Topic 11

Measuring Customer Loyalty

In This Chapter:

• Tooling up to measure loyalty

• Estimating future growth

• Measuring with the Net Promoter Score

• Assembling the key drivers of customer loyalty

Do you find yourself buying the same products over and over again? Do you have a

preferred airline? The last time you chose a new computer, did you ask a friend for a

recommendation? Consumer decisions are heavily based on prior experience and on the

experience of friends and colleagues. A once happy customer is likely to be a customer again and

to recommend a specific company to the people around him.

If a friend or family member helps you when in need, you are happy to reciprocate. You

may feel a sense of duty, a sense of loyalty to people who have been there for you. The emotions

that cement a customer’s relationship with a company are similar. If the computer you purchased

four years ago met or exceeded your expectations and customer service was outstanding, you’ll

purchase a similar model again. When a friend asks what computer you have, you’re happy to

recommend it. When you rent a car and the car is clean, the price is fair, and the pick-up and drop-
off experiences are easy and quick, you’re much more likely to use the same rental car company

in the future.

In this chapter, I help you understand the importance of customer loyalty and explain

common ways of measuring it. I also introduce methods for identifying what makes customers

more likely to recommend a company’s products or services.

Measuring Customer Loyalty

Understanding how to measure customer loyalty is an essential first step in predicting the

potential future growth or decline of a product, service, or company. The “best” metric for

measuring customer loyalty depends on the industry, company, and type of product or service.

Two that are applicable to most products and industries are the repurchase rate and the likelihood

to recommend.

Repurchase rate

Probably the first way to gauge customer loyalty is to compute the percentage of

customers who are repurchasing, reusing, or returning to a product or service. This data can be

collected from past sales or from surveying customers about their past or future intent. Data can

also be obtained from historical purchasing records, which are often captured in Customer

Relationship Management (CRM) systems.

Valuing Customer Loyalty

Measuring customer loyalty is one way of estimating how well a company or product is

positioned to grow or shrink. While not a perfect measure of actual future growth, there is some

evidence that positive measures of customer loyalty correlate strongly with increasing earnings.

For example, a 2013 survey of smartphone users by the Yankee group found that 91 percent of

iPhone owners indicated they will repurchase another iPhone.

Repurchase habits are measured differently, depending on the type of product

or service offered:

• For rental car companies, the repurchase rate is a good indicator of loyalty as certain

customer segments rent multiple times per year and have many companies to choose from.

• For car dealerships, a variation on the repurchase rate as a measure of loyalty is repeat

repair and maintenance visits.

• For software companies, a similar measure of repurchase loyalty is the maintenance

contract renewal rates.

A repurchasing matrix takes the repurchase rate and displays the relative rates for a set of

competitors or comparable products within the same company. To build one, compute the

percentage of customers who repurchase a product or a competitor’s product.

Table 12-1 is a repurchasing matrix for laptop computers using hypothetical

data:

• The first cell indicates that 68 percent of customers who bought a Lenovo computer ended

up buying a second one.

• The second cell indicates that 3 percent of the customers who first bought a Lenovo laptop

chose Dell the second time around.

The values on the diagonal (the large numbers where each brand’s column and row intersects) are

the repurchase rates. The values off each diagonal are the competitors to which the customers are

defecting.

Given that actual repurchase rates can take years to collect, especially for products that

aren’t purchased frequently, building a repurchasing matrix can take years. To speed up the

process and gauge your customers’ loyalty before they defect, you can ask their intent to

repurchase as well as their likelihood to refer a friend, which is the metric I discuss next.
Net Promoter Score

Word of mouth is a powerful and organic force that can’t easily be controlled like an advertising

campaign:

• On one hand, when customers continue to purchase and tell their friends about a positive

experience, word of mouth can spread as fast as the norovirus in winter through social

media and in-person conversations.

• However, ill will and customer defection spread like a virus, too, if customers have bad

experiences.

