how can you measure loyalty

re these customers “loyal”?

n You’re DuPont, and one of yourcustomers is a chemical engineerbuying polymers from you under amaster purchasing agreement. Hereceives a volume-pricing discount.This customer represents a lot ofrevenue and repeat business foryou, but is he loyal?

n Pfizer relies on physicians to prescribe its pharmaceuticals. Onedoctor admits that, all other thingsbeing equal, she specifies Pfizerdrugs because she appreciates theeducational seminars the companyprovides each spring in Florida.How loyal is she?

n A business traveler can buy coffeeanywhere but seeks out Starbucksin whichever city she finds herselfbecause she knows she can relaxthere. Can Starbucks assume it hascreated a loyal customer?

n An office manager gives Stapleshigh customer-satisfaction scoresfor breadth of merchandise, goodpricing, and friendly service. Healso carries one of Staples’ BusinessRewards cards. Can we assume he’s loyal?

n Nike has strong repurchase ratesamong amateur athletes who findNike shoes a better fit for wide feet. Are these buyers loyal to theNike brand?

Each of these scenarios describes aloyal customer. “Loyalty” comes inmany forms. But should it be defined as

a feeling? An attitude? Or is behaviorthe only thing that counts?

The key to loyalty measurement is hav-ing a very clear picture of the economicvalue you are trying to create. If thereis no expectation of superior economicvalue in either the short or long term,then initiatives intended to inspirecustomer loyalty can’t possibly passthe basic business-case test.

The Business Case for LoyaltyFor most businesses, the promise of customer loyalty implies potential economic value creation with some combination of the following five dimensions.

First, many companies invest dispro-portionately in customer acquisitionat the beginning of the relationship,placing themselves in a negative economic position. The hope (a.k.a.“the plan”) is to pay off the initialinvestment many times over throughretaining customers and capturing thelion’s share of their spending in thecategory year after year.

Second, loyal customers may beinclined to buy more types and morevolume of products and services fromyou, thereby generating an enhancedreturn over the life of the relationship.Estimate how much these customerspend with you over their lifetimes,and arrive at the financial benefit.

Third, loyalty can be a strategy forreducing ongoing expense. A companythat is retaining customers is one thatcan, in theory, reduce its investment incustomer replacement. By closing theproverbial hole in the bottom of thebucket through which customers leakout, the company can improve prof-itability substantially. This was amplydemonstrated by Frederick Reichheldin his breakthrough 1996 study, TheLoyalty Effect. It analyzed the bottom-linevalue of an additional five percentagepoints in retention rate, across a variety of industries. [For an exclusiveinterview with Reichheld on his current thinking, please see page 10.]

If you hear a lot of companies talkingabout the importance of customer retention, it’s because they have goodreason. Competition in most industriesis brutal. Customers are promiscuous.Couple these trends with the old-but-truesaw that it costs more to acquire a customer than it does to retain one, and focusing your marketing efforts on existing customers makes soundbusiness sense. The more attractive and relevant your value proposition remainsto your customers, the less likely theyare to defect to the competition.

Fourth, customer loyalty can be associated with lower price elasticityand willingness on behalf of thecustomer to pay more for the privilegeof doing business with you. Highermargins almost always drop to thebottom line.

AHow Can You Measure Loyalty?Feature Story

Originally printed in MarketingNPV Journal vol. 2, issue 4, pages 4-9

Copyright © 2005 MarketingNPV LLC www.MarketingNPV.com

And finally, loyalty can be equatedwith the mother of all profitabilityengines — referrals. If loyal customersare happy customers, then it’s likelythey are unpaid ambassadors for yourcompany, spreading the word on howwonderful it is to do business withyou. That saves you real money inreduced customer acquisition costs.

Four Types of LoyaltyThere are four essential types of loyalty, each with its own benefits,risks, and measurement approach. Youmay be able to distill your market intocategories that align with these fourloyalty types.

CONTRACTUAL LOYALTY. When a customer purchases from youthrough a formal agreement, youhave contractual loyalty. This isvery common in business-to-busi-ness situations. The DuPont examplefalls into the contractual loyaltycategory. Contractual loyalty alsoapplies to consumer situations likesubscriptions for newspapers andmagazines, or for cable, telephone,or broadband services.

Contractual loyalty can be veryprofitable when looked at on thebasis of the net present value of thecontract. But it is often less prof-itable as contracts come up forrenegotiation and competitors useaggressive promotional tactics tosteal your customers. Contractualloyalty also can instigate dissatis-faction. Customers may feeltrapped in a business arrangement.Dell uses its key account serviceprogram, Premier.Dell.com, to addvalue to the traditional contractual

relationship by allowing corporatebuyers to place their orders online24-7, buying under the termsdefined in their contracts. However,the computers still have to matchthe needs of the customers.

