CREATING AND MAINTAINING VALUED RELATIONSHIPS Principles of service marketing management

For the service provider, a valued relationship is one that is financially profitable in the long run. In addition, the benefits of serving a customer may extend beyond revenues to include such intangibles as the knowledge and pleasure obtained from working with that customer over time. In a healthy and mutually profitable relationship, both parties have an incentive to ensure that it extends for many years.

The seller, in particular, recognizes that it pays to take an investment perspective. The initial costs of acquiring new customers and learning about their needs—which may even make the account unprofitable in the short run—are justified by the expectation of future profits.

How do customers define a valued relationship? It's one in which the benefits received from service delivery significantly exceed the associated costs of obtaining them. Research suggests that relational benefits for individual consumers include greater confidence, social benefits, and special treatment (see the boxed discussion on "How Customers See Relational Benefits").

Valued relationships in business-to-business services are largely dependent on the quality of the interactions between individuals at each of the partnering firms. "As relationships strengthen over a period of time," Pixyish Kumar observes, "the service provider's personnel often assume the role of outsourced departments and make critical decisions on behalf of their clients."

How Customers SeeRelational Benefits

What benefits do customers gain from an extended relationship with a service firm? In personal interviews, respondents were asked to identify service providers that they used on an ongoing basis and discuss any benefits they received as a result of being a regular customer. Their comments included the following:

  • "I like him [hair stylist] He's really funny and always has lots of good jokes. He's kind of like a friend now."
  • "I know what I'm getting—I know that if I go to a restaurant that I regularly go to, rather than taking a chance on all of the new restaurants, the food will be good."
  • "I often get price breaks. The little bakery that I go to in the morning, every once in a while, they'll give me a free muffin and say, 'You're a good customer, it's on us today.'"
  • "You can get better service than drop-in customers We continue to go to the same automobile repair shop because we have gotten to know the owner on a kind of personal basis, and he can always work us in."
  • "Once people feel comfortable, they don't want to switch to another dentist. They don't want to train or break a new dentist in."

After evaluating and categorizing such comments, the researchers designed a second study. Subjects were told to select a specific service provider with which they had a strong, established relationship. They were then asked to indicate what benefits they received from this relationship and how important these benefits were to them. Analysis of the results showed that most of the benefits could be grouped into three clusters.

Confidence benefits the most important group included feelings by customers that in an established relationship there was less risk of something going wrong, more confidence in correct performance, greater ability to trust the provider, lowered anxiety when purchasing, better knowledge of what to expect, and an expectation of receiving the firm's highest level of service.

Social benefits involved mutual recognition between customers and employees, being known by name, friendship with the service provider, and enjoyment of certain social aspects of the relationship.

Special treatment benefits included better prices, discounts or special deals that were unavailable to most customers, extra services, higher priority when there was a wait, and faster service than most customers.

The Loyalty Effect

Loyalty is an old-fashioned word, traditionally used to describe fidelity and enthusiastic devotion to a country, cause, or individual. More recently, in a business context, it has been used to describe a customer's willingness to continue patronizing a firm over the long term, purchasing and using its goods and services on a repeated and preferably exclusive basis, and voluntarily recommending it to friends and associates.

"Few companies think of customers as annuities," says Frederick Reichheld, author of The Loyalty Effect, and a major researcher in this field.9 And yet that is precisely what a loyal customer can mean to a firm: a consistent source of revenues over a period of many years. However, this loyalty cannot be taken for granted. It will only continue as long as the customer feels that he or she is receiving better value (including superior quality relative to price) than could be obtained by switching to another supplier.

There are many possible ways to disappoint customers through service quality failures. A major source of disappointment, especially in high-contact situations, is poor performance by service employees. Researchers believe that there is an explicit link between customers' satisfaction with service and employees' satisfaction with their jobs To the extent that service workers are capable, enjoy their jobs, and perceive themselves as well treated by their employer, they will be motivated to remain loyal to that firm for an extended period of time rather than constantly switching jobs.

Competent and loyal workers tend to be more productive than new hires, to know their customers well, and to be better able to deliver high quality service. In short, employee loyalty can contribute to customer loyalty through a series of links referred to as the "service profit chain."