The Net Promoter Score (NPS) is a popular way of measuring customer loyalty through

understanding word-of-mouth marketing. It is based on a single question: “How likely are you to

recommend to a friend or colleague?” This type of question was found to be the best or secondbest

predictor of repeat purchases or referrals in 11 out of 14 industries. Net Promoter, NPS, and Net

Promoter Score are trademarks of Satmetrix Systems, Inc., Bain & Company, and Fred Reicheld.

Computing the NPS

One of the most appreciated aspects of the Net Promoter Score is how it’s presented as a

percentage, which is appealing to executives.

Follow these steps to calculate the Net Promoter Score:

1. Ask your customers how likely they are to recommend your product or

service to a friend or colleague.

Use an 11-point scale: 0 = Not at all likely and 10 = Extremely likely. Figure 12-1 shows

a layout example for this question.

Figure 12-1: The Net Promoter Score.

2. Compute the proportions of promoters, passives, and detractors.

Part of the research into building a Net Promoter Score is finding which numbers on the

scale map to customers who are more likely to say good things, more likely to say bad

things, or not say much of anything to friends about an experience.

They can be divided into three groups:

a. Promoters are customers who rate a 9 or 10 on the response scale.

These are the customers who were found to be most likely to speak favorably

and recommend your product or service based on the research by Bain and

Fred Reicheld. You want to have as many promoters as possible for your

product or service.

b. Passives are customers who rate a 7 or 8 on the response scale.

Passive customers are generally satisfied with their experience and are loyal.

However, they are less likely to recommend your product or service to

friends. The goal is to turn passives into promoters.

c. Detractors are customers who rate a 0 to 6 on the response scale.

These customers are not only the least loyal, but also the most likely to

actually discourage friends and colleagues from purchasing or using your

product. Some detractors can be turned into passives or promoters by

 identifying their dissatisfaction and fixing it. Some detractors, however, are

“lost” customers and no amount of product improvement will keep them.

Once you identify who the promoters, passives, and detractors are, convert them to percentages by

dividing the number in each category by the total number of customers who answered the

likelihood to recommend question. For example, if 100 customers answered the likelihood

to recommend question and 10 responded with numbers between 0 and 6, then 10 percent

of the sample are detractors.

3. Compute the NPS.

To compute the NPS, subtract the percentage of detractors from the percentage of

promoters.

For example, if 50 out of 100 customers responded with 9's or 10's, then 50% of the sample

are promoters. If 10 responded with numbers between 0 and 6, then 10% of the sample are

detractors. The Net Promoter Score for this sample of data is then 50% – 10% = 40%. The

NPS can range from –100% (all detractors) to 100% (indicating all promoters).

Combining qualitative and quantitative data

A powerful way of making qualitative, open-ended comments more actionable is to combine

them with a closed-ended rating scale response question, like the Net Promoter Score. In addition

to the open-ended reasons from the likelihood to recommend question, I often ask customers to

name what could be improved. This way, I collect suggestions, even from promoters who are
happy but still might have ideas to help improve the experience. An example is shown in Figure

12-3. A survey on an automotive website netted 110 open-ended comments from customers.

Customers were asked to name one thing they would improve on the website.

Figure 12-3: Associating the Net Promoter Score to open-ended comments helps prioritize what

to address.

Bad profits are a ticking time bomb. They lead to customer resentment and a decrease in

customer loyalty, and eventually impact profits negatively. Each company generates a certain

share of bad profits and it is useful to know how much it represents to re-orient the company’s

strategy. But how are bad profits effectively and objectively measured?

By combining Net Promoter Score data with customer-by-customer revenue data, you can

estimate the amount of revenue derived from bad profits. Even if you don’t have access to financial

data for your company or a competitor, you usually can estimate the percentage of revenue from

bad profits. For example, when my company measured customers of consumer software products
a couple years ago, we found that about 17 percent of Adobe Photoshop users were detractors.

Assuming that everyone pays around the same price for a Photoshop license, then around 17

percent of Adobe’s revenue from Photoshop comes from detractors.

