A framework for customer retention improvement, involves three major steps- the measurement of customer retention; the identification of root causes of defection and key service issues; and the development of corrective action to improve retention. Each of these steps consists of a number of critical tasks, which are now examined in turn.
Step # 1. Measurement of Customer Retention:
The measurement of retention rates for existing customers is the first step in improving customer loyalty and profitability. It involves two major tasks – measurement of customer retention rates and profitability analysis by segment.
Customer Retention Measurement:
The customer retention rate can be defined, at its simplest level, as the percentage of customers at the beginning of a period that still remain customers at the end of the period. This definition is appropriate for products such as motor insurance where the customer selects either a given company or one of its competitors.
However, it should be recognized that other more complex definitions of customer retention rate might be appropriate (for instance, a customer may bank with more than one bank or shop at more than one supermarket).
Where customers buy products or services from many suppliers, it is necessary to weight customers by the amount they spend with a given organization (their ‘share of wallet’). Also, it is important to track changes in customer spend, for apparently high customer retention rates can hide serious problems.
For example, there are a number of banks that boast high levels of customer retention but which, in fact, have high levels of account dormancy. Customers may have defected to other banks with the majority of their business, but have not bothered to close their original accounts.
To measure customer retention, a number of dimensions need to be analyzed in detail. These include the measurement of customer retention rates over time, by market segment, and in terms of the product/service offered. If customers buy from a number of suppliers, share of wallet should also be identified.
Segment Profitability Analysis:
The second task within this initial step is to ensure that relevant segmentation analysis is undertaken. It must not be assumed that companies will wish to retain all their customers. Some customers may actually cost too much money to service, and may never prove to be worthwhile and profitable. Clearly, it would be inadvisable to invest further in these customers.
Different customer segments need to be considered on the basis of both present and future profitability. Increasing customer retention of the most attractive segments should become a critical element of an organization’s strategy. This will help identify the type and frequency of the marketing activity that should be directed towards the different segments.
We term this activity ‘developing a segmented service strategy’. To assist with this task, an index can be developed and used to grade the customer base according to profitability so that appropriate strategies can be devised to manage customer relationships most effectively.
Using such an approach may present some surprises. For example, a large insurance company discovered that it was not high net worth individuals that were providing the largest future profit streams, although this group had been the focus of much of the company’s customer retention activity.
Instead, segment profitability analysis showed that schoolteachers were actually the most profitable market segment. Previously, the company had never considered schoolteachers a worthwhile market segment and had directed little marketing activity towards them.
Measurement systems are needed which allow managers to analyse their customer base, to identify the profit potential within each segment and then to develop strategies to retain the most profitable prospects. An important part of this evaluation process is establishing both the existing and potential ‘customer lifetime value’. Customer lifetime value is defined as the net present value of the future profit flow over a customer’s lifetime.
The stage reached in the customer’s life cycle can also impact profit potential. This will influence the pattern as well as the amount of customer profitability. For example, early in the customer’s life cycle, profitability may be low. Marketing activity may be directed at relationship-building and gaining a greater share of wallet.
However, later in the life cycle, when there is greater understanding and trust in the customer relationship, profitability may increase. During the advanced stages of the customer’s life cycle marketing activity may decline, if the customer’s needs change and other suppliers are able to provide greater value or a more appropriate offering.
Research by Bain & Company, highlighted the need for management to adopt a stronger focus on customer retention. However, this study did not allow managers to identify the value of retention in different businesses and for specific customer segments, Recently, Payne and Rickard developed a model for calculating the profit impact of retention by customer segment within individual organizations.
The model allows informed investment decisions to be made on how to balance retention and acquisition strategies, and which customer segments should be the focus of these strategies. This model has been used to review the profit potential of the customer segments of a large UK service company.
Four key consumer segments were identified, each with very different profiles in terms of socio-economics, expected switching behaviour, and customer characteristics.
Future profitability was modeled for each segment on the basis of both existing retention rates and improved retention rates, varying between 1 and 9 percentage points across the different segments according to the proposed segmented service strategy.
