Review of “The Loyalty Effect” (by Frederick Reichheld)

Reichheld (1996)

The Loyalty Effect:  The Hidden Force Behind Growth, Profits, and Lasting Value

(Reichheld, Frederick F., Boston:  Bain & Company, Inc., 1996).

2001 Revision

A highly respected authority on the topic of customer loyalty, Reichheld (1996) notes that, “on average, U.S. corporations now lose half their customers in five years, half their employees in four, and half their investors in less than one.  We seem to face a future in which the only business relationships will be opportunistic transactions between virtual strangers” (p.1).  Also, “in a typical company today, customers are defecting at the rate of 10 to 30 percent per year; employee turnover rates of 15 to 25 percent are common; and average annual investor churn now exceeds 50 percent per year” (p.4).   Reichheld then goes on to argue, though, that loyalty is not dead, but rather continues to be key to profits and the long term prosperity of corporations.

In short, businesses today are facing increasing problems maintaining customer and stakeholder loyalty; consequently, rather than loyalty being less important today than in the past, it is more critical and therefore requires greater business attention than ever.

In The Loyalty Effect, the author puts forward several widely regarded and now commonly held beliefs about customer loyalty.  Four in particular stand out.  The first is that loyal customers are less expensive to serve than non-loyal customers.  This is based on the assumption that customers familiar with a business’s products and services require less company resources in the way of explanations, problem-solving and general product information issues.  “In most businesses other than retailing,” the author argues, “the costs of acquiring a customer, setting up an account, and checking credit are so high that the economics just won’t work unless the customer stays loyal” (p.83).

Next, more than average customers, loyal customers are generally willing to pay higher prices because of their comfort and satisfaction with the business and their relationship with it.  Reichheld points out that “this is sometimes the result of trial discounts available only to brand-new customers,” but also due to self-selection, noting that “studies show that loss leaders [items sold at no or minimal profit to entice customers into the store] make up a smaller fraction of an old customer’s shopping basket” (p.49).

Third, loyal customers are bigger than average spenders and, fourth, loyal customers are valuable sources of word-of-mouth advertising as they recommend the products and services that they believe in.

Reichheld is also credited with originating other fundamental assumptions about customer loyalty, including the claim that a five percent increase in customer retention rates can potentially increase by 25 to 100% the value of a business’s customers. Assumptions such as these have received great attention in academic literature and have many supporters, although critics include Dowling and Uncles (1997), Reinartz and Kumar (2002) and others.  Although also particularly critical of many of his assumptions, Keiningham et al. (2005) in their book Loyalty Myths recognize that “Reichheld is without question a thought leader in the customer loyalty community.  Furthermore, the business community and the authors are in his debt for championing the importance of customer loyalty as a viable business strategy” (p.99).

Like the article by Nunes and Dréze (2006), Reichheld’s book is also full of applicable findings, quotes and illuminating points.   For example, Reichheld points out that in a study by Chick-fil-A, a large privately-owned American fast food restaurant, it was discovered that customers who used “coupons [spent] less, [were] less likely to give the store repeat business, and [were] very likely to use coupons during peak traffic hours, when handling coupons slows the lines.”  It was also revealed, the author points out, that “loyal customers who do not have coupons feel short-changed, and that frequent price promotions tend to convince them that [the] product is not worth its normal price” (p.84).

Summing up his opinion on the topic of coupons, Reichheld says “coupons and price discounts generally … do little or nothing to inspire loyalty in new customers, and actually discourage it in old ones” (p.83).  Regarding coupons and discount promotions, he asks, “Why would you want customers who will renounce their loyalties to save a dime, or even a dollar?  Traditionally, retailers have gone to a lot of trouble and expense to attract such people, with results that are largely negative” (p.82).

In short, although now over 15 years old, this was an excellent book and one that brought the importance of customer loyalty to the forefront of business attention and strategy.  Frederick Reichheld is the original thought leader in the area of customer loyalty.
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Frederick Reichheld is from Bain & Company, a leading business consulting firm.

(Review Source: Customer Loyalty Programs: What Makes an Effective (Community-based) Program, MBA Thesis, 2007).

 

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