If more than 10 percent of company or product revenue comes from detractors, there are two

things you can probably do:

• Stop selling to these customers. While that may seem crazy, in some cases, getting

rid of mismatched customers may better your reputation and increase your profits in the

long run.

• Find out the reasons these customers are spreading negative word of

mouth and attempt to fix it: Start by analyzing the comments of these detractors in

surveys to identify the low-hanging fruit. Next, conduct a key driver analysis using

multiple regression to understand what factors in their experience have the biggest effect

on customers’ likelihood to recommend.

Finding Key Drivers of Loyalty

One of the most effective ways to understand what drives customer loyalty is to conduct

a key driver analysis. A key driver analysis uses a statistical technique employing multiple

regression analysis. It tells you which features or aspects of a product or service have the largest

statistical impact on customer loyalty. It can be conducted for all customers but also for each of

your different customer segments (see Chapter 2 for more on finding customer segments).
Here are three steps to conducting a key driver analysis:

1. Obtain a baseline set of Net Promoter Scores (or whatever measure of

loyalty you use)H.

If you aren’t doing so already, survey your customers to get a current baseline of

how likely customers are to recommend the product to a friend. Ask the 11-point LTR

(short for “likely to recommend”) question about both the brand and the product. In fact,

you can extend the LTR question down to feature and functional areas if you have a lot of

functionalities. Include an open-ended question to ask what’s driving users to give the

ratings they gave. These surveys should be conducted monthly or quarterly or set up to

collect data in some systematic way. You can email customers, use a pop-up window on

the website, or use a third party to gain perspective. Ideally, use all three approaches —

they all provide different perceptions of the experience.

2. Conduct a multiple regression analysis.

With the NPS scores and items about features and the experience, you likely can

identify the pool of candidates who are driving word of mouth for better or worse.

To determine which are having the biggest impact, you can use a multivariate technique

called multiple regression analysis. It can determine statistically what aspects are having

the biggest impact on NPS and allow you to prioritize. More details on conducting a key

driver analysis are provided in the appendix.

 3. Identify the most popular or unpopular features or aspects of your

product or service and have customers rate that experience as well.

Figure 12-4: Output of a key driver analysis from a web-based software application.

By understanding both the value of positive word of mouth and the cost of negative word of mouth,

you can estimate the net value of word of mouth for a product or services for a group, or for all

customers.

Valuing positive word of mouth

While companies should strive to obtain as many promoters as possible, it’s often helpful

to understand how valuable a promoter is, both in terms of revenue and in how many new

customers a promoter brings to a company. With the lifetime value of a customer understood
 The best way to understand how much revenue a promoter generates is to tie actual sales

to survey responses to see how many promoters actually recommended someone, and how many

of those people who heard the recommendation actually became customers.

COMMON KEY DRIVERS OF CUSTOMER LOYALTY

What customers value in your company may vary widely. Results of NPS surveys across multiple

industries reveal that four main areas affect customer loyalty:

• Quality: Are you products and services of a high quality or are they unreliable and don’t

work as expected?

• Value: Customers don’t like to feel ripped off and like a bargain (some segments more

than others). The total cost and the price relative to what customers receive for their money

can generate a lot of detractors or promoters, especially for business-to-consumer products

and services.

• Utility: Do your products offer all the essential features your customers need and value?

A product doesn’t have to do everything, but it should do the right things for your

customers.

• Ease of Use: A product or website can have all the bells and whistles, but if it’s hard to

use, or an otherwise frustrating experience, the features might as well not work.
Here are six steps to estimate the value of a promoter from customer

survey data.

1. Positively Referred: Ask all customers in a survey if they recall actually referring

anyone to consider using a product or service in the past year. People have notoriously

inaccurate memories but this can give you a rough idea of a historic referral rate.

As shown in the upper-left corner of Figure 12-5, it was 61% from a sample of TurboTax

customers (2011 data).