This modeling revealed a significant increase in overall gross profit, before costs of improved service, of 48 per cent at Year 5 and 71 per cent at Year 10. The results within each of the four segments varied considerably because of differences in the improvement in retention rates and other inputs to the model.
The outcome of this first step should be a clear definition of customer retention, a measurement of present customer retention rates, and an understanding of the existing and future profit potential for each market segment.
Step # 2. Identification of Causes of Defection and Key Service Issues:
Once the customer retention and profit improvement potential has been measured, this second step can be taken. This involves the identification of the underlying causes of customer defection. Four analytical approaches are useful in undertaking this task. These include root cause of defection analysis, trade-off analysis, competitive benchmarking, and customer complaint analysis.
a. Root Cause of Defection Analysis:
Traditional marketing research into customer satisfaction does not always provide accurate answers as to why customers abandon one supplier for another. All too often customer satisfaction questionnaires are poorly designed, superficial and fail to address the key issues, forcing respondents to tick predetermined response choices.
For example, a questionnaire for a major high street bank asked departing customers why they were closing their accounts. Among the available multiple-choice answers was ‘the account is no longer required’. Not surprisingly, the vast majority of respondents ticked this box because it represented a safe and easy answer and none of the alternative answers addressed the real reasons for defection.
The root causes of customer defections should be clearly identified, for it only by understanding them that the company can begin to implement a successful customer retention programme. It is imperative that root cause of defection analysis be undertaken by specially trained researchers.
For example, customers may say that they no longer frequent a particular supermarket because the prices are too high, while in reality customers have been put off by unhelpful staff, long queues, and difficulty in finding products on the shelves, and so on.
b. Trade-off Analysis:
It is also important to undertake research to identify the key customer service dimensions that result in customers being retained. This can be accomplished through trade-off analysis, which allows the different service features identified by the customer to be ‘traded off’ against each other in order to establish the customer’s service priorities.
The supplier can then use this information to develop service strategies that match customer needs and priorities. Trade-off analysis is described in more detail in Christopher, Payne and Ballantyne.
Competitive benchmarking enables companies to compare their performance and that of their competitors on critical elements of customer service and retention performance. It is then possible to establish service standards that match or exceed those of competitors. The search for best practice may involve questions such as- what is the maximum length of time a customer should be left waiting in a queue?
Should employees be expected to answer the telephone within three rings? What level of product knowledge should employees is expected to have about the products and services that they sell? Service standards are best set by examining how competitors perform and focusing on the service dimensions that are most important to customers.
d. Customer Complaint Analysis:
Another useful way of identifying key service issues is to analyse customers’ complaints. Customer complaint analysis not only highlights possible causes of customer defections, but also acts as an early warning system, enabling the company to resolve problems with customers early on and to implement preventive action to avoid the same problems recurring.
Some companies are now developing ‘customer recovery teams’ which immediately move into action when a likely defector is identified. The recovery team is charged with finding out the real reasons for the customer’s dissatisfaction. It can also be empowered to come up with solutions and to develop a rescue plan, which forms part of the final step.
Step # 3. Corrective Action to Improve Retention:
The third and final step in the process of enhancing customer retention involves taking remedial action. At this point, plans to improve retention become highly specific to the organization concerned and any actions taken will be particular to the given context.
We can, however, identify some broad guidelines that should form part of any plan to improve retention. These include- marshaling top management commitment; ensuring employee satisfaction and dedication to building long-term customer relationships; utilizing best practice techniques to improve performance; and developing a plan to implement customer retention strategy.
Visible Top Management Endorsement:
Visible top management endorsement is vital to the success of any customer retention programme. Where senior management is seen to be genuinely enthusiastic and actively supportive of a new retention initiative, it is more likely that employees will be inspired to follow the example and to take the retention programme seriously.
If, however, the initiative is seen to be just another management fad, employees will not firmly adopt the practices necessary to implement an effective retention programme. The level of commitment expressed by senior management to any programme is often regarded as indicative of the amount of support that employees should give.
Customer Retention and Employee Satisfaction:
A major driver of customer retention improvement is whether employees perceive that the organization gives priority to customer satisfaction and retention. There is increasing evidence to suggest that the internal customer service climate has a strong impact upon employee satisfaction and customer retention. Heskett and his colleagues have developed a model – ‘the service profit chain’ – that links leadership and human resources practices with employee satisfaction, customer satisfaction and business performance.