TRANSACTIONAL LOYALTY. Repeatpurchasing without any contractualobligation can be called transac-tional loyalty: The customer is inthe market for widgets, and yousell widgets. Loyalty is based onfactors such as price, value per-ception, and convenience. The customer may find a better deal atany time, and if so, will switchwithout hesitation.

The doctor giving her prescription-writing business to Pfizer is anexample of transactional loyalty.She writes one prescription at atime. Because the doctor’s loyaltyis affected by her value assessment— the product costs her nothing,

and she gets a free trip to Floridaeach year — the economic relation-ship is vulnerable to a better deal.If some other pharmaceutical manufacturer develops a bettereducational curriculum in a moreattractive warm weather location, it is likely the physician will prescribe equivalent products fromthe new company.

Transactional loyalty is easy tostimulate with promotions orrewards programs. But to thedegree non-core components areused, “loyalty” can be difficult tosustain at an acceptable profit level.It’s also important to note thattransactional loyalty can be achievedsolely due to customers’ perceptionof the switching cost associated with moving their business. Withfinancial services, consumers mayperceive a hassle in switchingbanks for marginally superiorvalue propositions.

FUNCTIONAL LOYALTY. To thefunctionally loyal customer, theproduct’s very attributes are per-ceived as superior, thus preferable.One wireless phone company mayprovide better reception near thecustomer’s home, making for func-tional loyalty. The Nike examplealso falls into this category; if youhave wide feet, you develop a veryfunctional loyalty to shoes that fit.

Functional loyalty is often the first hope of efforts to differentiate.To the degree that you can offer customers something tangibly, palpably different yet relevant to the category purchase, you

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can lock up the portion of the market that prioritizes youradvantaged function.

EMOTIONAL LOYALTY. This is the“feeling” part of loyalty, in which acustomer develops preferences forproducts or services based on theirappeal to the individual’s values,ego, sensibilities, or other intangi-bles. Customers identify with thebrand, like the traveler searchingfor a Starbucks, because they seeksome nonfunctional benefit fromthe association or experience.Emotional loyalty is the Holy Grailfor many marketers — most oftensought and least often attained.

One of the primary pluses of emotional loyalty is its ability towithstand challenge to the economicor service relationship: Emotionallyloyal customers will forgive minorerrors in their experience andmaintain the relationship. Also,emotional loyalty often is associatedwith price premiums in powerfulbrands that have no discernabledifferences in form, function, value,or convenience.

Loyalty and SatisfactionOver the years, most companies haveacknowledged that happy customersare more likely to be repeat customersthan unhappy ones. Owing to the difficulty of defining “happy,” loyaltyindicators predominantly have beenlinked to satisfaction measurement.Some have even gone further, settingtheir sights on nothing less than“delighting” customers or eliciting therare reaction of “wow.”

Yet none of these descriptors hasproven sufficiently objective to spanbusiness units, channels, or customertouchpoints so as to create a consistentstandard for managers to achieve. Norhas any been more than loosely correlated to incremental profitabilitybecause few attributes are so distinctthat they exceed the matching efforts ofcompetitors. Nevertheless, the majorityof mid-sized to large companies todayhave some sort of measurement systemfor customer satisfaction, if for noother reason than to ensure continuedperformance at or above their category’scompetitive standard.

Satisfaction = Loyalty?Satisfaction, though necessary, is aninsufficient solo condition for loyalty.You can achieve high levels of satisfac-tion yet not inspire any real loyalty.For an example, look no further thanyour local car dealer. Automotivecompanies have been fast — and thorough — in their willingness toembrace satisfaction metrics. But anyone who has bought a car knows

how sales reps manipulate thesatisfaction scoring system. In a quietmoment during the new car deliveryprocess, when one might reasonablyexpect the customer to be at the verypeak of happiness, salespeople blithelyinform their customers of the impendingarrival of a J.D. Power satisfaction survey. Even if dealerships play itstraight and work hard to meet customers’ needs, the manufacturersthey represent have no better insightinto customer loyalty.

That’s because functional satisfactiondoesn’t necessarily ensure that eitherbehavioral or emotional loyalty willfollow. Satisfaction rates among U.S.auto buyers are often reported in theupper 80th percentile range — thispast summer Toyota Motor Corp.topped the University of Michigan’sAmerican Consumer SatisfactionIndex with an 87 — but actual manu-facturer repurchase rates hover in the30th to 40th percentile range. Dealerloyalty is even worse, with only about20% of customers returning to the samedealer to purchase their next car. This

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suggests that even though customersmay want different car experiencesevery three to five years, no one automanufacturer is meeting their needs.Loyalty is low in the category, regard-less of what satisfaction scores say.

