Should you reward your existing customers for their loyalty, or spend your marketing budget on attracting new business? This is the dilemma explored by Jiwoong Shin and K. Sudhir, writing for MIT Sloan Management Review.
The authors observe that expert opinions differ on the relative merits of the two strategies.
Those who favour rewarding existing customers often point out that customer retention is less expensive than acquisition. Those who prefer to use resources to attract new business cite the fact that existing customers have already shown a willingness to pay the full price for the company’s products or services.
Shin and Sudhir comment: “Both arguments have merit; the appropriateness of each strategy depends on the circumstances a company faces. What this means is that executives need a framework for deciding the best way to increase maximum profitability.”
The authors say such a framework should be based on two rules of customer behaviour:
1) Consumers’ preferences for a product change depending on the occasion of the purchase. These changes can occur regardless of marketing or pricing, because customer need depends on the specifics of the purchase occasion.
2) In many markets, not all customers have equal value, as some contribute far more to the profits of a company than others. According to the authors’ research, in the majority of cases the most value is created by rewarding and acquiring new customers. However, under certain circumstances, attention should shift to retaining existing high-value customers.
The authors cite magazine subscriptions as an example of a market where both value concentration and shopping flexibility are fairly low. Typically, a subscriber will purchase just one subscription per periodical over an extended length of time – usually six months or a year. In this case, managers should focus on rewarding new customers with introductory offers.
The market for cellphone contracts also has low shopping flexibility but with more value concentration – contract terms are long but consumer usage and contract types vary substantially, with customers contributing different amounts of value. However, again, it is advisable to focus on the acquisition of new customers as it is difficult for existing customers to switch contracts.
Retail stores, however, have high degrees of both shopping flexibility and value concentration. Customers spend vastly different amounts and can switch between stores easily. In this case, retailers should focus their efforts on rewarding and retaining existing customers – discount value catalogues and membership cards can be used as incentives.
But which existing customers should be rewarded, and how should you select them?
High-volume customers can demand a great deal of service – such as a business customer who exploits free delivery to order small quantities to minimise inventory costs. These customers might offer less value than you might think, and can even be unprofitable.
Careful analysis of customer value is essential in developing an effective and profitable customer management and marketing strategy.