Does Loyalty Count?
By Michael Alan Hamlin
July 29, 2002

If contemporary wisdom can be conventional, the conventional wisdom is that successful companies compete for share of profitable customers, rather than market share. The idea is that market dominance can mean that a company is spending valuable resources serving customers that aren't, and never will be, profitable. Those customers should be jettisoned from the corporation's field of vision.

Instead, marketing executives and strategists are told to concentrate on building relationships with profitable customers for the purpose of making them loyal customers. If that's done properly, loyal customers are assumed to be a source of consistently profitable transactions. Now, a couple of marketing professors are pretending this contemporary but conventional wisdom is a new thing.

In an article titled "The Mismanagement of Customer Loyalty," Professors Werner Reinartz and V. Kumar argue in the July 2002 issue of Harvard Business Review that "the relationship between loyalty and profitability is much weaker - and subtler - than the proponents of loyalty programs claim." Their research showed "little or no evidence to suggest that customers who purchase steadily from a company over time are necessarily cheaper to serve, less price sensitive, or particularly effective at bringing in new business."

Reinartz and Kumar are saying nothing we don't already know. As I've pointed out, loyalty programs are supposed to focus on profitable customers, not just all consistent customers. So what we have here is an effort by Reinartz and Kumar to appear to be challenging conventional wisdom, when in fact they quickly wind up affirming it. "Instead of focusing on loyalty alone, companies will have to find ways to measure the relationship between loyalty and profitability so that they can better identify which customers to focus on and which to ignore," they say.

But there are lots of people who have been saying this for years. They include both marketing consultants like one-to-one marketing gurus Don Peppers and Martha Rogers and Philip Kotler and competitive strategists like Adrian Slywotzky, Gary Hamel, and Michael Porter. And Reinartz and Kumar introduce their argument with painfully simplistic assumptions, such as "it costs less to serve loyal customers," and shoot them down.

Let's consider that assumption for a second, which is about all it deserves. Indeed, it does cost less to serve loyal customers, whether they are profitable loyal customers or unprofitable loyal customers. While efficiently serving unprofitable but loyal customers is preferable to inefficiently serving unprofitable but loyal customers, no executive wants to serve unprofitable customers at all.

The same sort of kindergarten logic frames the authors' other claims of loyalty mismanagement. They include the assumption that loyal customers pay higher prices and help market the company. Even profitable customers aren't going to pay a higher price for the same bundle of goods that they could buy elsewhere more cheaply unless there are attractive reasons to do so, such as convenience, credit arrangements, or an intimate understanding by the seller of the customer, the customer's business, or perhaps even the customer's clients.

And you probably don't want unprofitable customers talking you up to their equally unprofitable friends, either. So is their any merit in the work of Reinartz and Kumar? Is there a good reason that the normally rigorous Review published this piece?

Sadly, mostly no. The authors present a certifiably laughable quadrant, for instance, that purports to demonstrate that unprofitable customers come from just about every customer classification, such as corporate service provider, grocery retail, mail-order, and direct brokerage. The quadrant and the research that went into developing it appear to suggest that unthinking companies target one of these segments because they vary in degree of profitability.

It's really no surprise that both loyal profitable and unprofitable customers can be found in each of these categories. The trick is in finding and developing profitable customers in these categories that a company can turn into loyal customers. Despite all the time the authors spend getting to that point, they finally - and briefly - do offer some insights into making profitable customers long-term friends.
Using a second quadrant, customers are classified into four categories: True Friends (High Profitability, Long-Term), Butterflies (High Profitability, Short-Term), Strangers (Low Profitability, Short-Term), and Barnacles (Low Profitability, Long-Term). True friends are customers that that provide a good fit between the company's products and services and the customer's needs. Fit has to do with the issues that make a customer willing to pay more for a bundle of products and value-added services.

Reinartz and Kumar tell us a little about how to keep these customers. First, communicate consistently, but not too often. Second, build both attitudinal and behavioral loyalty, and third, delight these customers to nurture, defend, and retain them. Unfortunately, they offer few insights into how to do these things. But that's okay, too, because loads of other people do that.

The Review is now published monthly, instead of every two months. Perhaps that explains how a paper as empty as this one got published. But if it's so worthless, why am I spending all this time on it? The reason is that I do agree with Reinartz and Kumar. Most customer loyalty programs fail because they are about as mindless and simplistic as this their article is.

(Michael Alan Hamlin is the managing director of consultancy TeamAsia and the author of three books on Asian economies and companies. His latest book is Marketing Asian Places, of which he is a co-author (Wiley, 2001). He can be reached at mahamlin@teamasia.com.ph.).

Copyright © 2001 Michael Alan Hamlin. All Rights Reserved.

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