To reinforce the point, a number ofacademic studies in recent years haveshown that satisfied customers don’tnecessarily buy more or more often, inany category. Satisfaction as a proxyfor loyalty is relative to each brand’sposition in the market at any giventime. If we accept that the perceptionof value most heavily influences

comparative purchase decisions at anypoint in time, and past satisfaction isbut an element of that perception, thenif company B offers me greater value,all my satisfaction with company Alikely will not prevent my switchingfor greater relative value.

So if you cannot rely on satisfactionmetrics to measure loyalty, what is the solution?

How to Measure LoyaltyThe overwhelming evidence todaypoints to the power of triangulation —

evidence of emo-tional loyalty cou-pled with one ormore elements offunctional, transac-tional, or contractu-al loyalty.Emotional loyaltyovercomes prob-lems, sustains thebrand relationship,and drives a desireto repurchase.

When paired with a strong rationale ofa functional, contractual, or transaction-al nature, the combination works toerect barriers to competition anddecrease price elasticity.

We know that the drivers of loyaltyare complex, and may be based on different — but equally important —factors like experiences, beliefs, prefer-ences, or fit with one’s self image. Butif we are investing in improving ourproducts, services, or processes, weneed to link those investments to specific economic value creation. Andbecause after-the-fact measurementapproaches may come far too late toeliminate bad investments or course-correct those with minor flaws, weneed methods for forecasting the creation of economic value based onchanges we see early in the marketresponse cycle.

All this suggests that to successfullymeasure loyalty, we need first to defineit in very specific terms that apply tothe desired business outcome. Forexample, a gasoline retailer might defineloyalty as a high share of customer,measured in gallons purchased annually.Because it has no idea of total consumption for each individual, theretailer estimates share of customer bylooking at total household consump-tion of gasoline across the country and breaking it down into purchasedeciles. The marketer assumes, bystudying aggregate driving behaviorsin miles per year and average fueleconomy, that the purchase patterns of drivers in the 7th decile representthe practical maximum annual purchase volume for most households.(Customers in deciles 8, 9, and 10 may be viewed as abnormally

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Citi American Wells Capital Bank of Chase DiscoverExpress Fargo One America

Citi

American Express

Wells Fargo

Capital One

Bank of America

Chase

Discover

After 3 years, 42% of Citi customers remain loyal; 6% switch to American Express; 14% switch toWells Fargo, and so forth. Numbers do not equal 100% due to options not shown.

Customer ReferralEmployee Referral Customer Selection

Efficiency Training Hiring

Customer Retention

42 6 14 16 2 4 5

8 65 6 11 1 4 8

11 4 38 3 7 9 4

14 10 5 37 3 3 8

4 4 10 2 55 1 10

6 14 4 6 7 45 2

3 4 3 5 9 6 20



high-mileage/low-economy drivers).Consequently, a customer purchasing100% of the decile 7 consumption level is believed to be directing a high percentage of overall category businessto the company and thereby judged to bevery loyal (without indication of an emo-tional connection to the marketer as yet).

The retailer then collects self-reportedsurvey data from customers in deciles4, 5, 6, and 7 about their perceptions ofthe brand and its quality, convenience,value, etc. With this information, theretailer can build predictive models toestimate emotional factors’ impact onpurchase behaviors and thereby evaluatethe potential return on spending moreto drive emotional brand loyalty vs.investing in credit promotions, stationlighting, or premium item giveaways.

Some marketers measure loyalty byengagement. They monitor the correlations between customers’ actual purchase behaviors and the use of thebrand Web site, interactions with customer service channels, responsesto price increases or discounts, etc.Engagement actions, taken by the customer between purchase events,are generally good leading indicators ofthe customers’ likeliness to repurchaseor purchase complementary productsor services. This is the basis of thebundling model being pursued sovigorously by telecommunications and cable companies today as theyfight to get their hooks into customersby building high levels of engagementin the “stickiest” of services likebroadband access or digital entertain-ment. A customer who orders threepay-per-view movies per month is farmore likely to stick around than onewho orders only sporadically.

So the measure of true loyalty doesn’t rely on any single indicatorbut rather several, all pointing in acommon direction. Here are a fewwe’ve compiled.

Indicators of LoyaltyEach kind of loyalty — contractual,transactional, emotional, and functional— is open to its own set of metrics.

