December 1998 Ref : 1998-330-0018

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Customer loyalty, a literature review & analysis

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Marketing Strategies & Consumer Policy Working Group

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As of 1st January 1998, UNIPEDE and EURELECTRIC have formed a Joint Secretariat situated in Brussels. UNIPEDE and EURELECTRIC are organisations with a separate identity, co-operating closely to provide effective and coherent assistance to their Members, in order to ensure and develop the Industry's competitiveness and in order to offer and develop competitive and environmentally sound products, in the interest of its customers. In doing so, UNIPEDE and EURELECTRIC will pay due respect to the specific missions and responsibilities of other international organisations of the European Electricity Supply Industry. UNIPEDE is the association of the European Electricity Supply Industry and of world wide affiliates and associates that operates as a centre of strategic expertise and that acts as a liaison with other international associations and organisations with the aim to identify and respect the common interests of its Members and to assist the Members in deciding on the solutions to be implemented and in co-ordinating and carrying out the necessary action. EURELECTRIC is the association of the European Union Electricity Supply Industry representing it in public affairs, in particular in relation to the EU institutions, in order to promote its interests at the political level. The reports published by UNIPEDE are the result of the work of its structure of expertise: they represent one of the most direct methods of circulating knowledge and information throughout the sector, on subjects of common interest. They are intended for wide circulation both within the electricity supply industry and outside it. Please do not hesitate to ask for the latest available printed UNIPEDE/EURELECTRIC publications catalogue (with currently about 200 summaries of UNIPEDE reports) from:

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You can also use the UNIPEDE/EURELECTRIC Internet Web site, which provides the following information: UNIPEDE/EURELECTRIC general information Publications Catalogue Events & Conferences UNIPEDE/EURELECTRIC Statements Statistics

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Customer loyalty, a literature review & analysis

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Working Group Marketing Strategies & Consumer Policy

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Paper prepared by:

Jacques Rossat (CH), Jan Larsen (NO), Drahomir Ruta (CZ), Manfred Wawrzynosek (PL)

Copyright UNIPEDE, 1999 All rights reserved Printed at UNIPEDE, Brussels (Belgium)

EXECUTIVE SUMMARY

This report on Customer Loyalty comprises of a first part devoted to a theoretical approach of customer loyalty and a second part focusing on the electricity sector. Customer satisfaction is not customer loyalty warns this report so as to highlight the rather complex, -not to say elusive-, nature of customer loyalty. If a loyal customer is no doubt a satisfied customer, this does not entail that a satisfied customer is loyal. In fact, a satisfied customer remains very likely to switch to other competitor products. s One of the main insights provided by this report is to point out that the loyalty question does not just consist in looking at the customer in relation to products / services on offer, but implies a whole virtuous management of the company, the employees and the investors. Though underlining the difficulty to define loyalty, the report analyses in practice how profitable loyal customers are, and how important it is to retain them, namely through zero defection schemes or by carrying out studies on defections and complaints. In other words, customer loyalty creates value and anything that might undermine it should be identified and eliminated. With regard to the electricity sector, the authors of the report endeavour to establish what are the needs and wants of the electricity customers. In doing so, they also emphasise that electricity companies need to improve their understanding of their customers. In a liberalised electricity market, a database storing customers names, addresses and electricity demand is no longer sufficient. Special attention should be paid to the subjective component of the customer, his emotional reactions and feelings. It emerges from market research studies that price is the main driven criteria of customer needs and wants but it would be hasardous to only take into account this s aspect. It clearly arises from a number of studies that customers are very sensible to the quality of services (reliability, simplicity, guarantees, etc). Therefore, it is worthwhile for marketers to explore the range of services that can be developed in view to meet customer needs. s The report also examines the propensity to switch in fully liberalised electricity markets, in particular in the UK and in Norway. The propensity may appear rather low in the first years following the opening as a result of a wait and see syndrome. It might also be limited due to the hassle caused by switching. In the UK, it seems that the percentage of customers that are switching is now fixed at a steady 25-30 % rate. Finally, the report addresses the incentive issue that can be successfully used to attract customers, such as cash back incentives, price reductions, tariff options, payment options and dual or combined packages of fuel and electricity services.

Part I: Brief Survey of Current Trends and Theories

Customer Loyalty, a literature review and analysis

Working Group Marketing Strategies & Consumer Policy

CONTENTS

Part 1: Brief Survey of Current Trends and Theories 1. 2. Introduction ____________________________________________________ 2 Definitions _____________________________________________________ 2
2.1. Loyalty ________________________________ ________________________________ ___ 2 2.2. Customer loyalty ________________________________ ___________________________ 2 2.3. Customer satisfaction ________________________________ _______________________ 3 2.4. Satisfaction-Loyalty link ________________________________ ____________________ 4

3. 4. 5.

