- American Customer Satisfaction IndexAmerican Customer Satisfaction IndexThe American Customer Satisfaction Index is an economic indicator that measures the satisfaction of consumers across the U.S. economy. It is produced by the American Customer Satisfaction Index, a private company based in Ann Arbor, Michigan....