Marketing Management: A Systems Framework (4)

Customer Focus

This is Chapter 4 in a 15-part series that makes up this book. Enjoy!

It is at this stage that we turn our attention to live humans: consumers. While the business objective is expressed in terms of profits or units sold, the customer focus expresses a goal with respect to the purchasers of our product or service. This focus on the consumer is a distinguishing characteristic of marketing vs. other strategic disciplines, which generally only considers actions at the firm level. In the final analysis, it is the actions of individual consumers, not markets or industries, that will determine whether our marketing plan succeeds or fails. In the framework, this link between business objective and customer focus represents a crucial transition from thinking about abstract numbers to thinking about warm bodies.

Every firm that has existing customers must decide how to allocate resources between customer acquisition and customer retention. We distinguish these investments because marketing activities for potential customers differ from those for retained customers. The customer focus decision is therefore one of prioritization; we will always be spending for acquisition and retention; the key is to determine our primary focus. We will then develop our analysis based on that primary customer focus. After this analysis is complete, we can do an analysis for our secondary focus; however, for this chapter we will concentrate on our primary customer focus.

As a first step, we must first determine 1) how our investments are currently allocated across acquisition and retention, and 2) what percent of our revenues are accounted for by retained vs. acquired customers. By monitoring this relationship between investment and revenue vis-à-vis retention and acquisition, the firm can better assess the true impact of its marketing efforts. This exercise can provide insight into our firm objective. This relationship, illustrated in Figure 3.1, reflects the firm’s goals and position in the marketplace. For example, a firm whose investments and revenues are both primarily associated with acquired customers is likely a start-up or high growth firm. In contrast, if retention investment and revenue is primary, the firm is likely a well-established competitor. Companies that derive most of their income from retention but are investing primarily in acquisition are usually those who are attempting to enter new markets or attract new customer segments. Finally, a firm whose primary revenue source is acquisition but has begun to invest more heavily in retention is generally attempting to solidify a position in the marketplace.

Customer Definition

The first step in the process of identifying customer focus is the customer definition. At this step we start to explore and define who constitutes a potential, acquired, and retained customer. We will deepen this definition as we move through this chapter, but for now we are concerned with developing a basic description of attitudes and behaviors in each of these categories. Figure 2 is an example for Hertz rental cars. This example describes the transition that customers undergo as they move from potential, to acquired, and finally to a loyal customer. should generate and retention activities cannot be clearly specified until we understand who is in our franchise and who is not. Is our current customer anybody who has ever purchased our product, or only our most recent purchasers? Is it all purchasers, or only those who purchase our products exclusively? Should it be limited only to customers who consider themselves brand loyal? The answers to all these questions are crucial at this step of the process. The discussion below outlines key issues to consider in developing a customer definition.

Our two goals in customer definition are to 1) identify the key transition points between categories, and 2) identify key linkages between attitudes and behaviors.

Transition Points

When does a customer become a customer? When do they transition from a potential or newly acquired customer to a retained, loyal customer? The answer to these questions will inform our analysis going forward and should be answered carefully. Transition points vary from industry to industry and from company to company, but they general involve some form of purchase behavior. The key is to carefully specify this behavior in context. For non-durables such as packaged goods, this is a straightforward process since purchases occur frequently. We might assess purchase quantity, frequency, or perhaps our share of the customer’s total purchases. For example, we could consider a customer loyal and retained once more than 50% of their total purchases in the category are with us, or when their purchase volume is in the top 25% of all customers.

This analysis becomes more difficult in the case of non-durables with longer purchase cycles, such as cars and computers. It is quite possible that the prevalence of umbrella branding in non-durable categories is attributable to this fact. While a customer may purchase an Apple computer once every 4 years, they may visit the Apple App Store weekly. Hence a common approach for durables is to do an umbrella analysis where a loyal customer is someone who purchases several different products in our line. Alternatively, we may rely more heavily on attitudes or non-purchase behaviors such as willingness to recommend.