Loyalty model __________________________________________________ 4 Consequences of customers loyalty________________________________ 6 Toward "zero defections" ________________________________________ 7
5.1. Target the "right" customers ________________________________ ________________ 8 5.2. Analysis of defections and complains ________________________________ __________ 9 5.3. Defection costs ________________________________ ____________________________ 10

6. 7.

Measure of loyalty______________________________________________ 10 Conclusion ___________________________________________________ 11

STATISTICS____________________________________________________________ 13 BIBLIOGRAPHY _________________________________________________________ 14 Part II: Customer Loyalty in the Electricity Supply Industry 1. 2. 3. 4. 5. Introduction ___________________________________________________ 15 Needs and wants ______________________________________________ 15 Propensity to switch____________________________________________ 17 Reasons for switching __________________________________________ 20 Barriers / Incentives ____________________________________________ 21
5.1. Barriers ________________________________ ________________________________ _ 21 5.2. Incentives ________________________________ ________________________________ 22

6.

Conclusion ___________________________________________________ 24

BIBLIOGRAPHY _________________________________________________________ 26

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Part I: Brief Survey of Current Trends and Theories

Part 1: Brief Survey of Current Trends and Theories

1. Introduction
Loyalty is dead, the experts proclaim, and the statistics seem to bear them out. On average, the U.S. corporations now lose half their customers in five years, half their employees in four, and half their investors in less than one (Reichheld, 1996). No, loyalty is not dead; it remains a dominant key of success. In fact, the corporate leaders in loyalty that apply a strategic loyalty-based management have enduring records of productivity, solid profits and steady expansion. More than a limited customer approach, the loyalty effect should be viewed as a wide context in which all the key players of a firm are far more powerful, further reaching, and more interdependent than we have ever imagined. There would be no customer loyalty without loyal employees as there would be no loyal employees without long term investors. We will later focus on the customer side, but the employees and the investors problematic should be kept in mind during the entire process. We will also, now and then, show the implications of such a three dimensional environment in which creating value for customers has become a strategic issue. The advantages of loyalty are numerous, but the implementation of such a culture does not go without posing problems. What should be done, who should be responsible for these changes, who should be targeted, and how should these changes be conducted are some of the questions we will try to answer in this compilation of some classical theories of the day (1998).

2. Definitions
2.1. Loyalty Reichheld opposes loyalty to the actual profit-theory. This theory gathers the firm's resources toward one unique goal: creation of profit. Reichheld views loyalty as a value-creation theory. The fundamental mission of a business is oriented toward the creation of value for the customer and profit becomes a consequence of value creation. It turns out to be a mean rather than an end. This theory will be developed in the loyalty model described in chapter 3. 2.2. Customer loyalty Customer loyalty is not always easy to construe and many definitions have been proposed. Let's first settle what customer loyalty is not (Prus & Randall, 1995): Customer loyalty is not customer satisfaction. Satisfaction is a necessary but not sufficient criterion. We know that "very satisfied" to "satisfied" customers sometimes switch to competitors.

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Customer loyalty is not a response to trial offers or incentives. Customers who react to incentives are often highly disloyal and they often leave as fast as they came. They are very much inclined to respond to a competitor's incentive. Customer loyalty is not a strong market share. High level of market share can also be influenced by other factors such as poor performance by competitors or price issues. Customer loyalty is not repeat buying or habitual buying. Some of your consumers choose your products because of convenience or habits and they can be tempted to defect for any reason. Prus & Randall then describe customer loyalty as follows: "Customer loyalty is a composite of a number of qualities. It is driven by customer satisfaction, yet it also involves a commitment on the part of the customer to make a sustained investment in an ongoing relationship with a brand or company. Finally, customer loyalty is reflected by a combination of attitudes (intention to buy again and/or buy additional products or services from the same company, willingness to recommend the company to others, commitment to the company demonstrated by a resistance to switching to a competitor) and behaviors (repeat purchasing, purchasing more and different products or services from the same company, recommending the company to others)". 2.3. Customer satisfaction Satisfaction is often confused with loyalty. Satisfaction is an emotional or feeling reaction (Westbrook, Newman, Taylor, 1978). It is the result of a complex process that requires understanding the psychology of customers. The range of emotion is wide with, for example, contentment, surprise, pleasure, or relief. Satisfaction is influenced, in the end, by expectations and the gap between perceived quality and expected quality, called "expectancy disconfirmation". The figure below shows the predominant linkage of this process.

Expectations

"Objective" Quality

Perceived Quality

Disconfirmation

Future Expectations

Satisfaction

Source: Rust, Zahorik, Keiningham, 1996

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2.4. Satisfaction-Loyalty link High-quality products and associated services designed to meet customer needs will create customer satisfaction. This high level of satisfaction will produce increased customer loyalty. According to conventional wisdom, we would be tempted to believe that the link between satisfaction and loyalty is a simple, linear relation. But reality proves us wrong: it is neither linear nor simple (see figure "The effect of satisfaction" below). The relation reacts differently according to time and circumstances. Unless they are totally satisfied, there is always a chance you will see your customers be lured away (Jones & Sasser Jr., 1995).

