Customer Retention: Simple yet Sophisticated

It’s my contention that retailers are more likely to have better customer retention programs than catalogers. Direct marketers have all of their customers’ data, but they do not focus enough on formal programs to retain their best buyers. In fact, many don’t even track retention rates for different groups of customers, let alone have targeted strategies for each group.

True, retailers are often limited in the sophistication of their targeting programs, due to a lack of information, but they at least make a serious effort to hang on to their most profitable customers. So if direct marketers hope to compete successfully against the brick-and-mortar players, they need to leverage their information advantage.

Direct marketers don’t excel at retaining customers for many reasons. First, most are actually direct mailers. They base their mailing plans on break-even mailing strategies, not marketing strategies. Direct marketers use RFM (recency/frequency/monetary value) or scoring techniques to manage circulation and contact strategies, but they don’t generally put enough effort into trying to change customer behavior. RFM and modeling techniques have served the industry well for several decades, but they have not advanced much in that time. As a result, very little strategic marketing to different customer segments actually occurs within the mailing plan.

You’ve no doubt heard time and again that in addition to being crucial to survival of the business, a well-planned and well-executed retention program can increase profitability and improve the quality of the customer list. The Pareto principle — 20% of customers produce 80% of profits — stands up very well in our industry, yet little is done to capitalize on it. This is despite the fact that direct marketers have the ability to identify the top 20% of customers, as well as the bottom 20%.

Many companies find that they can cost-effectively offer extra benefits and services to their best customers. In addition to spending more with you, these customers now have higher levels of satisfaction and a stronger personal connection with your company. Specifically tailoring these extra benefits and services to the better customer groups is one of the key elements of a profitable retention program. The top customers become even bigger advocates and fans of your company and will act as an outside sales force for you. Don’t underestimate the power of word-of-mouth advertising, both good and bad.

How to get there

How do we build loyalty? How do we develop a true relationship with our customers? Is there such a thing as loyalty in our businesses? Do customers really want a relationship with us?

I think the words and the terms we use confuse us. “Loyalty” is too strong a word when we are selling merchandise; loyalty is something we want or expect when we are talking about friends, spouses, team members, or pets.

And in most cases a “relationship” is beyond our reach. We want our customers to buy from us regularly and to be satisfied with the experience. Customers want efficient and satisfying transactions. They want a company they can trust, one that understands them, just as we want the customers to say things like “That’s my company” or “It’s the company for me.”

There is nothing wrong with providing soft benefits or “warm and fuzzies” to accomplish this. Doing so can put you at an advantage when your product, pricing, and service are similar to or the same as those of your competitors. But buying gifts or clothes periodically from a retailer doesn’t truly constitute a relationship. Relationships require constant communication, trust, and a lot of work. Customers don’t want a lot of work. They want ease and efficiency in their transactions, and they want respect.

Recognizing their value is one way of showing them respect. Customers typically choose to shop via catalog and the Internet for convenience. Making their transaction as easy and efficient as possible respects their needs.

Product, value, and service are the primary drivers of customer loyalty and satisfaction. It all begins with the product and the value of that product to the customer. Companies drive higher levels of retention and satisfaction by delivering excellent product and/or service values more than anything else.

At the beginning, the customer is interested only in the product or service. More-appealing products at compelling values have a bigger effect on retention than anything else. This is quite obvious, but important not to forget. Customers today expect and even demand high levels of service. If a company makes it easier to purchase products or to return products or to get information about the products, customers will reward the company with a repeat purchase. Again, quite obvious, but customer retention programs will be ineffective if the company is not providing customers with competitive levels of product or service.

Assuming that you’re offering these basic drivers, let’s look at the five steps typically involved in developing a retention program:

Step 1: Analyze performance of different segments of file

Key to developing a basic program is understanding the purchasing behavior of your different customer groups. You can do this by conducting some database analysis or simply by knowing the purchasing life cycles of your best customers. You can use the same types of variables found in the typical RFM scoring systems. The only difference is that you will want to look more at what customers do over a period of time, whereas the tendency of most RFM systems is to focus on the most recent activity. By applying simple scoring algorithms you can fairly quickly isolate the targeted segments. Database marketing tools can help you develop more sophisticated breakdowns, but the main point is that there are ways to do this with the kinds of data that you are now working with.