Attitudes also vary at well-defined transition points. A potential customer may have little or no interest in or knowledge of our brand positioning; a newly acquired customer likely understands the key benefit we are promoting, and a retained customer will have a deeper and more substantial relationship with our brand. The ability to identify when and how these transitions occur is a crucial marketing skill.

In the metrics chapter we will take a more detailed look at customer transitions and relate them directly to key marketing activities. The analysis we are doing here will serve as a foundation for this more exhaustive analysis of the customer journey.

Attitudes and Behaviors

A core precept of marketing is that attitudes drive behaviors. We are in the business of changing attitudes, and it is this attitude change that leads to the behavior we are seeking. Trying to get someone to buy something is selling; changing attitudes to drive purchases is marketing. The key insight we deliver in this area of the framework is exactly which attitudes drive the sought-after behavior. By considering attitudes and behaviors in relationship to each other we will gain insights more quickly. There are some attitudes that may seem powerful and interesting to us as marketers, but unless they drive behaviors they won’t work. For example, many people express a strong agreement with the idea of eating healthy foods, yet a significant portion of these same people consume a high volume of highly processed (unhealthy) salty snacks. The key here, then, is to look for strong attitudes in the context of behaviors. We begin this process here and will continue updating our decisions as we deepen our knowledge over time and working through the framework.

Relationship to Fundamental Entity

Our customer definition must reflect and be consistent with our fundamental entity If our FE is a distinct brand, our current customer will be defined relative to that brand. Alternatively, if our FE is the brand umbrella, our customer definition will be constructed to include customers who have purchased any product sold under that umbrella brand. Hence, in the case of umbrella branding, our customer base will likely be much more diverse. Figure 3 describes three different FE’s and their respective customers. In this example we consider how we would categorize a person who has purchased a pair of Nike golf shoes. If Nike chooses to define the FE as the Nike umbrella, then we would likely consider this person as acquired for the FE. In contrast, if we have chosen to define our FE at the level of business units (Nike Fashion, Nike Team Sports, and Nike Individual Sports) then our customer would be consider acquired to the Nike Individual Sport FE, but not the others. Finally, if we decide to create 6 FE’s for each of the distinct brand lines, then the golf shoe purchaser would only be counted as acquired by the Nike Golf FE.

One important aspect of the systems thinking approach is attention to relationships between variables, in this case FE and customer definition. As we move through this customer definition exercise, we may find that our FE definitions may need to be refined or even entirely changed. This flexibility in thinking should be a habit: as we gain understanding as we move through the framework, we let this understanding inform our previous decisions, and we can decide to back up and make changes to these decisions. Our end goal is to ensure that all elements of the framework are, in the end, aligned and coherent. We adjust the framework to achieve this goal where they make the most sense, not based on when we made the original decision.

Customer Acquisition and Brand Loyalty

Customer acquisition activities are those activities dedicated to acquiring or reacquiring customers to our brand franchise. As discussed above, a clear understanding of exactly when a potential customer becomes an acquired customer is crucial. An acquired customer is just beginning to develop a relationship with our FE. As this relationship deepens, they will move to the retained category. Since this is the start of our customer relationship, it is more uncertain — we are, in essence, on a first date, getting to know each other, sharing information about ourselves, and setting expectations. While it is of course important to achieve our customer acquisition goals, this is only the first step in the process. Our ultimate goal is to transition these customers from acquired to retained. We must always keep this goal in mind. A common marketing error is to over-spend on customer acquisition and then be caught with insufficient resources to convert this population to retained, profitable customers. Therefore, we must always engage in acquisition with retention in mind. For example, if we ultimately plan on a luxury positioning for our brand, it is a bad idea to acquire customers with price promotions that suggest we have a low-cost positioning.