Impact

Dissatisfie d Satisfaction scale

Delighted

Source: Rust, Zahorik, Keiningham, 1996

3. Loyalty model
Most present-day strategic plans focus on a profit target and work backward to arrive at required revenue growth and cost reduction. Time spent on studying loyalty leaders has convinced Reichheld to develop a totally different model (see loyalty model below). The decisive key in this model is not profit but, instead, the creation of value for the customers. The three forces - customers, employees, and investors - that play an important role in the enterprise form the forces of loyalty. Since a linkage between loyalty, value, and profits exists, these forces can be measured in terms of cash flow. "Loyalty is inextricably linked to the creation of value both as a cause and an effect." (Reichhled, 1996) As an effect, loyalty measures permanently whether or not the company has delivered superior value. Defects can doubtlessly be explained by a lack of value for the customer. As a cause, loyalty creates a chain reaction. Reichheld describes it as follow: Revenues and market share grow as the best customers are swept into the company's business, building repeat sales and referrals. Because the firm's value proposition is strong, it can afford to be more selective in new customer acquisition and to concentrate

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its investment on the most profitable and potentially loyal prospects, further simulating sustainable growth. Sustainable growth enables the firm to attract and retain the best employees. Consistent delivery of superior value to customers increases employee's loyalty by giving them pride and satisfaction in their work. Furthermore, as long-term employees get to know their long-term customers, they learn how to deliver still more value, which further reinforces both customer and employee loyalty. Long-term employees learn on the job how to reduce costs and improve quality, which further enriches the customer value proposition and generates superior productivity. The company can then use this productivity surplus to fund superior compensation and better tools and training, which further reinforce employee productivity, compensation growth, and loyalty. Spiraling productivity coupled with the increased efficiency of dealing with loyal customers generates the kind of cost advantage that is very difficult for competitors to match. Sustainable cost advantage coupled with steady growth in the number of loyal customers generates the kind of profits that are very appealing to investors, which makes it easier for the firm to attract and retain the right investors. Loyal investors behave like partners. They stabilize the system, lower the cost of capital, and ensure that appropriate cash is put back into the business to fund investments that will increase the company's value-creation potential.

The Right Customers

Surplus Cash Reinvested Customer Loyalty

Superior Customer Value

Investor Loyalty

Growth

The Right New Employees

The Right New Investors

Compensation Advantage

Profits

Employee Loyalty

Cost Advantage

Superior Productivity

Source: Reichheld, 1996

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To sum up, this model demonstrates that a company willing to follow a loyalty-based management should concentrate its resources in order to offer a superior value.

4. Consequences of customers loyalty

Businesses with high customers' loyalty rates have proven to reach great financial results. Buchanan & Gillies identified six reasons explaining why long-term customers are more profitable than others are: Regular customers place frequent, consistent orders and, therefore, usually cost less to serve. Long-established customers tend to buy more. Satisfied customers may sometimes pay premium prices Retaining customers makes it difficult for the competitors to enter a market or increase their share. Satisfied customers often refer new customers to the supplier at virtually no cost. The cost of acquiring and serving new customers can be substantial. A higher retention rate implies that fewer new customers need be acquired, and that they can be acquired more cheaply. In fact, the acquisition cost of a new customer is three to five times more expensive than retention cost. We could also add that a loyal customer is more willing to give feedback on his dissatisfaction and becomes this way a sort of quality controller. Finally, loyalty is an excellent weapon, since it is almost impossible to measure a competitor's retention rate. All these explanations become evident on the figure below. The same ascertaining can be demonstrated for the employee or investor's point of view.

60

50

An nu al Cu st o m er Pr ofi t

40

30

20

Price premium Referrals Cost savings Revenue growth Base profit Acquistion cost

10

-10 0 1 2 3 Year 4 5 6 7

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5. Toward "zero defections"

Any way, loyalty has to become a strategy and should be applied to customers, employees, and investors. Because of the interconnection of these key players, it is not possible to operate on only one. For example it would be a non-sense to concentrate on customer loyalty if employees were not formed to do so, or if the investors reacted only to short term profits. It has to be considered as an indivisible system. We have now seen the numerous advantages of having loyal customers. In fact, the process of acquiring new customers and retaining the old one can be illustrated by the image of a bucket of water (see the figure below).

Customers that leave the market

New to market customers

Customers that switched to us form competitors

Market share

Customers that switch to the competition

Source: Rust, Zahorik, Keiningham, 1996

This scheme is quite easy to understand. A hole in the bucket causes a loss of water. The same happens with customers. In order to keep at least the same level of activity, we now have to compensate by attracting new customers, or customers who are currently linked to a competitor. There are two ways of reacting if you ascertain a leak. The first one would be to find more customers coming in than those going out. The second tactic consists in plugging the leakage. It's exactly what a zero-defection program aims. But zero-defection does not mean there will be no further loss of customers. The objective is to target the good customers and retain them.