Step 2: Identify the target groups

Based on the analysis you completed on purchasing patterns of different customers on your file, you are now ready to establish the groups. When looking at your customer file, however you define it for your business (12 or 24 months typically), you will want to break it down into at least five groups: best customers, good customers, new customers, infrequent customers, and lapsed customers.

More sophisticated or advanced programs break the file into finer groupings, but I would recommend keeping it fairly simple when you are starting out. The specific attributes of each group will vary for each business or industry. For example, best customers in one business might place one order a month; in another business they may place one order a year.

The “Customer Performance” chart on the opposite page shows how these customer groupings would look and perform for a typical direct marketing company. As you can see, the ratio of demand to marketing investments varies greatly among the groups. A good marketer will see nothing but opportunity in this type of view of the customer file. While these numbers will vary by company or industry segment, the overall relationships will be the same. This type of information is easy to pull from a marketing database, but it can even be developed manually if you don’t have the systems capabilities.

Step 3: Define targeted behaviors

While the overall goal of the program is to increase the spending levels of all customers, the targeted behaviors for each group will be different. In the end, you should try to get as many people as possible into the “best” category. Not everyone on file can realistically end up in that segment, however, so the first objective is to move customers up one level on the hierarchy. For example, you should try to get the lapsed group to buy again and move into a higher-performing group. Infrequent customers should be moved up to the good category, and good customers should be pushed up to best customers. And even though the best customers are already in the top level, it should be possible to increase spending or decrease defections within this group

Customer Performance
Best customers 15% $200 $15.60 12.8
Good customers 15% $100 $ 13.20 7.6
New customers 15% $70 $ 10.80 6.5
Infrequent customers 40% $30 $10.20 2.9
Lapsed customers 15% $15 $ 7.20 2.1
Total customers 100% $ 70 $11.10 6.3

Step 4: Develop offers for each target group

Direct marketing companies tend to excel in this area, as they are known for their aggressive testing programs; they know which offers work best for prospects or customers, and they are skilled in creative presentation techniques.

Each segment of the customer file requires its own targeted offer. Understanding the needs and wants of each group is critical in developing each component. The more you know about each group of customers, the better you will be able to design effective and powerful offers. In addition to the normal testing history, consumer research can be helpful. Knowing why a customer has lapsed, for example, will allow you to tailor a specific offer to that particular group. Customers will let you know what the key triggers are to more purchasing.

It is possible that you will mail the same offer to more than one group of customers. This can simplify things, but you need to be careful not to oversimplify. Remember that today’s occasional and lapsed customers could have been good or very good customers last year. If a customer receives the same set of offers when they are in the “good” category as they do in the “lapsed” category, the offer could become stale and be less interesting to the customer. You need to think through the possible sequence of offers that a customer receives as he moves through the various customer classifications.

Also, the economics are different for each group, so the levels of investment and return will vary by customer category. For example, a 10% increase in sales from the top group is worth a lot more than a 10% increase in spending from one of the bottom groups. Therefore you can afford to invest more in the best customers to generate a 10% increase in sales, whereas you can’t afford to spend as much among on the lapsed and occasional customers.

Step 5: Develop offers for each of the target groups

Once you have defined the groups and defined the offers for each group, it is time to begin testing. Create your test and control groups, and conduct test mailings to measure the effectiveness of each offer. Because we want to measure behavior over time, the test and control panels need to be set aside for analysis at the end of the season or the year to measure sales and profit over a series of mailings. Be prepared to react quickly to successes and failures by analyzing the early results from the first few mailings. Reaction time is critical, since we know that likelihood of customer response decreases over time.

Philip McAvoy is senior vice president of the catalog group for Wakefield, MA-based CRM and database services provider BeNow.

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