David vs. Goliath – Round II: Challenging Fred Reichheld on the Economics of Loyalty (Again)

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The verdict is still out on my last challenge to Fred regarding the issue of whether or not there is a loyalty price premium (see previous blog: David vs. Goliath I) or price discount. While we differ on the question as to whether loyal customers are more likely to pay a price premium, as Fred claims, or an effective discount, as I argue, we both still agree that there is a compelling argument that loyalty yields greater customer lifetime value.

Our agreement on the economic value of loyalty notwithstanding, I take exception with another blanket claim that the dean makes in his discussion of loyalty economics: loyal customers, he states, generate efficiencies (both in their own behaviors and in the behaviors of service staff) that translate into cost savings.



Fred says it; others repeat it; that classic “Why Loyal Customers Are More Profitable” graph (The Loyalty Effect, p.39) gets more play; and the assertion becomes part of the lore.

There are some clear examples of instances where it no doubt costs less to serve loyal customers over time. Someone using Turbo Tax for the tenth consecutive year probably is less likely to have install or download problems or need help from customer service or tech support than they did in their early years as a user.

In The Ultimate Question Fred provides a solid example based on financial planning, which can be applied to any similar ongoing highly personalized service relationship – from a personal trainer to a tax preparer. Other than this learning effect – in the first (self-service) case the customer does the learning, while in the second (highly personalized services) the employee does the learning – however, I don’t find a compelling general argument for reduced costs for loyal customers. These examples do not establish a universal case for cost savings realized from loyal customers. In fact, the opposite often is the case.

If you go to Fresh Foods for your weekly shopping, you probably know where everything is and are less likely to ask staff questions about where to find the white truffles. On the other hand, you are far more likely to ask the meat guy what looks good today, coax your friend in the bakery to get you the fresh cake they just made in the back and ask the server at the deli counter to customize your order in some manner; that is, you are likely to soak up more staff time, not less (i.e. generate increased operating costs).



For every example Fred offers, I see counter examples where loyal customers cost more to serve: at the bank, customers who frequent the branch often are the most loyal, while they use the most expensive service channel; at the cell phone provider, loyal customers are more likely to get freebies when they renew their contracts, get new phones and want their contacts/pictures/etc. transferred to their new device; don’t BMW aficionados test drive more BMWs more often than non-loyalists?

I see countless examples where loyal customers are more costly to serve. Loyalty is a relationship concept, and that relationship often rests upon a personal connection between the customer – who expects personalized, customized, attentive service – and an employee delivering the service. This means investing more time (i.e. costs) to serve loyal customers, whether it’s because they know the manager by name and want to speak with “the boss,” want their product or service customized in some manner or they simply schmooze more with staff they know. So while there are some clear instances where there is a cost savings companies realize from serving loyal customers, there are as many examples where companies spend more serving and cultivating relationships with loyal customers.

None of this undermines the fundamental argument regarding the economic advantages of loyalty: the additional incremental time spent catering to loyal customers is an investment in the relationship with a positive payoff in boosting customer lifetime value. Once again, Fred and I agree on the overall value of loyalty. But the blind assumption that it costs less to serve loyal customers is a gross over generalization with examples that rub both ways.

So when I walk into Starbucks and order myself a “grande white mocha with skim and a dash of raspberry and whipped cream and a tall white mocha with skim, an extra shot, raspberry, hold the whipped” for my wife, without asking any questions or even looking at the menu board, I suppose I have been an efficient customer who costs less to serve. Score one for Fred.



I have never seen Fred challenged on his blanket generalization, so often repeated, that it costs less to serve loyal customers. So, once again, I ask this community to weigh in. Do loyal customers create costs savings, period; or are there sufficient exceptions and counter examples to support my point?

2 COMMENTS

  1. Interesting points here, Howard. Maybe it’s my background in sales, but I’ve always heard that loyal customers cost less to sell to than developing new customers. They also are more likely to refer friends to you, which means additional sales with less effort than finding new ones on your own and having to invest in helping them come to know, like and trust you. There’s one other value that defies economics, that is the emotional satisfaction all of your staff gets from connecting with your repeat customers. That relationship is one of the main reasons repeat customers do come back again and again. In my experience with small business employees, only a fraction rank money as their first or second reason for staying with a company. Job satisfaction and other non-monetary motivators are also important. And anything that keeps your employees happy and motivated cuts down on your real costs of hiring and training.

  2. You raise a good point, John: we should consider the impact of loyal customers on the retention and performance of employees. While it would be very hard to quantify the cost savings that could be attributed to the specific impact loyal customers have on retaining and keeping current employees engaged — thereby reducing the costs of recruiting, training and bringing new people up to speed — those are real costs.

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