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5.1. Target the "right" customers Before retaining all the customers at any price, it is very important to identify your core customers. There are three easy questions you can ask yourself (Reichhheld, 1996). First, who are your more profitable and loyal customers? You will look for those who spend more, pay promptly, require less service, and prefer stable, long-term relationship. Second, which customers place the greatest value on what you offer? Those for whom the product fits best to their needs. Third, which of your customers are worth more to you than your competitors? The more customers fitting one, two, or three of these groups you attract, and the more you increase the chances to have loyal customers. All customers are not good to keep. That's why it is critical to know the characteristics of the customers you target. Jones and Sasser have identified four different ways consumers behave. A resume is proposed in the frame below.

The Loyalist and Apostle. In most cases, the loyalist is a happy customer who has had good experiences with the company and who is ready to return on a regular basis. This customer has a need and the company provides exactly the product or service that fits him. It explains why this customer is so easy to serve. Even more enthusiastic than loyalists, the apostle is so overwhelmed, his experience brings him so much more satisfaction than he expected, that he share his strong feelings with others. The Defector and the Terrorist. Defectors' ranks include very dissatisfied, quite dissatisfied, neutral, or even satisfied customers. The number of merely dissatisfied customers or satisfied customers who have encountered failures and defect can be quite impressive. It would be a huge error to let them go since the company has the tools to turn them into highly satisfied customers. The worst defector a company can dream of is called the terrorist. This customer has endured a bad experience and he cannot wait to communicate his frustration and anger to others. These people are angry because no one was there to respond, listen or correct the failure they encountered. The Mercenary. This is a kind of customers having no rule and reacting in unpredictable ways. Even if they are highly satisfied, they will show almost no loyalty. "These customers are often very expensive to acquire and quick to depart. They chase low prices, buy on impulse, pursue fashion trends, or seek change for the sake of a change" (Jones & Sasser, 1995). The Hostage. These customers have endured the worst the company has to offer and still have to accept it. These individuals are stuck in a monopolistic environment. From there, Jones & Sasser enact what should be every company's ultimate objective: "Turning as many customers as possible into the most valuable type of loyalist, the apostle, and eliminating the most dangerous type of defector or hostage, the terrorist". Individual Customer Satisfaction, Loyalty, and Behavior
Satisfaction Loyalist/Apostl Defector/Terroris e t Mercenar y Hostage high low to high medium low to medium Loyalt y high low to low to medium high medium Behavior staying and supportivehaving left and leaving or coming and going; low unhappy commitment unable to switch; trapped

Source: Jones & Sasser, 1995

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5.2. Analysis of defections and complains "Any defection is the result of a lack of value". (Reichheld, 1996) The defection analysis has a double purpose. First and before anything, it is a very convenient and reliable indicator of customer loyalty. Customer loyalty is often calculated in terms of satisfaction, repurchase, but none of these rates give the results retention rate has. Second, by creating a data base on the reasons expressed by your customers for leaving, you give your company the means to correct the mistakes done while processing with customers. The reasons a customer invokes could lead other customers to defect too. View it a warning signal and take advantage of it. One way to collect this information is to listen to the customer and analyze his complains. Most of the time, listening, showing you care, and find a way to repair the damages can transform a rather unsatisfied customer into a loyal one. But paying attention to complain is not enough. You should now that "only 4 % of customers complain. This means that a company will probably never hear about 96 % of her clients, and from the 91 % of them who will defect because they think it would be of no use to complain". (Gerson, 1995) This gives us a good justification to conduct interviews with defectors.

You are maybe one of many skeptical who thinks most of the defections are natural and cannot be controlled by a company. You will be surprised to see what has been found by Gerson. Your customers stop buying your products because: 1 % die 3 % move 5 % look for replacement solutions or develop other relationships 9 % go directly to your competitors 14 % are not satisfied with the product or the service 68 % are displeased with the way they have been treated. If you look closely at these numbers, you will find out that you can indeed overcome 96 % of the reasons why a customer stop buying your products or services. De Souza, on her side, has identified 6 types of defectors: Price defectors. They switch to a lower price. Product defectors. They switch to superior product. Service defectors. They switch because of poor service. Market defectors. These customers are lost but not to a competitor since they leave the market. Technological defectors. They switch to convert to a product offered by companies outside the industry. Organizational defectors. These customers are lost because of internal or external political considerations.

