David vs. Goliath I: Challenging Fred Reichheld on the Economics of Loyalty

Before I take out my slingshot, let me say that I think of Fred Reichheld as the dean of the school of customer loyalty. His Loyalty Effect is a true classic. He is one of the field’s defining figures and certainly its best known. No one has done as much to bring the issue of customer loyalty into the boardroom and the lexicon of corporate America.

And this is not (whew!) another rant about the evils or laurels of NPS.

I am a staunch defender of the economic value of loyalty. Loyalty is expressed by customer behavior that, in turn, drives value to a company. For any given customer, they express their loyalty to a company by continuing to be a customer, perhaps buying  more (or more expensive) products and services, giving the company a larger share of their spend, recommending the company to others and so on. The same customer expresses their disloyalty by doing the converse of these things. Consequently, for any given customer, their lifetime value to a company is significantly greater if they behave loyally than if they behave disloyaly. The dean (if I may speak for him) and I are in agreement on these points, and GfK’s LoyaltyPlusSM has validated this over and over again.  
 
Fred (whom I have never met, but he can call me Howard, so we’re even) also asserts, however, that loyal customers will pay more than non-loyal customers. His classic graph of “Why Loyal Customers Are More Profitable” (The Loyalty Effect, p.39) indicates that there is a price premium a firm can capture from loyal customers. He is not saying that Nordstrom’s can charge more than Macy’s which can charge more than Wal*Mart for the same products, that a devotee of a neighborhood bookstore will be willing to pay more for book from their favorite haunt despite the fact they can buy it for less online, or that people will pay more for better value/products/service/experience. Fred implies that a company can boost the lifetime value of a loyal customer by charging loyal customers more (that is, capture a price premium) than it charges less-loyal customers for the same products or services. This is where we part company.

 
I have seen a total of 1 (that’s ONE, uno) instance in which a firm actually was sufficiently confident about its ability to identify a small (very small) segment of customers it considered so loyal that they could charge them a small (very small) premium above its regular interest rate. The company in question is a bank that charged customers identified as its most loyal 7 basis points (that’s 1/16% or 0.067%) more than its regular interest rate on mortgages. In other words, the bank truly captured a price premium from a subset of customers it was able to identify as extremely loyal. (They tested 1/8% as well, but found that even their most loyal customers balked at 0.125% more and took their business elsewhere.)
 
For this one small example, I can cite hundreds of instances of banks – including the same bank that commanded this tiny mortgage premium – charging loyal customers lower rates on loans and offering them bundled products that are, in effect, packaged discounts from regular prices. Perhaps Fred is right and everyone in business is wrong, but it seems to me that most companies look for every opportunity to “reward” their most loyal customers with coupons, points programs, special savings, extra services, freebies, bennies and an endless array of incentives, all of which translate into a discount of some sort, not a price premium.

 
I am not suggesting that providing such incentives to customers to be more loyal or rewarding their loyalty is a bad idea or that it in any way undermines the economic value of loyal customers. In fact, it may actually punctuate the point: even though a company may effectively charge its most loyal customers less than other customers by virtue of incentives and packages it gives to loyal customers, the economic value of loyal customers still is greater than the value of non-loyal customers. In the experience of this David staring up at Goliath, at least, however, I see virtually no evidence of price premiums captured from loyal customers and a sea of examples where loyal customers realize price discounts.
 
I have never heard Fred challenged on this point, which is often repeated as a biblical truth without comment – but never with real examples. (Discounts to lure new customers or get them to try a product are simply new customer acquisition costs, not an example of more loyal customers paying premiums over less loyal customers, BTW.) Am I a lone voice in the wind? I know no one likes to respond to posts, but as a community of researchers and practitioners in the arena of customer loyalty, this group should be hyper-aware of these issues and any examples of such loyalty price premiums – so “show me the money.” Take ten seconds and weigh in: either there is no real price premium from loyal customers (who, I think, actually often realize price discounts) or register your agreement with Fred that companies capture price premiums from loyal customers (but with specific examples of loyalty premiums, not simple “I like Fred” raves).
 
Fred and I agree that the economic case for loyalty is compelling, boosting customer lifetime value. But I say that loyalty has a positive payoff despite incentives that amount to effective discounts, not because of supposed price premiums.