Figure 12-5: The estimated value of a promoter from data collected on the tax preparation

software TurboTax.

2. Conversion Rate: Ask each customer if a friend or colleague referred him/her to the

product. Again, memories are faulty, but this gives you some idea about the percentage of

current customers who visited the website or purchased the product or service based on a

referral.
 For TurboTax, it was 42%.

3. Referral Impact: By multiplying the percentage that made a positive referral by the

percent of current customers who were referred, you have an idea about the number of

customers you get through each referral.

0.61 x 0.42 = 0.2562

Note: The slight difference from 25% shown in Figure 12-5 to 25.62% is due to rounding.

4. Referrals Needed: Because there aren’t quarters of people walking around, it helps to

get a whole number of customers you need to generate a referral.

Dividing 1 by the referral impact gets you the total number of referrals you

need to generate one new customer, like this:

1/0.25 = 4

5. Promoter Referral Rate: Keep in mind that despite the guidance that answers of 9's

and 10's are more likely to recommend a website or product, it doesn’t necessarily mean

all the respondents actually will recommend.

 While people’s ability to recall past behavior can be poor, their ability to predict future

behavior is even worse. To help account for that uncertainty, look at which promoters say

they referred someone else in the last year and use that as a proxy for those who are more

likely to refer someone in the future.

I also call this the Promoter Efficiency Rate.

For TurboTax, 81% of the sample of promoters said they referred someone else to the

product in the last year.

6. Promoters Needed: By dividing the Referral Impact Rate by the Promoter Referral

Rate, you get the number of promoters needed to gain a new customer.

This works out to be five new promoters needed to generate one new TurboTax customer.

With some estimate of the number of promoters you need to gain a new customer, you can then

weigh the cost of new programs, features, pricing, and promotions to determine if the benefit from

new customers outweighs the cost. For websites, a new “customer” might just be a new visitor or

subscriber, so the cost of gaining new promoters can be important.

Valuing negative word of mouth

While companies should strive for more promoters, it’s often the customers who are

least satisfied with their experience who have a much larger impact on referrals and the brand.
Research supports that customers who are dissatisfied with a product or service experience are

actually more likely to be vocal and tell more friends and colleagues about their bad experience

than generally satisfied customers. The negative effects of detractors can outweigh the positive

effects of promoters. You can estimate this negative effect by using a similar procedure for

estimating the value of promoters.

1. Negative Word of Mouth Rate: Ask all customers in a survey if they recall actually

discouraging anyone from using or purchasing the product. Convert this to a percentage.

For example, if 20 out of 100 people discouraged someone else from using the product, the

rate is 20%.

2. Number Discouraged: Ask customers to estimate approximately how many people

they discouraged from purchasing.

If you don’t have this information from customers, use the number 4 as a

placeholder. There’s some evidence that dissatisfied customers tell on average four friends

and colleagues about their poor experience.

3. Conversion Rate: Use the same conversion rate used in estimating the value of a

promoter. This is calculated as the percent of respondents (from a survey) that were

referred to a product by a friend or colleague.

In the TurboTax example, it is 42%.

4. Cost of Discouragement: Multiply these values to compute the cost of a

discouragement:

o Negative word of mouth rate

o Number discouraged o

Conversion rate

For this example, the negative word of mouth rate (20%), the number discouraged (4), and

the conversion rate (.42) work out to be 34%.

You can divide 1 by this number to get the number of discouragements that

result in one lost customer. In this case, it’s 3.

5. Detractor Discouragement Rate: Not all detractors will discourage customers

from using a company’s product, especially those detractors who score higher, such as 5's

and 6's on the LTR question. Find the percentage of detractors who also negatively referred

to friends from the survey data.

Use as an example that roughly 50% of detractors actually discouraged others. Divide 3 by

50%, and you get 6. That means for every six detractors, on average one customer is lost.

The calculations are shown in Figure 12-6.

Figure 12-6: Calculate the detractor discouragement rate.