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5.3. Defection costs No existing accountable system can measure the costs of a customer defection. Of course, a loss has to be compensated by the acquisition of a new customer. We know these costs can be very expensive (advertising, promotion, recruitment, establishment of a personal file, etc.). But companies often forget to consider the potential profit a loyal customer represents. When he leaves, he takes everything with him. During the time a relation lasts, the customer spends more each year and the costs of processing diminish in regards of experience and volume. Nevertheless, the company will not benefit of the free advertising and recommendation a loyal customer can make. The figure below illustrates the case of a credit card company that has a return rate of 2 or 3 % for direct marketing. This company sends 30 to 50 thousands letters in order to record 1000 adhesions. This figure also shows that the company will not make any profit if it does not keep its customers for at least two years

87 79 72 66

40

-80

Age of account (years)

Source: Reichheld, 1996

6. Measure of loyalty
"Measurement turns vision into strategy and strategy into facts" (Reichheld, 1996). Measure is a necessity in every system, it allows the company to identify its weaknesses and control it has reached its objectives. Measure also establishes the feedback loops, which are essential for any organizational learning. This task is not easy. How can we measure what drives customer value? First it is important to understand the cause-and-effect relationships between loyalty and value creation (see model at page 4). The mission that consists in delivering superior value can be measured by customer loyalty, best expressed by retention rate, share of purchases, or both. Indirect effect can also be stated with indicators such as revenue growth (increases as a result of repeated purchases and referrals), costs (declines as a lower acquisition expenses and from efficiencies
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of serving experienced customers), employee retention (increases because job pride and satisfaction increase, creating a loop that reinforces customer loyalty and reduces costs of hiring and training and productivity rises). We could also be tempted to measure a third order effect, that is profit (increases as costs go down and revenues augment). Reichheld suggests building a reporting system that will focus on a couple of factors and would send a warning signal when the indicator leaves a certain range. It would be composed of two basic reports for each of the three sectors (customers, employees, and investors), analogous to balance sheet and income statement in financial accounting, but more centered on human capital. In this system, all the data converge toward one main focus, Net Present Value (NPV). This system offers the advantage to measure all three factors: customer duration, lifecycle cash flow, and new-customer gain rate (see figure above).

Level 1

Customer-base Net Profit Value

Level 2

Customer duration

Lifecycle profits

New-customer Gain rate

Level 3 Investment

Volume Cost

Price Referral

Level 4 Value drivers

New customer Quality (yield rate)

Source: Reichheld, 1996

7. Conclusion
As a conclusion, we could imagine a wise Chinese man discharging some of his favorite proverbs on customer loyalty. His sentences would be close to these: a business should serve its customers. People are your most important asset. Choose your associates carefully and be sure you share the same important values. Learn the lesson of each and every one of your mistakes. You can manage only what you measure. Treat the others as you would like to be treated. Profit is not everything. Even if these clichs are known by all, it is worth repeating them one more time. They seem obvious but surprisingly, they seem to be forgotten with increasing frequency as companies look for short-term profits (Reichheld, 1996). Loyalty leaders have found the way to put it in practice and with their zero-defection program they now climb the hill for consistent superiority. Loyalty is not a strategy decided by the marketing department, loyalty is a commitment, a culture made by the entire company,
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focusing on the creation of superior value. By developing a loyalty-based management, these leaders have entered in the ascending spiral of profit, growth, and lasting value.

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STATISTICS
For each complains your company receives, there are 26 other customers with unknown complains or non-solved problems and 6 of them have serious problems. They are people you will probably never hear about. But they are also people who can tell you how to improve your business. (Gerson, 1995) Most of the customers who complain (54 to 70 %) will do business with you again if you solve their problem. If they feel you react quickly and to their satisfaction, 95 % of them will do business with you and there is a great deal of chances they will talk about you in a positive way around them. (Gerson, 1995) One unsatisfied customer will communicate his feelings to approximately 10 persons around him. These 10 persons will then talk to another 5 people. (Gerson, 1995) Happy customers, for whom you have found a solution to their complains, will talk to 3 to 5 people about their positive experience. (Gerson, 1995) You will need 5 to 6 times more time to acquire a new customer than to retain old ones. Customer loyalty and his long life value can be 10 times greater than the price paid for a single purchase. (Gerson, 1995) In most business, 60-80 % of customer defectors said they were 'satisfied' or 'very satisfied' on the last satisfaction survey prior to their defection! In the interim, anything can happen, and often does. (Reichheld, 1993) It has been found that a decrease of 5 % in defection rates can increase profits by 25 to 100 %. (Reichheld, 1993) Disloyalty at current rates stunts corporate performance by 25 to 50 %, sometimes more. (Reichheld, 1996) Success is Getting the Right Customers and keeping them (Cawley Charlie, founder of MBNA1) Unless you have 100 % customers satisfaction and I don't mean that they are just satisfied, I mean that they are excited about what your are doing you have to improve. And if you have 100 % customer satisfaction, you have to make sure that you listen just in case they change so you can change with them. (Jones & Sasser Jr., 1995)

