Higher the Levels of Customer Satisfaction and Rentention Don't Always Translate Into Higher Profitability
“Give all your customers a new car.” It was not all that funny when we first said it, but the line still provokes laughter, if not guffaws. Several years ago a major PC manufacturer, inspired by the bugle call for “total quality management was interested in increasing its level of customer retention form 86 percent to 100 percent. They invited us to help develop a strategy to do so, which we didn’t think made all that much sense. Our recommendation was “Give all your customers a new car.”
“What do you mean, ‘Give them a car’?” they asked. We said, “If you gave each one of your defecting customers an automobile—you know, give them a new Mazda Miata convertible—they'd stay on for at least another year.” It was a joke of course because the value of that defecting customer averaged less than $800 a year, while a new Miata costs at least 25 times that amount.
(In most product categories, the customers you lose are more likely to be of less than average value because they’re either price sensitive, brand-to-brand migrators, or people who didn’t use your services that much in the first place.) In this case, giving people a $25,000 car to earn $800 in annual revenues was a surefire way to go broke, even if it did result in 100 percent customer satisfaction and retention. The client quickly got the point and began to laugh with us.
This is another example of the relentless pursuit of a dysfunctional goal—“anything worth doing is worth overdoing”—which can be observed every day and everywhere as companies seek to achieve goals that make little sense.
100 Percent Customer Satisfaction and Retention Are Rarely Profitable
As the Total Quality Management movement swept the American business landscape throughout the 80’s and 90’s, zero defects in products and perfect service, a move to build quality into every product category. There was an obsession with building quality into every organizational process. This was, we believe, a necessary and valuable pill to swallow. Japanese and German cars and consumer electronics—the most complex, important and visible consumer products around—were made better than their American counterparts. American manufacturers had a lot to learn from the foreign manufacturers who had learned their lessons from American consultant W. Edwards Deming.
But while there is no question that TQM means greater efficiency with less waste, fewer reworks, and saved time—all leading to greater customer delight—marketers made an intellectual leap. They came to believe that the relationship between customer satisfaction and profit is monotonic if not linear; the higher the level of satisfaction, the greater the profitability. This is simply not true.
As an example, consider retail banking. In a time-starved world, a 30-second wait in a teller’s line is better than a five-minute wait. But unless you know that shorter lines will attract significantly more customers or that your customers are so unhappy spending those five minutes in line they will take their business elsewhere, putting on additional tellers to cut the wait to thirty seconds will be costly without generating enough more business to cover the extra cost.
We’ve tested this theory in banks, gas stations and fast food restaurants and have found that a short wait doesn’t really bother the customer (of course, they’d rather have no wait at all) and contributes to a more profitable business. This is because zero waiting time doesn’t generate enough incremental revenue or retention to cover the cost.
It also raises the possibility of a perception that if there’s no wait, the product or service can’t be that good. And that is a bad thing.
American businesses often spend time and money to study customer satisfaction and the so-called “determinants” of satisfaction without knowing the relationship between satisfaction and profitability. They look for these determinants as if, once they identify them, they will be able to obtain 100 percent customer satisfaction and maximize program profitability.
Assume that customer satisfaction is measured on a 100-point scale, from 0 (total dissatisfaction) to 100 (perfect satisfaction). Illustration 13 shows one simple scale we like and the “weights” that we use in a typical product category.)
Do companies know how profitability changes as they move from 74 percent satisfaction (a global average across a broad range of products and services to 80 percent satisfaction? Do they know what happens to customer retention if it drops from 92 percent satisfaction to 80 percent satisfaction? Do they know what happens if they retain 85 percent of their customers from one year to the next, versus retaining 90 percent? Do they know what it would cost and what they would gain if they achieved 100 percent satisfaction and 100 percent retention?
The answer to all of these questions is an unequivocal NO. Ford and General Electric can’t answer these questions. Neither can Apple or Dell, Procter & Gamble, or Altria, MasterCard or VISA. Few companies know the relationship between customer satisfaction and retention, or between satisfaction and profitability, or between retention and profitability. This basic lack of business intelligence makes the exhortations of the consultants preaching the 100 percent solution misleading to say the least. They’re like early 20th-century psychiatrists touting electric shock therapy for psychiatric disorders without understanding how it works or its side effects.
Our own research, has repeatedly found the relationship between satisfaction and profitability and retention and profitability to be non-linear. The relationship is curvilinear—profitability does rise as satisfaction rises up to a point, maybe about 93%. After that point, the cost of delighting the customer by delivering ever-increasing satisfaction rises faster than the satisfaction-linked retention.
To return to our example, our PC manufacturer could achieve close to 100 percent satisfaction and retention—at least temporarily—if it gave all its customers a new car. But as every manager knows and as the next illustration suggests, (another one of my favorite graphs) the cost of achieving this goal would be prohibitively expensive. The goal is dysfunctional—improving customer satisfaction and retention is worth doing, but pushing them to the max is overdoing it and highly unprofitable.