"Defector" was a nasty word during the Cold War in the mid-1900s. It described disloyal people who sold out their own side and went over to the enemy. Even when they defected to "our" side, rather than away from it, they were still suspect. Today, the term defection is being applied to customers who transfer their brand loyalty to another supplier.

Reichheld and Sasser popularized the term "zero defections," which they describe as keeping every customer the company can profitably serve. (As we've already said, there are always some customers a firm is not sorry to lose.) Not only does a rising defection rate indicate that something is wrong with quality—or that competitors offer better value—it may also signal the risk of a future decrease in revenues. Profitable customers don't necessarily disappear overnight; they may signal their mounting disaffection by steadily reducing their purchases.

Observant firms record customer purchase trends carefully and are quick to respond with recovery strategies in the event of decreased purchases, customer complaints, or other indications of service failure.

Loyalty Effect

Realizing the Full Profit Potential of a Customer Relationship

How much is a loyal customer worth in terms of profits? In a classic study, Reichheld and Sasser analyzed the profit per customer in many different industries, categorized by the number of years that a customer had been with the firm. They found that the longer customers remained with a firm in each of these industries, the more profitable they became to the company. Annual profits per customer, which have been indexed over a five-year period for easier comparison, are summarized for four different service industries.

Realizing the Full Profit Potential of a Customer Relationship

According to Reichheld and Sasser, four factors work to the supplier's advantage in creating incremental profits over an extended period of time. In order of magnitude at the end of a seven-year period, these factors are:

  1. Profit derived from increased purchases (or higher account balances in credit card or banking environments). Over time, business customers often grow larger and need to purchase in greater quantities. Individuals may purchase more as their families grow or as they become more affluent. Both types of customers may decide to consolidate their purchases with a single supplier who provides high quality service.
  2. Profit from reduced operating costs. As customers become more experienced, they make fewer demands on the supplier (for instance, less need for information and assistance). They may also make fewer mistakes when involved in operational processes, thus contributing to greater productivity.
  3. Profit from referrals to other customers. Positive word-of-mouth recommendations are like free sales and advertising, saving the firm from having to invest as much money in these activities.
  4. Profit from price premium. New customers often benefit from introductory promotional discounts whereas long-term customers are more likely to pay regular prices. Moreover, when customers trust a supplier they may be more willing to pay higher prices at peak periods or for express work.

Reichheld argues that the economic benefits of customer loyalty noted above often explain why one firm is more profitable than a competitor. Further, the upfront costs of attracting these buyers can be amortized over many years. For insights on how to calculate customer value in any given business, see the worksheet.

It's important to note that not all loyal customers are necessarily profitable. Banks and telephone companies, for instance, have many small accounts whose revenues do not cover the costs of servicing them. Reinarz and Kumar suggest that the loyalty model works best in situations where customers enter into a formal membership relationship with the supplier. When such a relationship is absent, then customers are free to shop around each time they need to make a transaction.

economic benefits of customer

For profit-seeking firms, the potential value of a customer should be a key driver in marketing strategy. Grant and Schlesinger state:

Achieving the full profit potential of each customer relationship should be the fundamental goal of every business. Even using conservative estimates, the gap between most companies' current and full potential performance is enormous

They suggest analysis of three gaps between actual and potential performance:

  • What percentage of its target customers does a firm currently have, and what percentage could it potentially obtain? (If there is a large gap between a firm's current share and its potential, then it may make sense to develop strategies to attract new customers.)
  • What is the current purchasing behavior of customers in each target segment? What would the impact be on sales and profits if they exhibited the ideal behavior profile of (1) buying all services offered by the firm, (2) never purchasing from competitors, and (3) paying full price? (To get customers to buy more, firms should examine opportunities to cross-sell new services to existing customers. Frequent user programs that reward loyalty can help to strengthen relationships. But getting customers to pay higher prices than they are used to may be difficult unless competitors are also trying to reduce the availability of discount promotions.)
  • How long, on average, do customers remain with the firm? What impact would it have if they remained customers for life? (As we showed earlier, the profitability of a customer often increases over time. If valued customers are defecting, it is important to identify the reasons why customers defect and then take corrective action.)

Many elements are involved in gaining market share, cross-selling other products and services to existing customers, and creating long-term loyalty. The process starts, as we suggested earlier, by identifying and targeting the right customers, then learning everything possible about their needs, including their preferences for different forms of service delivery.

