Editor's note: Howard L. Lax is vice president, consulting, GfK customer loyalty, at GfK Custom Research of North America, New York.
I think of Fred Reichheld as the dean of the school of customer loyalty. His book The Loyalty Effect is a true classic and he is one of the field's defining figures - and certainly its best-known. No one has done as much to bring the issue of customer loyalty into the boardroom and the lexicon of corporate America. And this is not (whew!) another rant about the evils or laurels of NPS. But I take exception with some of his contentions that typically are accepted at face value as uncontestable truths. Specifically, his price premium and cost-savings arguments.
Reichheld asserts that loyal customers will pay more than non-loyal customers and that it costs less to serve loyal customers. His belief that loyal customers generate both a price premium and cost-savings is taken as gospel and the price/cost advantages of loyal customers have been inscribed in the canon of customer loyalty lore as if Reichheld were infallible. Both of these claims, however, are subject to question.
I am a staunch defender of the economic value of loyalty. Loyalty is expressed by customer behavior that, in turn, drives value to a company. For any given customer, they express their loyalty to a company by continuing to be a customer, perhaps buying more (or more expensive) products and services; giving the company a larger share of their spend; recommending the company to others; and so on. The same customer expresses their disloyalty by doing the converse of these things. Consequently, for any given customer, their lifetime value to a company is significantly greater if they behave loyally than if they behave disloyally. The dean (if I may speak for him) and I are in agreement on these points and GfK's LoyaltyPLUS has validated this over and over again. The economic value of loyalty does not, however, hinge on the price/cost advantages claimed by Reichheld.
Charge a premium vs. offer an incentive
Reichheld's classic graph of "Why Loyal Customers Are More Profitable" (The Loyalty Effect, p. 39) indicates that there is a price premium a firm can capture from loyal customers. He does not say that Nordstrom can charge more than Macy's, which can charge more than Walmart for the same products; that a devotee of a neighborhood bookstore will be willing to pay more for a book from their favorite haunt despite the fact they can buy it for less online; nor that people will pay more for better value, products, service or experience. Reichheld implies that a company can boost the lifetime value of a loyal customer by charging loyal customers more (i.e., capture a price premium) than it charges less-loyal customers for the same products or services. This is not Company A charging more than Company B because of some product, service or marketing advantage - this is Company A charging loyal Customer Jones more than less-loyal Customer Smith. This is a loyalty price premium; and this is where Reichheld and I part company.
I have seen a total of one (that's 1, uno) instance in which a firm actually was sufficiently confident about its ability to identify a small - very small - segment of customers it considered so loyal that it could charge them a small - very small - premium above its regular interest rate. The company in question is a bank that charged customers identified as its most loyal about seven basis points (that's 1/16 of a percentage point or 0.0625 percent) more than its regular interest rate on mortgages. In other words, the bank truly captured a price premium from a subset of customers it was able to identify as extremely loyal. (They tested 1/8 of a percentage point as well, but found that even their most loyal customers balked at 0.125 percent more and took their business elsewhere.)
For this one small example, I can cite hundreds of instances of banks - including the same bank that commanded this tiny mortgage premium - charging loyal customers lower rates on loans and offering them bundled products that are, in effect, packaged discounts from regular prices. Perhaps Reichheld is right and everyone in business is wrong but it seems to me that most companies look for every opportunity to reward their most loyal customers with coupons, points programs, special savings, extra services, freebies, bennies and an endless array of incentives, all of which translate into a discount of some sort - not a price premium.
I am not suggesting that providing such incentives to customers to be more loyal or rewarding their loyalty is a bad idea or that it in any way undermines the economic value of loyal customers. In fact, it may actually punctuate the point: Even though a company may effectively charge its most loyal customers less than other customers by virtue of incentives and packages it gives to loyal customers, the economic value of loyal customers still is greater than the value of non-loyal customers.
I have never heard Reichheld challenged on this point, which is often repeated as a biblical truth along with "I like Fred" raves - but never with real examples. Charging more for a better product or service is a different issue. I credit my friend Mike Saxon with clearly articulating this critical distinction: "There are two forces at play: Companies that engender loyalty (or brand engagement if you come at it from that angle) can charge a premium (relative to other firms). But, loyal customers expect a discount." Similarly, discounts to lure new customers or get them to try a product are simply new-customer acquisition costs, not an example of more-loyal customers paying premiums over less-loyal customers.
Reichheld and I agree that the economic case for loyalty is compelling, boosting customer lifetime value. But I say that loyalty has a positive payoff despite incentives that amount to effective discounts, not because of any supposed price premiums.
Less vs. more costly to serve
Our agreement on the economic value of loyalty notwithstanding, I also 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. Reichheld says it; others repeat it; that classic "Why Loyal Customers Are More Profitable" graph 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 TurboTax 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, Reichheld 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 - 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 Reichheld 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; and at the dealership, BMW aficionados test-drive more BMWs more often than non-loyalists.
I see countless examples where loyal customers are more costly to serve. This is because 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 to serve and cultivate relationships with loyal customers.
Investment in the relationship
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, Reichheld 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 go 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 Reichheld. But his blanket generalization, so often repeated, that it costs less to serve loyal customers is far from a universal truth.