The only way for any company to understand and address this issue is through satisfaction/retention research. One useful approach is the use of studies to assess customer satisfaction and retention, as well as terms to monitor charges in satisfaction and retention, as well as their determinants and consequences. Smart companies have developed systems to monitor changes in satisfaction/retention/purchasing behavior in a timely manner followed by econometric analyses to study the relationships between them. More important than the numbers themselves (e.g., whether satisfaction is at 74 percent vs. 72 percent) are findings related to the costs associated with implementing changes in satisfaction and retention, and the consequent deltas in forecasted profitability.
Let’s Get Real: Delighting Customers Is a Good Thing To Do
Before we go any further, we should make it clear that we believe customer service, satisfaction, loyalty, and retention are all important to a business’s success. As we’ll show, improving customer satisfaction can actually improve sales and market share. Without proper customer satisfaction processes in place, you will screw up and someone like Sanford P. Blank will—justifiably—tell The Reader’s Digest how dumb you are.
Blank told the digest that his wife had received a credit card application in the mail. She did not want the card but he did, so he crossed her name out, entered his, and returned the form. Within a week, a woman from the credit card company called to say he had been rejected. Why? The card could only be issued to the person originally solicited by the offer. “However, she invited me to reapply, which I did during the same telephone call.”
A few days later, another company representative called Blank to tell him that his second application had been rejected. Why? “The woman told me their files showed that I had previously applied for a card and had been denied.”
Customer service leads to customer satisfaction, which leads to customer loyalty, and customer loyalty leads to customer retention. It is expensive and wasteful to lose a significant number of customers every year, particularly if you don’t want to lose them. In The Loyalty Effect (Harvard Business School Press), Frederick F. Reicheld argues that raising customer retention rates by five percentage points could increase the value of an average customer by 25 to 100 percent. (Any manager concerned about his business’s customer loyalty ought to study Reicheld’s book.)
At the same time, as even Reicheld notes, it is usually expensive and wasteful to retain every single customer. Trying to keep certain customers can actually decrease profits and destroy value. Some customers are so demanding, so price-conscious, or so small (or all three) they cost more to serve than they pay. These are the customers who should receive the company’s benign neglect, certainly not its investment.
Our first suggestion to any manager concerned with the business’s customer service is to analyze the customer base to answer questions like: Which customer groups are growing? Shrinking? What is the value of each customer to us today and over, say, the next five years? And very important, what are the costs and benefits of increasing customer satisfaction and retention?
Every marketer of consumer and business-to-business products and services need to better understand these links.
How satisfied are your customers and how many are retained each year are issues every marketer should be able to understand and address. It may surprise you to learn that with all the talk about 100% customer satisfaction and retention, the average scores across a broad range of B2C and B2B products and services are about 73% (satisfaction) and 89% (retention). So is the question, what is the financially optimal level of satisfaction and retention? How far should you push the throttle on satisfaction before retention levels are too high? At what point does profitability decline as satisfaction and retention rise?
For the majority of customers, of course, you should provide the best products and services that you can afford (i.e., that are profitable) and monitor the quality of service and customer satisfaction to make sure you are delivering what you intend. Enlightened managers know what their good customers want and feel and will make adjustments to satisfy them. One way is to regard any customer complaint as an opportunity to learn something about the company’s product, distribution, sales process, or after-sale service.
But do not confuse the process with the goal. James D. Mendelsohn, director of marketing research at Olive Garden Italian Restaurant, wrote in Marketing News that he once gave a hotel restaurant meal a “poor” on a consumer satisfaction measurement form. “In doing so, I created a reaction worthy of pulling a fire alarm. I received four phone calls and a note slipped under my door asking me to discuss my responses. Then I was flagged at checkout to talk to a manager. The manager was willing to make amends if I would change my rating from ‘poor,’ because this hotel chain rates managers on the percentage of responses that are rated ‘poor.’ What was missing was any focus on whether the meal actually was a poor value.”
Clancy had a similar experience when he bought a new BMW, his 10th in 25 years. After the sale was made, papers signed, and the car was being prepped, the salesperson—who had been an okay guy throughout the entire process—okay but not outstanding—informed him that there would be a follow-up phone call from BMW headquarters to gauge his satisfaction with the process. Fine, no problem. But the salesperson then went on and on about how important this call was and was there anything he could do now to insure perfect ratings? He was clearly anxious about Clancy’s reaction. Here again there seemed little interest in learning how the process could have been improved but a great deal of interest in a summa cum laude report card. Clancy was so annoyed by the salesperson’s behavior that he vowed never to buy another car from that dealership and he hasn’t.