However, there's a dark side to the emphasis on identifying and catering to an organization's most profitable customers. Some companies are making very little effort to serve those customers who offer little or no financial value to the firm. According to a recent Business Week article,

The result could be a whole new stratification of consumer society. The top tier may enjoy an unprecedented level of personal attention, but customers who fall below a certain level of profitability for too long may find themselves bounced from the customer rolls altogether or facing fees that all but usher them out the door. . . . [MJarketers . . . are doing everything possible to push their customers especially low-margin ones toward self-service.

Such strategies take segmentation analysis and database marketing to a new extreme in identifying which customers will be most profitable to a firm in the long run and actively courting them at the expense of less-profitable segments.

Loyalty Reward Programs

The big challenge for service marketers lies not only in giving prospective customers a reason to do business with their firms, but also in offering existing customers incentives to remain loyal and perhaps even increase their purchases. Among the best-known strategies for rewarding frequent users are the "frequent flyer" programs offered by passenger airlines (see box).

American Airlines was probably the first service firm to realize the value of its customer database for learning more about the travel behavior of its best customers. The company uses this data to create direct mail lists targeted at specific customers (such as travelers who fly regularly between a certain pair of cities). The airline was also quick to examine bookings for individual flights to see how many seats were filled by frequent flyers, most of whom were probably traveling on business and therefore less price sensitive than vacationers and pleasure travelers.

This information helped American to counter competition from low-cost discount airlines, whose primary target segment was price-conscious pleasure travelers. Rather than reducing all fares on all flights between a pair of cities, American realized that it only needed to offer a limited number of discount fares. These fares were available primarily on those flights known to be carrying significant numbers of no business passengers. Even on such flights, the airline would limit availability of discount fares by such

Reinforcing Loyalty byRewarding Frequent Flyers

American Airlines established the original "frequent flyer" program in 1983. Targeted at business travelers (the individuals who fly the most), this promotion enabled passengers to claim travel awards based on the accumulated distance they had traveled on the airline. "Miles" flown became the scoring system that entitled customers to claim from a menu of free tickets in different classes of service.

American was taken by surprise at the enormous popularity of this program. Other major airlines soon felt obliged to follow and implemented similar schemes of their own. Each airline hoped that its own frequent flyer program, branded with a distinctive name such as "Advantage" (American) or "Mileage Plus" (United), would induce a traveler to remain brand loyal, even to the extent of some inconvenience in scheduling. However, many business travelers enrolled in several programs, thereby limiting the effectiveness of these promotions for individual carriers.

To make their programs more appealing, the airlines signed agreements with regional and international carriers, "partner" hotels, and rental car firms, allowing customers to be credited with mileage accrued through a variety of travel-related activities.

What had begun as a one-year promotion by American Airlines was soon transformed into a permanent and quite expensive part of the industry's marketing structure. In due course, many international airlines felt obliged to introduce their own frequent flyer programs, offering miles (or kilometers) to compete with American carriers and with each other.

As time passed, airlines in the United States started to use double and triple mileage bonus awards as a tool for demand management, seeking to encourage travel on less-popular routes. A common strategy was to award bonus miles for flying during the low season when many empty seats were available or for changing flights at an intermediate hub rather than taking a nonstop flight.

To avoid giving away too many free seats at peak time, some airlines offered more generous redemption terms during off-peak times. A few even created "blackout periods" during key vacation times like Christmas and New Year, in order to avoid cannibalizing seat sales to paying customers.

Competitive strategies often involved bonus miles, too, with "bonus wars" breaking out on certain routes. At the height of its mid-1980s battle with New York Air on the lucrative 230-mile (370 km) New York-Boston shuttle service, the Pan Am Shuttle offered passengers 2,000 miles for a one-way trip and 5,000 miles for a round trip completed within a single day. Bonus miles were also awarded for travel in first or business class. And bonuses might also be used to encourage passengers to sample new services or to complete market research surveys.

To record the mileage of passengers enrolled in their frequent flyer programs, the airlines have had to install elaborate tracking systems that capture details of each flight. They have also created systems for recording and maintaining each member's current account status.