Maryland National Bank

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BIBLIOGRAPHY
BARSKY JONATHAN, "Guarantee; Warranty; Loyalty", Marketing Tools Magazine, September 1995 CSR, "Loyal customers- Fact or fiction?", Customer Service Review, 1996 FORNELL CLAES, JOHNSON MICHAEL D., ANDERSON EUGENE W., CHA JAESUNG, & EVERITT BRYANT BARBARA, "The American customer satisfaction index: nature, purpose, and findings", Journal of Marketing, Vol. 60 (October 1996), pp. 7-18 GERSON RICHARD, "Fidlisez vie vos clients", Les Presses du Management, Paris, 1995 HARVARD L'EPANSION, "Fidliser le client", Groupe Expansion Magazines, Paris, 1991 HENNARD DANIELLE, " Comment fidliser vos clients", Bilan, 2/98, pp. 70-74 JONES THOMAS O. AND SASSER EARL W. JR., "Why satisfied customers defect", Harvard Business Review, November-December 1995, pp. 88-99 KEAVENEY SUSAN M., "Customer switching behavior in service industries: An exploratory study", Journal of Marketing, Vol. 59 (April 1995), pp. 71-82 LOWENSTEIN MICHAEL W., "Keep them coming back", Marketing Tools Magazine, May 1996 NAUMANN EARL, "Creating customer value", Thomson Executive Press, Cincinnati, 1995 O'BRIEN LOUISE AND JONE CHARLES, "Do rewards really create loyalty?", Harvard Business Review, May-June 1995, pp. 75-82 PAYNE ADRIAN, CHRISTOPHER MARTIN, CLARK MOIRA, PECK HELEN, "Relationship marketing for competitive advantage. Winning and keeping customers", Butterworth Heinemann, Oxford, 1998 PINE II JOSEPH B., DON PEPPERS, AND ROGERS MARTHA, "Do you want to keep your customers forever?", Harvard Business Review, March-April 1995, pp. 103-114 PRUDEN DOUGLAS, VAVRA TERRY G., SANKAR RAVI, "Customer loyalty: the competitive edge beyond satisfaction", Quirks Marketing Research, April 1996 PRUS AMANDA AND BRANDT RANDALL D., "Understanding your customers", Marketing Tools Magazine, July-August 1995 REESE SHELLY, "Happiness isn't everything", Marketing Tools Magazine, May 1996 REICHHELD FREDERICK F., "Learning from customer defection", Harvard Business Review, March-April 1996, pp. 56-69 REICHHELD FREDERICK F., "The loyalty effect. The hidden force behind growth, profits, and lasting value.", Harvard Business School Press, Boston 1996 REICHHELD FREDERICK F., "Loyalty-based management", Harvard Business Review, March-April 1993, pp. 64-73 ROMAN ERNAN, "Customer for life", Marketing Tools Magazine, July-August 1996 RUST ROLAND T., ZAHORIK ANTHONY J., KEININGHAM THIMOTHY L., "Return on quality", IRWIN Professional Publishing, Chicago, 1994 WESTBROOK ROBERT A., NEWMAN JOSEPH W., TAYLOR JAMES R., "Satisfaction/Dissatisfaction in the purchase decision process", Journal of Marketing 42 (October), pp. 54-60

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Part II: Customer Loyalty in the Electricity Supply Industry

Part II: Customer Loyalty in the Electricity Supply Industry

1. Introduction
The aim of this paper is to review and to extract the teachings of open electricity and gas markets experiences in the field of customer loyalty. At this writing (autumn 1998), a few countries such as England and Norway have passed through all the different stages and changes that will become unavoidable for most other developed countries in a very near future. As we assumed, customer loyalty is very often in the middle of the preoccupations of the industry since competition gives numerous opportunities to newly freed customers. It is thus particularly interesting to compare the similarities and differences that may exist between theoretical knowledge and reality. In the UK, the first customers to access the opening electricity market in 1990 were the largest industrial users who had installed power of 1 MW and over. This first step concerned about 5000 sites. Later in 1994, customers with a demand of 100 kW and over (about 52'000 sites) were also offered the chance to choose their electricity provider. The final phase of liberalization took place in 1998, giving supplier's choice to 1.5 million businesses and 24 million households. In Norway, "deregulation" gave household customers complete access to the market in 1995. All the remaining obstacles such as supplier switching fee were finally removed in the beginning of 1998. Please note that the observations being exposed in this document have to be taken with a lot of circumspection and are by no mean a prediction of what will happen in other countries. The very competitive nature of first hand information about customer loyalty makes access to this information difficult to those outside of the circle of the studies' owners. Therefore, even if it gives a valuable background, this small number of information available does not allow any broad-based generalization. This report focusses on customer loyalty of household customers. Obviously, customer loyalty of small, medium and large size customers has to be analysed differently, as also the needs of these customers are different from those of domestic ones. In contrast to almost all other industries, the technical quality of the product "electricity" does not have an influence on domestic customer choice. This choice is therefore based on other factors that will be outlined below.

