The Loyalty Lie
How do brands grow?
Do they grow primarily by acquiring new customers?
Or do they grow primarily by retaining current customers, who then tell other potential customers and lead to growth through word of mouth?
Most people believe the latter – brands grow through loyalty marketing campaigns that retain customers and encourage word of mouth growth.
That’s why we’ve probably all heard “common wisdom” such as:
• “it’s 5 times more expensive to acquire a new customer than retain a current customer.”
• “if you can reduce churn just 5%, you can grow profits 60 – 80%.”
It’s easy to understand why growing through current customers is such a popular theory.
It is simple.
It offers riches.
It warms the heart.
It hits all the right notes.
Presumably, such a widely adopted idea would be backed by multiple studies and ample evidence.
Interestingly, all of the evidence for loyalty marketing can be traced back to the single article you’re seeing below: Loyalty-Based Management by Frederick Reichheld.
I find it fascinating that basically one lonely article underpins the entire loyalty marketing industry and its audacious claims about profitability.
Make no mistake, saying a mere 5% reduction in churn will lift profits a massive 80% is quite an extraordinary claim and, as Carl Sagan famously said, “extraordinary claims require extraordinary evidence.”
One person who went looking for – but didn’t find -- any extraordinary evidence for Reichheld’s claim was Dr. Byron Sharp.
Who is Dr. Byron Sharp and why is he important to our story?
Dr. Sharp runs the Ehrenberg-Bass Institute for Marketing Science, the home of “Evidence-Based Marketing,” and is a Marketing Scientist himself.
When Dr. Sharp investigated Reichheld’s claims he found two massive mistakes in the loyalty theory:
1.First, Reichheld states that a 5% drop in churn results in an 80% increase in profits, but cutting churn from 10% to 5% is actually a 50% drop! Reichheld was off by a factor of ten.
2.Second, Reichheld’s theory isn’t backed by any real data; instead, it was a thought experiment in an excel spreadsheet using fake data.
The real story about what drives growth is quite different from Reichheld’s fake data.
The real story was discovered by Andrew Ehrenberg (of Ehrenberg-Bass Institute fame) back in 1969 and has been replicated by Dr. Sharp and his fellow researchers many times since. The real story is what drives growth isn’t customer loyalty, but customer penetration.
Put another way, brands grow by acquiring new customers, not retaining old customers.
Interestingly, as you will see in the below data, companies with higher market penetration – more customers – can not only expect to grow profits, but also loyalty.
As you can see in the data below, there are few – almost no -- examples where a company has low market penetration and high purchase frequency (loyalty). This phenomenon holds true in B2C industries like toothpaste and in B2B industries like Concrete Supplies and Coronary Stent Production.
What you are seeing is what the Ehrenberg-Bass Institute calls “The Law Of Double Jeopardy.”
The LODJ is actually named for its effect on smaller brands, who are in jeopardy twice: they have less customers and less loyalty.
What is the lesson here?
For all brands, it is to spend advertising budgets on customer acquisition – not customer loyalty -- to grow. For big brands, it is to use large advertising budgets to box out small competitors and grow customer penetration and market share every year. For small brands, it is to develop different and effective customer acquisition campaigns to steal market share from bigger rivals. Interestingly, while the deck appears to be stacked against small brands, because small brands have fewer customers, they are often more likely to invest in customer acquisition. Big brands, because they have bigger customer bases, are often under more pressure to misallocate advertising budget to loyalty campaigns to keep their large customer base happy.
Now, back to the lesson at hand.
Just like Dr. Sharp wasn’t content to take Reichheld’s theory at face value, nor were we.
So, we commissioned Les Binet & Peter Field to run the same experiment against the IPA’s 1,500 case Databank to determine which strategy – acquisition or loyalty -- delivers the most growth.
• Is it loyalty – targeting current customers?
• Is it acquisition – targeting non-customers?
• Or is it simply targeting everybody in a category -- customers and non-customers?
What Binet & Field found corroborates the work from The Ehrenberg-Bass Institute.
Loyalty marketing strategies deliver little benefit to key business metrics like market share, sales volume, profit margin, and net profit.
Acquisition strategies, on the other hand, deliver real benefit to key business metrics.
However, the most profitable strategy is to continuously reach all category buyers – customers and non-customers.
Why does reaching all category buyers work best?
Because you acquire non-buyers, who contribute new growth, while also continuing to reach current buyers, who are reminded you exist and are likely to buy you again in the future.
The lesson is clear: target all category buyers to maximize growth.
We’ve spent a lot of time on theory here, so let’s walk through an example that explains, in simple terms, why marketing should focus on acquisition, not loyalty.
Imagine you don’t subscribe to Netflix, but you see an ad for Tiger King and decide to sign-up.
Once you’re a subscriber, you are likely to stay or leave based not on the continued quality of the advertisements, but on the continued quality of the product, shows, and service. If the product, shows, and service deliver a high-quality customer experience, you’ll likely stay. However, there’s almost nothing advertising can do to retain you if the product, shows, and service fail to deliver.
Simply put, advertising should focus on what it can control – acquisition – and let customer experience focus on retention.
There’s a couple other reasons why advertising isn’t – and shouldn’t -- be responsible for loyalty.
1. Most churn is out of a company’s control. Most churn occurs not because a company did anything wrong, but because a buyer retires, loses budget, or switches jobs.
2. Most customers already spend what they can. Even if you were to eliminate all churn – which is almost impossible – you are not likely to see nearly as much growth from current customers as you are from new customers, who are buying for the first time.
3. Most churn is a customer experience problem. As we saw with the Netflix example, customer experience should focus on retention.
In summary, what drives company growth is acquiring new customers, not retaining old customers.
All profitable roads lead to customer acquisition.