MarketingRx
Business model: Key to market success
And to beating competition and to profitability
By Ned Roberto, Ardy Roberto
Philippine Daily Inquirer
First Posted 04:23:00 12/05/2008
Filed Under: Marketing, Market research
First of a series
Question: We own two medium-size supermarkets up here in Northern Luzon. We put up our first store some 12 years ago when my husband retired two years earlier. We decided to invest half of his retirement money in a large grocery store. After three years, when the first store gained regular customers and became a small supermarket, we thought we’d invest the other half of my husband’s money in a second large grocery store in the neighboring province.
Both stores continued to do quite well until about a year and a half ago, when two new supermarkets opened in my province and a third in the neighboring province where our second supermarket was. Every time the new supermarkets hold a store promo, our sales would dip, although it would sometimes go back to its former level. So we decided to match our competitors. But the sales effect was mixed: It was sometimes up, but most of the time, it was unchanged. When we went over what had happened in the past year and a half, we saw that doing what our competitors did was not good for our profitability.
Uncover a model
Our daughter suggested that we consult her marketing professor at the school where she graduated. We did and this professor was very cynical about promos for business building or even for business maintenance. The summary of the teacher’s advice was to uncover “the right business model” for managing our supermarkets under the current competitive and market circumstances.
Although we were not too clear about what exactly is a “business model,” the professor told us that for a service company such as ours, the business model of customer loyalty is our only true chance of gaining back our former profitability and effectively beating competition. According to the professor, customer loyalty is key to profitability because “it’s much less costly to service loyal customers than disloyal ones.”
We then talked to business friends. While they did not disagree, they all told us that loyalty programs were expensive and so would affect our profitability. Can you help us to clearly think through this matter? What does a business model have to do with our business?
Answer: You actually have three related and strategic questions. The first is: “What is a business model?” Next is the question about the effectiveness and profitability of customer loyalty program as a business model. And the third is: “How can a customer loyalty program gain back your former profitability and effectively beat competition?”
We now take up each of these three related questions in turn.
What is a business model?
It’s simply a way of doing profitable business. If profit is total revenue or sales minus costs, then there are at least two ways of doing profitable business. One is raising total revenue at no substantial addition to costs. For example, consider the car companies. Honda or Toyota has been able to raise total revenue by tapping into their first-time car buyers to drive their second car purchase (for the wives). This did not entail that much additional cost as compared to the strategy of going after new buyers.
The other model for doing profitable business is gaining the same, or even higher, total revenue but at much lower costs. In your own supermarket business, this is a typical profitability strategy: “Get the once-a-month shoppers to become once-to-twice-a-month shoppers.” This raises revenue but at a much reduced costs because you don’t have to do expensive advertising to turn your once-a-month shopper into the once-to-twice-a-month shopper. Reminders are often enough—and sometimes more than enough.
When competition sets in or intensifies, a business model that specifically integrates competitive considerations is required. This is the case in your current situation with the entry of three competitor supermarkets.
Your daughter’s professor recommended that the relevant business model for you to adopt is the business model of customer loyalty. She asserts that this is “your only true chance of gaining back your former profitability and effectively beating competition.”
How exactly will this strategy do that?
As you mentioned, the professor’s answer was, “customer loyalty is key to profitability and getting ahead of competition because it’s much less costly to service loyal customers than disloyal ones.”
Your business and common sense led you to ask business friends, who warned you that “loyalty programs are expensive, and so will affect your profitability of doing business.” This in turn led you to write us. In effect, you doubt the assumption underlying customer loyalty.
A bit of combined marketing and manufacturing history is instructive at this point. We can trace the origin of the customer loyalty proposition from Boston Consulting Group (BCG). In the 1980s, BCG founder Bruce Henderson popularized the concept of “the experience curve.” This concept showed that for certain products, the costs of producing one of these products tend to go down by as much as 30 percent with every doubling of the accumulated experience in producing it.
At that time, the senior MRx-er was a market research and product management consultant at the local pharmaceutical giant United Laboratories, or Unilab. The late Unilab consumer health division head then, Cesar Orosa, was fascinated with the concept. Together, we persuaded Manufacturing to validate it. In repeated experiments, we never got any validation that this concept was true. At that time, we dismissed our findings as probably typical of only Unilab or that we were still manufacturing in the range of inefficiencies.
‘Zero defections’
Then, about 10 to 15 years later, two highly respected Harvard Business School professors, Frederick Reichheld and Earl Sasser, picked up the experience curve model and extended it into a customer loyalty model. Reichheld and Sasser said essentially what your daughter’s professor said, that “it’s much less costly to service loyal customers than disloyal ones.”
Because of this, Reichheld and Sasser claimed that a company could “boost profits by almost 100 percent by retaining just 5 percent more customers.” These politician sounding promises appeared in Reichheld and Sasser’s article, “Zero Defections: Quality Comes to Services,” in the September/October 1990 issue of the influential Harvard Business Review (HBR). For many years, it was the most cited and most reprinted HBR article.
According to Reichheld and Sasser, the reason it’s much less costly to service loyal customers than disloyal ones is this: “As the company gains experience with its customers, it can serve them more efficiently.” Efficiency means getting more output (more satisfied customers) from the same input (the same service processing), or getting the same output from less input.
So there it was again, this time the senior MRx-er referred to this service version of the experience curve model in promoting loyalty programs with his service clients. As with the Unilab consumer health division learning, we never were able to witness a confirmation. Both clients and the senior MRx-er himself asked: “What’s wrong with this customer loyalty business model?”
Our approach now for correctly diagnosing this question is twofold: One is via another business model that may eventually explain what was wrong with the original. The other (and more exciting way) is to work backward, i.e., to analyze the underlying and assumed consumer behavior model in any given business model and to find the correct one. This brings us to your third and final question.
We start with the consideration of a subsequent correcting business model.
Some 10 years after, when almost everyone had pledged unquestioning allegiance to the Reichheld and Sasser customer loyalty model, two young but brilliant professors and researchers, Werner Reinartz and V. Kumar, came out in 2002 with the correcting customer loyalty business model in the same journal, the Harvard Business Review. Reinartz and Kumar’s challenger article, “The Mismanagement of Customer Loyalty,” appeared in HBR July 2002 issue.
What Reinartz and Kumar did was to monitor the cost of servicing customers of several companies. In almost all these companies, they found that loyal customers are not less costly to serve than new and occasional customers. It was with the high technology service companies where they found the correlation but surprisingly, the correlation was in the opposite direction: loyal customers were costlier to service.
The Citibank experience
The senior MRx-er had a similar insight when he was a consultant for consumer banking research at Citibank. Citibank cost accountants had data showing that the average cost of serving individual depositors was U-shaped. Average cost of serving was highest for the smallest depositors (smallest in terms of lowest ADB or average daily balance) and for the largest depositors (who were also the most loyal). It was lowest for the median depositors. As Manny Blas, then Citibank’s marketing director explained, the large, loyal depositors (many of whom were Citibank’s “private banking” customers) were the most demanding—asking for the most perks—and the most complaining. It was these behaviors that raised this customer segment’s average servicing cost.
So, our conclusion logically follows: It’s not necessarily true that going after loyal customers will lead to profitability. The loyal customer business model is rarely the path that will lead you back to profitability, especially when competition sets in or intensifies. This shows you that your daughter’s professor, unfortunately, is not up-to-date with the latest in customer loyalty literature.
To be continued
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Keep your questions coming. Send them to us at MarketingRx@pldtDSL.net or post them at www.marketingrx.org.
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