Should You Punish or Reward Current Customers?

Is it better to reward existing customers for loyalty — or spend your marketing dollars on attracting new ones? Here is a framework to help you decide.

Charlie, a loyal customer of his local bank, had never thought of taking his business elsewhere, but the offer from a competing bank to refinance his mortgage at an extremely low interest rate seemed too good to pass up. He asked Rick, the loan officer he had been dealing with for years, if the bank could match the offer. Rick knows lowering Charlie’s mortgage rate won’t be good for the bank’s bottom line, but he thinks making a long-time customer happy is worth the investment. Should the bank match the offer, or should it let Charlie go? This anecdote, while fictional, represents a real customer management dilemma faced by many companies nowadays: Should we offer better deals to current customers or to new ones? In particular, at what cost should we keep current customers, as opposed to seeking out new ones? The question is simple, but the answer is not. A quick scan of offers found in the marketplace does not reveal obvious commonalities and provides little insight. While airlines give lavish frequent-flyer packages to their most loyal customers, wireless carriers generally focus on wooing new customers through introductory deals. Hotels often do both. Apparel catalog retailers send special discount “value” catalogs to existing customers, whereas magazines, newspapers and software companies often offer discounts to new customers by offering them lower introductory prices. But would it, for example, be more profitable for a newspaper to offer a better price for subscription renewal rather than new subscriptions? Should a wireless carrier instead offer lower rates to its high-volume customers who have stayed with the carrier for a long time? Should a hotel, airline or retailer offer better rates to new customers it aims to acquire? Ultimately, how can a manager reconcile the demands of current customers with the need to attract new customers? Expert opinions on this subject conflict. On one side, you can find people who argue that careful attention to the needs of existing customers like Charlie deepens the relationship between customer and company. That, in turn, leads to continuous increases in customer satisfaction, loyalty and company profitability in a virtuous cycle of mutual benefits.

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References

1. L. O’Brian and C. Jones, “Do Rewards Really Create Loyalty?” Harvard Business Review 73, no. 3 (May-June 1995): 75-82; and D. Peppers and M. Rogers, “Managing Customer Relationships: A Strategic Framework,” 2nd ed. (Hoboken, New Jersey: John Wiley & Sons, 2011).

2. D. Fudenberg and J. Tirole, “Customer Poaching and Brand Switching,” RAND Journal of Economics 31, no. 4 (winter 2000): 634-657; J.M. Villas-Boas, “Dynamic Competition With Customer Recognition,” RAND Journal of Economics 30, no. 4 (winter 1999): 604-631; and D. Fudenberg and J.M. Villas-Boas, “Behavior-Based Price Discrimination and Customer Recognition,” chap. 7 in “Economics and Information Systems,” ed. T.J. Hendershott, vol. 1 in “Handbooks in Information Systems,” (Bingley, United Kingdom: Emerald Group Publishing, 2006), 377-436.

3. J. Shin and K. Sudhir, “A Customer Management Dilemma: When Is It Profitable to Reward One’s Own Customers?” Marketing Science 29, no. 4 (July-August 2010): 671-689.

4. D. Peppers and M. Rogers, “The One-to-One Future: Building Relationships One Customer at a Time” (New York: Currency Doubleday, 1993).

5. D.C. Schmittlein, L.G. Cooper and D.G. Morrison, “Truth in Concentration in the Land of (80/20) Laws,” Marketing Science 12, no. 2 (spring 1993): 167-183.

6. R.S. Kaplan and V.G. Narayanan, “Measuring and Managing Customer Profitability,” Journal of Cost Management 15 (September-October 2001): 5-15.

7. R. Leszinski, F.A. Weber, R. Paganoni and T. Baumgartner, “Profits in Your Backyard,” McKinsey Quarterly no. 4 (November 1995): 118–127.

8. Kaplan and Narayanan, “Measuring and Managing Customer Profitability.”

9. M. Reardon, “Sprint Breaks Up With High-Maintenance Customers,” CNET News, July 5, 2007, http://news.cnet.com.

10. V. Mittal, M. Sarkees and F. Murshed, “The Right Way to Manage Unprofitable Customers,” Harvard Business Review 86, no. 4 (April 2008): 94-102.

11. L. Selden and G. Colvin, “Angel Customers & Demon Customers” (New York: Penguin Group, 2003), 157-158.

12. J. Shin, K. Sudhir and D. Yoon, “When to ‘Fire’ Customers: Customer Cost-Based Pricing,” Management Science 58, no. 5 (May 2012): 932-947.

i. Shin and Sudhir, “A Customer Management Dilemma”; and Shin, Sudhir and Yoon, “When to ‘Fire’ Customers.”

2 Comments On: Should You Punish or Reward Current Customers?

  • John Parisi | July 23, 2013

    Interesting article: Being the in the Quick Service Restaurant Industry, I believe our consumer base has high value concentration and flexibility. The most frequent visitors are not necessarily the most profitable. How would I determine who are the most profitable frequent users to then develop a focused marketing campaign for our mutual benefit? I can identify the frequent user by demographic but not by profitability.

  • Ajit Mathur | October 31, 2013

    Very insightful article. My experience in B-2-B settings suggests that where switching costs are high, the firm may have to sometimes carry relatively less profitable/unprofitable customers simply because they are like “passports” to attract new customers and at times, these customers might even exploit this situation. I would recommend that in such cases, assuming that all avenues to make them profitable have been exhausted, ask one last question: what will be the impact of this customer’s exit on new customer acquisition and decide accordingly. Lastly, this may be a dynamic decision and the firm may like to periodically review it’s portfolio.

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