Microeconomics of Customer Relationships

Customer Relationship Management is a way of creating and evolving your organization in the market place and at the same time in the mind of each individual customer. Customer expectations such as product quality, service responsiveness, price stability and the overall sales process experience are vital for a business to stay relevant and successful on a long-term basis. Amidst the amount of research on brand loyalty, customer retention and the word-of-mouth advertising, it is a difficult task to quantify these intangible assets and make an impact to a company’s bottom line.

This is where the article “Microeconomic of Customer Relationships” by Fred Reichheld investigates and analyzes a way that the quality of customer relationships affects the economics of a business. This investigation is based on a simple survey based customer-relationship metric known as “net-promoter score”, or NPS. Their CEO, Jeffrey R. Immelt, used this survey as an instrument in General Electric’s marketing efforts. Immelt announced that GE “organically” grew from 5% to 8%.

The NPS divides customers into three categories based on the simple question, “How likely is it that you would recommend us to a friend or colleague? ” (Reichheld, 2006, pg. 73) Customers at the high end are labeled promoters,

because of their likelihood of loyalty and positive word-of-mouth promotion. The low end of the spectrum is the opposite of the promoter and labeled a detractor. By quantifying the value the customers have the company can then devise action plans to solve problems, or expatiate growth.

The results of the NPS uncovered to Immelt and GE that they had three customer groups: promoters, passives and defectors. Promoters, who scored a nine or 10 on the NPS, were similar to aides for GE’s sales force and have the highest repurchase rates with accounts for majority of the positive word-of-mouth advertising. The passives, dubbed “the passively satisfied,” scored GE a seven or eight and had repurchase and referral tendencies roughly 50% less than the promoters. Lastly defectors, scored GE six or lower, are the least likely to repurchase or refer and are responsible for 80% of the negative word-of-mouth.

Ultimately, the NPS of a company is a simple arithmetic problem – percentage of promoters minus the percentage of defectors – and this metric is in directly correlation to the company’s growth. The investigation led to further examining the promoters and defectors and attempt to quantify each groups’ value. Besides calculating the lifetime value – cash flow generated over the life of a customer – the article lists five distinguishable attributes of promoters and defectors. First is their retention rate where the lifetime value of a customer staying with a company.

Conversely, it is greatly dependent on the likelihood of them defecting to the competition. The margins attribute refers to each group’s price sensitivity and the examination of purchases made over a certain time. Annual spending is an attribute that can directly affect the lifetime value of a customer, accordingly, over time through their purchases. Cost efficiencies are directly attributed to each group’s satisfaction and are impacted by the company’s credit losses, which are higher with defectors than promoters.

Lastly, word-of-mouth is the amount of positive referrals made and can be numerically calculated through surveys, such as the NPS. There is a benefit for any company using NPS. The NPS group segmentation leads to three strategically sound areas: investing in your core (niche market) that attribute to the highest profitability outcome and high promoter score; act in constructive PR/damage control with those with high profitability but low promoter score and adding promoters by working on pursuing those would-be promoters in the passives group.

The apparent value of NPS is that it allows experimentation through trial and error. Companies need to be diligent and aware that the data produced from the NPS should be done regularly. This due diligence will lead to strategies and methods that will be used to contribute to the company’s growth and assist in investments aimed at improving customer experiences leading to bettering the bottom line.