Customer acquisition is expensive. Researchers estimate the cost of acquiring a customer to be between 5 and twenty times more than the cost of retaining an existing customer.[1] This makes sense: non-customers are not yet aware of our product so we must first build this awareness. In the case of new-to-the-world products such as TiVo or Uber they may be wholly unaware of the category. In these cases, we must not only build awareness of a category and our brand, but we also must achieve a potentially substantial attitude and behavior change. On the other hand, if we are entering a mature category, we don’t have to worry about building category awareness, we instead face the daunting task of trying to convert customers from their current brands. In this case customer loyalty toward competitive brands increases our costs. In the end, all competitors in a category are seeking to establish and maintain customer loyalty; this is the source of our sustainable growth and profitability. While the layperson may think of brand loyalty as a singular concept, there are different varieties of brand loyalty with different implications for marketers. We will refer to these three types of loyalty: heart, head, and hand:

Heart loyalty is a strong emotional involvement with a particular brand. When a consumer says, “I love my Jeep” they are exhibiting heart loyalty. We often see this type of loyalty for “badge” or “neck-tie” products, products that are consumed in public and are thought to reflect something about the nature or identity of the person consuming them. Bottles of beer in a bar, a car, or a pair of jeans are all examples of badge products for which consumers often feel heart loyalty. This type of loyalty is quite difficult for competitors to challenge because it is highly personal and emotional in nature, and thus resistant to rational appeals. In addition, because a product choice based on heart loyalty is tied up with the consumers’ identity and ego, a competitive challenge to this choice can be perceived as a personal challenge to the consumer.

Head loyalty is also a type of highly involved loyalty, but it is more rational in nature. A consumer exhibiting this type of loyalty generally has one or more specific reasons why she has made her purchase decision, and she can readily articulate these. “I use this car seat because it has the highest safety ratings,” is an example of head loyalty. Products whose attributes clearly can be compared and differentiated tend to generate more head loyalty; many (but not all) technology products fall into this category. Competitors seeking to steal customers exhibiting head loyalty generally need to provide a compelling, rational argument for their brand. It should be noted, however, that customers who have already gone through an extensive evaluation phase in choosing their brand may prove quite resistant to evaluating new arguments, either because they are reluctant to invest more time and energy to evaluate another product, or simply because they want to continue to believe they have chosen the best product.

Hand loyalty is low-involvement, habitual loyalty. The consumer is loyal to the product not because of an emotional or rational involvement, but simply because of a routine that she has established. Her commitment to the brand is low, but her interest in expending the resources necessary to search for a replacement brand is even lower. “This brand toilet paper is good,” is a common hand loyalty statement. This type of loyalty generally is exhibited for low-ticket items that are purchased repeatedly, such as consumer packaged goods, categories like paper products or canned vegetables. (Interestingly, other consumer goods like milk and pet food are high involvement). However, there are examples of hand loyalty in high-cost categories as well, particularly if the perceived risk of switching brands or the cost of doing the research necessary to switch is high. For example, many consumers elect to continue paying a premium for different types of insurance, presumably because in these complex categories is onerous and the risk of choosing the wrong brand is high. A consumer is considered hand loyal if they are unwilling to commit the resources necessary to do the research necessary to switch brands. In contrast to heart and hand loyals, these consumers have low involvement, but remain brand loyal.

In general, a firm’s customers will consist of a mix of head, heart, and hand loyals. However, in industries, and for firms, a certain type of consumer usually predominates. Apple has a relatively high percentage of heart loyal customers compared to Dell or IBM; most purchasers of table salt tend to be hand loyal. This topic will be addressed in greater detail in the Product Chapter; however, it is important at this stage for the firm to have a clear understanding of exactly what type of loyalty the brand engenders in consumers.