2. Needs and wants

The first topic that should be explored in a customer loyalty's perspective is customers' needs and wants. This may seem evident but which company in the industry can truly state it possesses this information? Knowing what customers' expectations are and who these customers really are is the basis of the choice of any strategic option. Even if electrical companies have the advantage to know every single customer by her/his name, it looks like they often don't know anything more. The databases used by most of electricity companies
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still in monopolistic environment can be summarized to name, address, electricity demand, the kind and age of the meter, the date of the contracts, the tariff, the amount of the last bill, the bank details, etc. Yet often nothing about real needs and wants of the players who will dictate the market. This is perhaps due to the fact that building such a base requires time, sophisticated IT equipment and experience. However, this lack of customers' knowledge seems to be also found in some companies operating on an open market. How can therefore a company create value for its customers? Offering a product without taking into accounts what customers want is a bet nobody can take anymore. The "electrically correct" common wisdom on the "real" needs of consumers in an open market is that these consumers want a good price first, then a good price and, finally, a good price. This saying carries a lot of truth. Two hours spent with the salesman of a Norwegian utility, working his phone with potential customers is the best confirmation of this wisdom. Is this corroborated by available researches and studies? On the UK gas market, a research (Lias, 1997) concluded that customers needed familiarity, security, value for money, good customer service but more precisely a range of services, new products, and attractive brands. Another research2 illustrates the fact that large customers are more sensible to reliability than to price, as presented in the graph below. The problem faced by the supplier is the difficulty to communicate this reliability and turn it into a decisive strategic advantage. All competitors will claim they are reliable but it is extremely hard for customers to compare unless some kind of guarantee is proposed. Offering a guarantee is an approach commonly used with products but it also applicable to services. In fact, it can be a strong competitive advantage. The implications are numerous. It builds trust and loyalty, reassure skeptical customers, gives a warning signal in case of problem within the organization, shows you care about your clients, forces your company to give a perfect service and help to identify weaknesses. We could add to the list, but the result would be to emphasize on value creation for the customers. This value is worth paying attention to a few simple rules that assure the success of this strategy. Subjects like responsive emergency repair, uninterruptible power or protection against spikes, ranked as important by customers would suit perfectly to a guarantee clause. The next ascertaining we can bring to light at the reading of the figures below concerns the advantage established suppliers have on new comers. It shows the importance accorded to the track record and industry experience. Of course, the impact can be negative for suppliers who neglected their customers before the opening. Yvan Laroche, in his report3 at the recent UNIPEDE Lisbon convention identifies the basic demands. First, comes price (more or less important depending on the segment) and then follow: quality, simplicity, flexibility, choice, and quite often ecological preoccupations. But in our opinion, none of these results is fully satisfactory. The data collected do not go deep enough in the reasoning process of customers. In addition, most of the time, customers' characteristics and segmentation are not taken into accounts. This lack of data is responsible
2

DIAMOND M.S. (BOOZALLEN & HAMILTON), "Large customers. A misunderstood market opportunity", Lisbon: Conference on Customers & Markets, session 2, 1998
3

LAROCHE YVAN, "Nouvelles opportunits de dveloppement 5-10 ans", Lisbon: Conference on Customers & Markets, session 4, 1998
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for making difficult the building of marketing strategies. A great deal of efforts should be directed toward creating databases that could be used to add value for customers.

7 6.27 6 5.26 5 4 3 2 1 0 Re sp on siv e e m er ge nc y re pai El ect ric su ppl ier wit h a tra ck re co rd El ect ric su ppl ier wit h ind ust ry ex pe rie nc e Lo we st po ssi ble pri ce / k W h Re gul ar sal es re pai r co ntr act On e su ppl ier for en er se gy rvi co ce ms m odi tie s an d On e su ppl ier for ga s an d ele ctri cit y 5.17 4.99 4.88 4.42 4.41 4.12 4.12 3.86 6.13 6.06 5.97

3.76

3.73

3.73

3.54

Un int err up tibl e po we r

Pr ot ect ion ag ain st spi ke s

Cu sto mi ze d co ntr act s

Fix ed pri ce co ntr act s

Be nc h m ar k inf or m ati

Ri sk m an ag e m en t to

On e re gio nal su ppl ier

Bill co ns oli da tio n

E DT for pa yin g bill s

On e na tio nal su ppl ier

Source: Survey (Diamond, 1998)

3. Propensity to switch
We know the opening of electricity market creates a leakage in companies' reservoir of customers. We will now examine how big this hole is, how many customers are tempted to leave, how many actually put their threats into acts, and what is the rhythm of this defection. Defection is often compensated by acquiring new customers, but at what cost! In Norway, the 2 million household customers have the right to choose their supplier since 1995. Numbers for 1997 show that this trend is now slowly taking off; the figures for 1998 confirm an acceleration of the process. It corresponds to the time needed for those who adopted a wait and see method to gently consider switching. The second factor of influence is undoubtedly the recent free of charge switching policy. In April 1997, 4200 changes were recorded; this figure was of 7100 in July. The total number of customers with a different electricity supplier than the dominant provider reached 13'900 in July, of which 81 % had changed in the last two quarters. In January 1998, around 89'000 customers switched. Reported in percentage of the total of households, these numbers still look rather meagre since they represent 1,75 % of the total population of household customers. However, the acceleration pace is impressive. Companies offer simplified switching formulas on which the