The model proposes that the human resources practices of an organization are linked to the internal service quality perceived by employees and that this, in turn, impacts on employee satisfaction. Satisfied employees are likely to be more productive and to remain with an organization for a longer time, creating greater value for the customer.
Generally, happy employees make for happy customers and vice versa. Improved employee retention is likely to deliver improved internal and external service quality. Customer satisfaction impacts on customer retention, and this affects business performance.
It is also important to select and recruit customer contact staffs that have the appropriate interpersonal skills to build strong relationships with customers. These people should be willing to acquire the knowledge and skills necessary to identify customer needs and expectations, and to exceed the service standards specified.
For example, South West Airlines in the USA recruits employees largely on the basis of their attitude and enthusiasm towards the job role. The selection panel includes customers who are asked to choose the applicants that they would like to have served them. Employees are also invited to assist in the selection process by identifying candidates whom they feel will be good colleagues.
Best practice is a useful technique for disseminating superior practices throughout a company and is concerned with utilizing information derived from benchmarking. In this context, it involves identifying those organizations within the industry (and within departments or regions of the organization) that exhibit excellent customer retention performance and examining their operations to see how they are successfully managed.
Managers can then use this knowledge to develop new approaches to improve customer satisfaction and retention in their own businesses. Sometimes it is worth looking to other industries for ideas and advice on best practice as they may offer guidance that is more likely to affect competitive advantage.
Building Switching Barriers:
In addition to the usual procedural steps that form the basis of any implementation plan, several additional opportunities to create customer loyalty should be considered. These relate to the building of barriers, which inhibit or dissuade customers from opting for alternative suppliers.
A good retention strategy should try to identify the causes of defection and to build barriers that stop customers from switching to the competition, no matter what inducements the competition is offering. Strategic bundling can be a means of building a barrier to customer defection. This is where groups of associated products or services are offered to the customer with the pronounced advantage of convenience and/ or cost savings.
Banks with outstanding customer service, such as First Direct, illustrate the benefit of using strategic bundling to reinforce business patronage. For example, through the provision of superior service, customers are motivated to use the bank for mortgages and insurance policies as well as customary standing orders and direct debits.
Bain & Company’s research into financial services suggests that retention rates are significantly greater where customers use two or more of an organization’s services than in instances where they use only one service. However, if customers feel that an organization is taking advantage of them, they may resent attempts to offer bundled products and cross-selling.
Team-based relationship management can provide an effective means of preventing customer defection in business-to-business marketing. This approach is known as Key Account Management. This is where a team, led by a key account manager, manages the customer relationship. The aim is to make the relationship more enduring by building as many links as possible between the customer and the supplier.
For example, multiple linkages may be established between the supplier’s production team and the customer’s operations team, the supplier’s marketing team and the customer’s business development team, and so on. This is in contrast to the traditional buyer-seller relationship, which is dependent on a sometimes fragile and fairly limited connection between a supplier’s key account executive and a retailer’s buyer.
EDI can also be a ‘tie that binds’. Getting customers to invest in sharing information about sales and inventories can provide a powerful disincentive to switch suppliers. The benefits of such collaboration are reduced system costs, enhanced efficiency, and increased customer and consumer satisfaction.
In many industries, barriers to switching behaviour should only be constructed if they serve the interests of both the customer and the supplier. This guiding principle is not based on business philanthropy but on common sense. Bad publicity generated by disgruntled customers who feel they have been locked into unsatisfactory supplier relationships can significantly reduce profits.
This is especially true in consumer markets where, if things go wrong, switching barriers can mean that customers may find they are in a situation from which they cannot easily extricate themselves. Customers may feel trapped, helpless and even cheated.
For example, bank customers who feel dissatisfied with the service they receive often find the task of moving their account, with all its associated standing orders and direct debits, too onerous to carry out. This produces unhappy customers who will be reluctant to buy into any further services and who may go out of their way to tell others of their negative experiences with their bank.