Acquisition Activities

The main reason we distinguish acquisition from retention is because the marketing activities we engage in for these two customer objectives are very different. We will further distinguish these activities when we cover customer focus in the next chapter. In general, acquisition activities involve generating awareness, conveying information, and encouraging trial. In essence, we need to introduce potential customers to our brand and benefit. A common mistake made by marketers is to simply engage in random trial-generating activities to acquire new customers. While product trial is an obvious tactical goal for acquisition, this behavior change must be preceded, accompanied, or followed by an attitude change as outlined in our customer definition. Behavior change without attitude change will lead us to poor conversion rates when we try to move customers from acquisition to retention. In future chapters we will consider specific marketing tactics and their relationship to acquisition and retention.

Customer acquisition is the first step in the process of creating customer lifetime value, or CLV. This metric is probably one of the most powerful metrics in marketing and business practice. As we begin to explore CLV we will see that acquisition costs, while large at the outset, will not have a major negative impact on our CLV if we engage in appropriate and successful retention activities. Simply put, the costs of acquiring a new customer may be high, the potential benefits may be high as well, if we are strategic in our decision making. In some categories, such as diapers or dentures, the lifetime value of a customer is naturally constrained by demographic variables that cannot be altered by marketing activities. In other categories, this lifetime value is affected by activities on behalf of the brand and the category. The higher the lifetime value of the customer, the more money we should be willing to devote to acquisition activities.

The lifetime value calculation is simply the net present value of the total expected profit from one customer over the course of their relationship with the company. In addition to this calculation, it is sometimes valuable to calculate an associated lifetime value — an estimate of potential profits that might accrue from friends and associates referred to by our customer. It is often quite informative to calculate this estimate, however loose it may be at the outset. This concept is illustrated well in Frederick Reichheld’s 1996 book The Loyalty Effect. In this book, Reichheld illustrates that customer become significantly more profitable over time, due to a variety of factors that extend beyond direct profitability. Each of these factors should be considered when calculating the lifetime value of a customer.

In summary, an acquisition strategy is difficult, risky, and therefore expensive. However, it is a necessary component of any marketing campaign. The key to the development of effective acquisition strategies is to think realistically about the process by which a non-user or competitive user might be converted to a user, i.e., customer.

Retention

Once we have acquired a customer, we turn to the task of customer retention. Conceptually, we are seeking to build and strengthen brand loyalty; we should therefore have a clear idea of which kind of loyalty we wish to build; our retention tactics will be determined by this goal. Building heart loyalty is a completely different endeavor from building hand loyalty. For heart loyalty we want to increase emotional involvement and engagement; for hand loyalty we want to subtly support and maintain our customer’s habit of choosing our brand. To increase head loyalty, we must continually develop and reinforce the rational reason why for purchasing our brand. We will consider potential retention tactics through this lens. A company such as Zappos who is interested in building heart loyalty will invest heavily in customer service and high-engagement communications using social media. In contrast, Amazon is interested in developing hand loyalty; their investments will likely be in web design, quality control and logistics to ensure an incident-free customer experience. In contrast to Zappos, they don’t necessarily want to increase customer involvement beyond simply thinking of Amazon first for shopping.

In recent years, there has been a strong push for companies to increase their retention activities, given the potential efficiencies associated with this strategy. The increasingly popular practice of CRM, Customer Relationship Management, focuses on identifying profitable customers and developing tools to keep these customers. This approach has generated efficiency increases for many companies, particularly in sectors such as air travel and financial services. As with any popular strategy, however, it is crucial to maintain a balanced approach to retention activities. An overly aggressive focus on the heavy user can have deleterious effects on relationships with other potentially important customers. Nonetheless, effective retention spending is a vital aspect of any successful long-term marketing plan.

Examples of retention activities include customer loyalty programs (frequent fly/buy rewards), reminder advertising, and continuity coupons (incentives for multiple purchases, in-pack coupons.) Product development, particularly line extensions and product improvements, also may be considered retention activities. As with acquisition spending, it is important that money spent on retention is spent with the specific customer in mind. One of the most common examples of retention expenditure is a continuity promotion — a discount on multiple purchases of a product. However, if this promotion does not enhance customer loyalty or prevent switching, we simply are giving money away to customers who were planning on buying our product anyway. Very often, spending on non-price related retention activities, such as advertising and customer service can be more effective for maintaining long-term loyalty.

