What Makes a Loyal Customer Valuable

Fred Reichheld is held up as one of the defining figures in the field of customer loyalty.  His book The Loyalty Effect is on practically every executive’s bookshelf and has been both praised and dismissed by the field since it was published in 2001.  The debate is long and wide, so I was intrigued when I ran across an article that wasn’t another dispute about NPS, but instead a logical look at two specific blanket statements made by Reichheld in his book. 

The article, The economics of loyalty: What makes a loyal customer valuable? , written by Howard Lax, vice president of customer loyalty at GfK Custom Research of North America, agrees with Reichheld that the economic case for loyalty is compelling, boosting customer behaviors drives lifetime value to a company.  However, the economic value of this loyalty does not necessarily hinge on the price/cost advantages that are claimed by Reichheld.

For your loyal customers, should you be charging a premium or offering an incentive? Reichheld asserts that there is, in fact, a price premium that can be gained from loyal customers.  A company can boost the value of that customer by charging them more than less-loyal customers are charged for the same products or services.  The idea is that these loyalists will stay put because of the relationship and will not leave based on a small increase in price.  But has this ever been proven to succeed?  Lax found only one case in which the price premium succeeded, a bank that charged a very small premium above its regular interest rate.  Conversely, there are hundreds of instances where banks are charging loyal customers lower rates and bundling products for package discounts from regular prices.  This happens so often in banking and other industries that loyal customers have come to expect a discount.  Everyone in business is rewarding their loyal customers and despite the incentives handed out; Lax believes that loyalty has a positive payoff and not because of any supposed price premiums.

Are your loyal customers more or less costly to serve?  Loyal customers, Reichheld states, generate efficiencies both in their own behaviors and in the behaviors of service staff, which translates into cost-savings.  There are some instances where it does cost less to serve a loyal customer over time, it’s a learning effect in which the customer learns how to self-service and doesn’t require as much input from employees to get the desired result.  But according to Lax, there are just as many (or more) examples where loyal customers cost more to serve.  He points out that loyalty is a relationship concept which most often depends on a personal connection.  Customers expect personalized, customized service delivered by an employee in a manner that is more attentive than less-loyal customers.  This translates into investing more time to serve those customers (i.e. costs).  Lax’s main point here is that there are plenty of examples on both sides of the debate and a blanket statement of cost-savings is a blind approach to the economics of serving loyal customers.

There is no disagreement about the fundamental economic advantages of loyalty; the time invested in a loyal relationship does have a positive payoff in boosting customer lifetime value.  But we must be careful about the over-generalization of theories that may or may not be universal truths.

For more about customer loyalty, read Customer Loyalty in Retail Banking.