United uses its extensive customer database to reward loyalty in a unique way. If a flight is canceled, passengers are placed on a waiting list for the next available flight according to how many miles they have accumulated. Thus more loyal customers are given preferential treatment in terms of service and convenience. means as requiring an advance purchase or an extended stay in the destination city, making it difficult for business travelers to trade down from full fare to a discount ticket.

One problem with frequent flyer programs is that customers who travel extensively tend to belong to several different programs. To encourage loyalty to a single carrier, some airlines have added a points system, based upon the value of the customer's business in a given year, not just the mileage. For instance, at British Airways Executive Club, travel in business class and first class qualifies, respectively, for double and triple the number of points awarded in economy class, but discounted economy fares do not qualify for points at all.

Longer flights, being more expensive, yield more points. Once club members have amassed a certain number of points, they receive silver or gold tier status, valid for 12 months. This points-based reward system offers a number of privileges, including automatic doubling of air miles for gold tier members and a 25 percent bonus for silver tier members. A number of other airlines now use similar approaches, but the tier system gives travelers an incentive to consolidate their flights with a single airline.

Service businesses in other industries have sought to copy the airlines with frequent user programs of their own. Hotels, car rental firms, telephone companies, retailers, and even credit card issuers have been among those that seek to identify and reward their best customers. For instance, the Safeway supermarket chain offers a Club Card that provides savings on its own merchandise and discounts on purchases of services from partner companies.

Similarly, car rental firms offer vehicle upgrades and hotels offer free rooms in vacation resorts. Not all companies offer their own products as rewards; instead, many firms offer miles credited to an airline's frequent flyer program since air miles have become a valuable promotional currency in their own right.

Perhaps the most creative awards are those that even wealthy customers might find difficult to obtain on their own. For example, Merrill Lynch recently offered its premium clients an opportunity to use Visa card points to "purchase" top seats at an award- winning Broadway musical or a VIP package to attend the 2001 All-Star Hockey Game in Denver, including a champagne reception at which the legendary player, Gordie Howe, was scheduled to speak.

Despite the popularity of customer loyalty programs, researchers claim that these programs have proved "surprisingly ineffective" for many firms.To succeed in competitive markets, they suggest that loyalty programs must enhance the overall value of product or service and motivate loyal buyers to make their next purchase. In some instances, like the airline s frequent flyer miles, the benefits are popular with customers and virtually all players in the industry have felt obliged to offer a loyalty program.

Additional valued benefits for loyal airline customers often include priority reservation and check-in services, use of airport lounges, and upgrades. In other industries, however, the benefits are not perceived as valuable enough to encourage loyalty or justify a higher price than competitors. This may have been one reason why AT&T, facing fierce price competition in the telecommunications industry, ended its "True Rewards" loyalty program in 1998.

The bottom line is that rewards alone will not enable a firm to retain its most desirable customers. If these customers are not delighted with the quality of service they receive, or believe that they can obtain better value from a less-expensive service, they may quickly become disloyal. No service business can afford to lose sight of the broader goals of providing quality service and good value relative to the price and other costs of service that customers incur.

Ending Unprofitable Relationships

Although our focus so far has been on increasing customer loyalty, not all of a firm's existing customers may be worth keeping. Some customers no longer fit the firm's strategy, either because that strategy has changed or because the customer's behavior and needs have changed. Many relationships are no longer profitable for the firm, since they cost more to maintain than the revenues they generate.

Just as investors need to dispose of poor investments and banks may have to write off bad loans, each service firm needs to regularly evaluate its customer portfolio and consider terminating unsuccessful relationships. (Legal and ethical considerations, of course, will help determine whether it is possible or proper to take such actions.)

Occasionally customers have to be terminated directly (although concern for due process is still important). Bank customers who bounce too many checks, students who are caught cheating on exams or country club members who consistently abuse the facilities (or staff and other members) may be asked to leave or face expulsion.

In other situations, termination may be less confrontational. Banks have been known to sell accounts that no longer fit with corporate priorities to other financial institutions; the "traded" customers typically receive a letter in the mail or a phone call from the new supplier informing them of the change. Professionals such as doctors or lawyers may suggest to difficult or dissatisfied clients that they should consider switching to another provider whose expertise or style is more suited to their needs and expectations.


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