The Loyalty Ladder

Introduction

Strategy in service businesses has taken a new turn. The key to success now lies with concentrating
on, and retaining, existing customers.

Customers have always been the prime focus for marketing activity but the way service companies
view this relationship is changing. Transaction marketing of the 1980s placed the emphasis on the
individual sale: relationship marketing of the 1990s places the emphasis on individual customers and
seeks to establish a long-term relationship between customer and company (see Table I). (Table I
omitted) In an increasingly competitive business environment, marketing should be seen as a total
approach to business, placing the customer firmly at the centre; to regard it solely as an amalgam of
functional activities like advertising, promotions and market research is to miss the point completely.

The basis of the relationship marketing philosophy is that the attraction of new customers is merely the
first step in the marketing process. The key is retaining that customer. Marketing should not begin and
end with clinching the deal -- it must also concern itself with keeping, and improving, the relationship
with the customer.

The Relationship Marketing Ladder

The relationship marketing approach views customer loyalty as a ladder showing the progression of
relationships customers can have with an organization (see Figure 1). (Figure I omitted) The first step
on the ladder is a prospect. The first marketing task is to convert the prospect into a customer. (A
customer is described in a narrow sense as someone who has done business with the organization
only once.) The next marketing task is to generate repeat business with that customer. At this point,
they become a client -- someone who is neutral, or possibly negative towards the organization.

The distinction between a client and a supporter -- the next step on the ladder -- can be illustrated with
reference to a bank. A client may have been doing business with a bank for years, but may not be
particularly happy with it or may even have a negative attitude towards it. On the other hand, if they are
a supporter of the bank, they are positively disposed towards it and are quite happy with the bank's
services. However, a supporter is typically passive and not outspoken about the bank's performance.

At the next level, an advocate is someone who is so pleased with the services or products they are
receiving that they actively recommend them to others. Many of the customers of FirstDirect Bank can
be classified as advocates and much of this bank's success can be attributed to word of mouth and
referral through advocates who have been delighted with the bank's services and have found them
significantly better than those of traditional high-street banks.

The final step on the ladder is a partner. This represents a situation where a very close and long-term
relationship is developed between a supplier and customer, based on satisfaction of mutual needs.
This last step is particularly applicable to business-to-business relationships.

Bottom Rung

Organizations frequently acknowledge that existing customers are easier to sell to and are frequently
more profitable than new customers. In spite of this many of them still devote more resources to
attracting new customers than keeping those that already exist. In other words, companies are still
focusing on the bottom rung of the ladder, turning prospects into customers. The investment made in
winning new customers is immediately transferred to the next prospect -- little effort goes into keeping
the new customer, improving their relationship with the company and progressing them up the ladder.
In general, existing customers are taken for granted. Only when some breakdown in service quality
occurs and the customer defects or is about to defect does the attention swing towards them. Often
this is too late and the customer is lost.
No one would suggest that new customers are not important, indeed they are essential: but they
should not be the only focus of marketing efforts. The relationship marketing ladder illustrates that
there are two main marketing tasks -- attracting new customers and retaining those that already exist.
The secret is to balance scarce marketing resources between the two in an optimal manner.

Unfortunately, research at Cranfield shows that this is not happening. Interviews with 120 practising
managers in service business revealed that around 80 per cent of managers consider they are
spending too much time and money on marketing efforts to new customers and too little on existing
customers; about 10 per cent feel they have the balance right; and 10 per cent feel they concentrate
too much on existing customers.

Moving customers up the loyalty ladder is not simple. Organizations need to know in depth what each
individual customer wants and how they can continue to add value to the customer offer. Marketing
directed at retaining customers can be expensive and needs to be closely evaluated against results.
The most successful retention programmes segment customers into different levels of existing and
potential profitability and focus marketing activities on them. The most profitable customers are the
most valuable and these are the ones that should be concentrated on.

Economic Benefits

Getting the balance right and retaining customers makes good economic sense. There is a high
correlation between customer retention and company probability according to the US strategy
consulting firm Bain & Company. Its recent research showed that a 5 per cent increase in customer
retention leads to a considerable rise in net present value profits: this increase can be as much as 125
per cent for a credit card company and 50 per cent for an insurance broker. Nobody is pretending that
a 5 per cent increase in customer retention will be easy to obtain, but even a 1 per cent increase could
yield considerable improvement in profitability.

Bain & Company's calculation of profitability is based on the expected cash flow over a customer's
lifetime -- the longer they stay, the more profits they bring the company. What is more, customers
typically generate increasingly more profit each year they stay with the company. Retaining customers
allows the company to develop a deeper relationship with them and encourages repeated and
increasingly frequent buying activity.

If a company can communicate this value in financial terms to its employees they will give more
thought to ensuring that customer satisfaction is achieved. Staff of Domino's Pizza in the US are
taught to see every pizza customer as having $5,000 tattooed on their forehead -- the amount they
would spend over the next ten years if they bought two $5 pizzas a week. It is not enough simply to tell
staff that customers are valuable -- they must be able to quantify it and visualize it.

There are several reasons why retaining customers is so profitable:

*sales and marketing and set-up costs are amortized over a longer customer lifetime;

*customer expenditure increases over time;

*repeat customers often cost less to service;

*satisfied customers provide referrals;

*satisfied customers may be prepared to pay a price premium.

Not all of these reasons may apply to a particular service business but overall they represent a
significant opportunity for most service sector companies to improve profit. Customer retention also
helps predict the profitability of the company and is therefore an excellent management tool for
considering the success of quality and customer service programmes.

There is another important reason to remember: a customer lost through dissatisfaction with the
service provider will be one gained by a competitor. Keeping customers is therefore a key strategic
issue for service companies to address.

The Quality Link

There is a link between quality, client retention and profitability. This is not surprising -- customers who
are satisfied with the quality of the service are more likely to be loyal to the firm. But to move someone
from customer to advocate you need to go a step further and replace customer satisfaction with
customer delight by offering service quality that exceeds expectations.

When a quality breakdown does occur and customers defect, it is important to establish exactly why. A
long wait at the post office may be due to inadequate staffing, lack of training, lack of motivation of
staff, complicated form-filling, lack of administrative organization or a host of other reasons. The result
is the same -- a dissatisfied customer who probably perceives the problem to be a lack of staff. The
real root cause, however, may be very different and needs to be identified if the right strategies are to
be implemented to improve service quality and resulting customer retention.

As markets mature, customer retention will become even more important, differentiating successful
companies and taking priority over strategies to increase market share. At the moment, marketing,
customer service and quality programmes are often like three separate spotlights on a dark stage,
managed totally separately. If they are to perform to the full they must be better co-ordinated --
relationship marketing provides a framework for bringing them together.

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Adrian Payne is Professor of Services Marketing, Cranfield School of Management, Cranfield,

Bedforshire, UK