Customer Focus and the Framework

As we move through the framework, it is important to consider the relationships between the previous chapters and the current chapter. We have already discussed the influence of the fundamental entity choice on the customer focus decision, but other decisions made within the Business Objective step also have an impact on customer focus decisions. In particular when the firm is determining the type of brand loyalty they will pursue, it must be supported by a firm competence as described in Figure 4. How do we keep a hand loyal? By supporting their habit of purchasing from us. Much of this support comes in the form of never, ever, failing. Therefore, quality control and distribution competences are important for hand loyalty. Consistency is key. For heart loyalty, skills at increasing emotional engagement, such as customer service and ability to co-produce service and product innovations are key. For head loyalty, staying ahead of the competition in terms of innovation toward our customer benefit is key. Therefore, marketing skills at bringing new products to market, R&D, and communications about functional benefits are important.

Systems Thinking and Customer Focus

The choice of customer focus is not a binary choice; if we choose acquisition as our primary objective, we cannot forget retention entirely and vice-versa. It is essentially an optimization exercise. We will work through the framework first for the primary customer focus and then for our secondary focus. Our decision should be guided by our evaluation of our current success at both tasks. For example, if our customer retention rate is high, we will likely maintain our activities there and turn our attention to improving our acquisition rate. On the other hand, if we are not retaining customers, a strong acquisition rate won’t really help us. This situation of high customer churn is described in Figure 5a. In this model, there is a positive relationship between nearly all the variables: acquisition spend increases acquisition rate, which in turn increases the number of acquired customers and therefore total customers. However, if we have fixed resources then if we increase acquisition spend, we must necessarily decrease our retention spend, presumably causing a decrease in the number of retained customers, and therefore total customers. To replace these customers, we increase our acquisition spend, further reducing our retention spend and our number of retained customers. This situation can quickly devolve into a situation with high customer churn. Over time a higher percentage of our total customers will be newly acquired, less profitable, and less sustainable.

In systems thinking, we identify a causal loop that is leading to a problem, then identify the policies or assumptions that drive this causal loop and see what changes can be effected. In the current model the problem is in the acquisition/retention spend relationship. Figure 5b illustrates the solution to this issue, we need to introduce a positive relationship between 1) acquisition spend and retention rate, and 2) between retention spend and acquisition rate. In essence, we wish to acquire with retention in mind, and retain with acquisition in mind. What does this mean? When we acquire new customers, we consider our brand positioning and our retention activities, and we align our acquisition tactics accordingly. We set expectations among newly acquired customers that we can meet as we retain them. When we retain customers, we encourage word-of-mouth and other recommendations, ideally aligned with our overall positioning, such that they will increase our acquisition rate.

Moving Forward

Customer focus and competitive focus will form the foundation of our executional work. It is therefore crucially important that we carefully consider our choices at this stage. As we move through the framework, we must constantly check in to ensure that our actions are consistent with these choices.

[1] Sterne, J. (2002) ‘Web metrics: proven methods for measuring web site success’, John Wiley & Sons, New York, p. 283.

Thanks for reading!

Chapter 1: Introduction and Ethics

Chapter 2: Systems Thinking

Chapter 3: Business Objective

Chapter 4: Customer Focus

Chapter 5: Competitive Focus

Chapter 6: Estimating Market Potential/The 4 B’s

Chapter 7: Segmentation

Chapter 8: Targeting

Chapter 9: Positioning

Chapter 10: Product

Chapter 11: Service as Product

Chapter 12: Communications

Chapter 13: Channels

Chapter 14: Pricing

Chapter 15: Metrics