Because contractually loyal customersare buying under a purchase agreement,the agreement and its status need tobe measured. Ways to do this include:• Share of market under contract• Frequency distribution of contract

profitability• Frequency distribution of customer

share of wallet • Contract renewal rates (perhaps by

inception date cohorts) • Incidence of contract expansion into

new product lines or business units • Customer referral frequency• Effective price changes at renewal

Transactionally loyal customers arecharacterized by patterns that can be teased out by data analytics, such as: • Changes in recency-frequency-

monetary value by customer segment or cohort group

• Velocity of change in segment mobility• Cross-category purchase behavior

and trends• Latency (gaps between transactions)• Frequency distribution of

transaction value

With the functionally loyal buyer, thekey is to closely monitor the basis of thefunctional preference. Measurementapproaches include:• Top-of-mind awareness on key

functional dimensions• Changes in perceptions of key

functional attributes vs. those of competitors

• Willingness to recommend• Price elasticity

continued from page 7

Potential Customers Customers

Awareness– accurate– salient

PerceivedRelevance

“for me”

PerceivedValue

“worth doing”

Purchase/Trial

Engaged

Measure drop-out rates and causes

Perception tracking studiesBehavior tracking Experience perceptionsQuality metrics

– Opt-in– Survey

Response– Cross-sell– Dialogue– Referral



Measuring emotional loyalty involves:• Attitudinal surveys on key attributes

–“like me”–“a brand I can trust”–“the right brand for the times”

• Competitive brand preference • Price insensitivity• Problem tolerance• Resistance to competitive offers• Overall brand preference

Timing Is EverythingWhile marketers and managers placehigh value on loyalty measurement,it’s important to not only select the

metrics carefully but time them right,too. With perceptual metrics such asthose collected in surveys, experiencehas shown how the timing of the question can influence the result. Toosoon after the transaction the responsereflects the “honeymoon” when theconsumer wants psychological rein-forcement of his or her spendingbehavior. But too long after the transaction, many of the discriminatingdetails can be lost, resulting in mid-rangescoring patterns. The goal is to pick atime when the customer’s perspectivewill be fresh, but reflect considerationof the experience vs. expectation.

With those guidelines, it is criticallyimportant to continuously measureloyalty. Too many companies are stillfielding monthly or quarterly surveys,then reading the results several weeksafter the data is aggregated. Thismakes it difficult to gauge the impactof any single or series of loyalty initia-tives precisely: Too many variablesmay be present to tease out causality.Instead, the more effective approach isto sample customers every day or atleast every week and continuouslyread moving averages (of sufficientsample size). With time, you’ll be able to isolate the exact time whencustomers’ perceptions or beliefschanged and correlate that to bothbehavior changes and the presence ofthe loyalty stimulus.

The Bottom Line Isthe Bottom LineUltimately, the objective of a loyaltymeasurement process is to forecastchanges in customer profitability.Loyalty, properly measured, is a leading indicator of future purchasebehavior, and thereby profitability. It’snot about satisfaction, transaction frequency, or favorable imagery. Therelationships between them driveshareholder value. There are manyways to measure loyalty. The key is to measure more, do it faster, and connect your measurements to theeconomic outcomes of the organization.With a focused approach on the keydrivers of loyalty in your business —contractual, transactional, emotional,or functional — and a set of metricsagainst each, you will manage customer loyalty in an efficient andactionable way.

Recognizing that satisfaction is NOT a predictor of economically profitable behavior(although dissatisfaction has been found to be highly predictive of negative economicbehaviors), many companies look to factors such as “likelihood to recommend,”“likelihood to continue as a customer,” and “good value for the money” to triangulateon a customer’s loyalty.

Using 1-to-5-point scales for each, with 1 being very low and 5 being extremely high,customers who rate the company as a 4 or 5 on each of the three dimensions areconsidered “loyal.” Those who rate the company high on any two dimensions but lowon the third are assumed to be “vulnerable.” And customers rating the company lowor neutral on two or more dimensions are assumed to be “neutral” — neither loyal nor disloyal.

The simplicity of this approach can also be its downfall. Be careful to validate thatthese are the right questions for your business and that the results correlate to actualcustomer spending patterns with respect to longevity, frequency, or share of customer.

“Loyal” “Vulnerable” “Neutral”

Likelihood to refer a friend to us 4 2 2

Likelihood to purchase from us again soon 5 4 3

Value you get for the money you spend with us 5 4 4

On a scale of 1 to 5, with 1 being the lowest and 5 being the highest,please rate us on each of the following:



how can you measure loyalty

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