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customer only has to write down the date, the numbers indicated on his meter, choose a new contract and sign. The company will then take care of the rest. The Norwegian market is quite complex as it is divided into approximately 200 sub-markets. The figures show that 20 % of customers live in areas where the market share for the dominant electricity supplier is below 99 % and 10 % live in an area in which no one has changed supplier. These figures prove that the traditional supplier still holds a dominant position and that customers' switching has not really started yet. In the UK, figures (Electricity Association) for industrial market (100kW) show that over a third of customers has changed supplier since April 1994. Answering the survey, 7 % of households have said they were "very likely" to "likely" to switch supplier and 31 % remained undecided. This would give us a maximum of 40 % potential switchers. However, the experience lived in the gas industry seem to suggest a far lower potential, probably around 25 %. Another research conducted in 1998 on "Customer attitudes in the UK domestic electricity market" (MarketLine International, 1998) gives us more details. These figures are expressed in the table below. We see that 16.6 % of household customers declare they will switch before the end of the first year of liberalization. 24.3 % are not sure or did not know this opportunity was offered. Finally, 59 % claim they will not switch. Again, the overall maximum switching prognoses is estimated around 25-30 %. But these numbers are not static; the market, or more precisely the difference between the expectations of the market and reality will influence switching rates. For example, important disparity in prices could encourage people who said they wouldn't switch to change their mind, just as a small gap could dissuade others. Going deeper in the analysis, we verify that little variance has been observed on the basis of sex segmentation. A slight difference of 3 % (higher will to switch for male) seems to predict there will be no major behavior contrast for these segments. Age has a greater impact: Customers in the 25-34 age group are more inclined to switch. They are typically considered to be early adopters and embrace new ideas and technological changes first. The older the customer is and the more reticent to switching he is. The 65 and more age group is very reluctant to switch with a rate of 74.4 % saying they will not exchange their actual provider. A significant difference has been reported according to the region. Working status also plays its role. Part time and full time workers are more receptive to switching then any other group (retired or others) and make us believe they will behave in very similar manners. Other groups such as retired are far less enthusiastic. MarketLine International has tempted to draw a profile of the most likely and the least likely to switch: The most likely person to switch is A male, 25-34 years old, living in Wales or The Midlands, belonging to a well-to-do social class, and working part time. The least likely to switch is A female, 45-54 years old, living in Scotland or the North, belonging to less favored social class, and being neither employed part nor full time.

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65

59
55

45

35 % 25

20.9

15

11.1

0.9
No -5 Yes, already switched

1.5
Yes, immediately

3.2

3.5

Yes, after a few month

Yes, after year

Unaware I would be able to switch

Don't know / Not stated

Source: MarketLine International

In the US, 33.2 % of residential customers declared in a recent survey 4, they would consider switching with no price difference, and 24.2 % additional would definitely switch with "significant" cost savings. In Germany, people were asked the question: "if you could freely choose, would you choose your existing electricity supplier again?" 5. "Convinced" customers said "definitely" at 35.5 % and "probably" at 18.9 %. "Satisfied" customers answered "definitely" at 24 % and "probably" at 18.1 %. Finally, "disappointed" customers responded "definitely" at 11.9 % and probably at 6.4 %. This confirms that a complex link exists between satisfaction rate and loyalty, but it is worth repeating it cannot be the only explanation. This is even better demonstrated in a survey (British Gas, 1997) realized on the UK gas market: The relation between customer satisfaction and likelihood of switching supplier and the relation between value for money and likelihood of switching were opposed. It showed value is undoubtedly a more reliable indicator of switching propensity.

McINTOSH H.E. (ANDERSEN CONSULTING), "Customer service. Satifying and saving", Lisbon: Conference on Customers & Markets, session 1, 1998 5 Source: Das Deutsche Kundenbarometer Qualitt und Zufriedenheit, Jahrbuch der Kundenzufriedenheit in Deutschland, 1995
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4. Reasons for switching

Studying the reasons that push customers to switch from one supplier to another gives your company the tools to comprehend and measure its performance. As Reichheld claims in his book6, "any defection is the result of a lack of value". Knowing what is going wrong also enables the company to take corrective actions. It can also be a good indicator of the company's global performance or its performance in a special domain in comparison with competitors. On UK's gas market, the identified reasons for switching were listed as follow (Lias, 1997): - Price only - Dissatisfaction with British Gas - Innovators - Early adopters 15 % 5% 1% 9%

On the electricity market (MarketLine International, 1998), price was the dominant answer with 61.7 %. Still, over one third of respondents did not mention price as a dominant factor. Once more, the other options were far behind. The second most popular choice, customer service, gathered only 23 %. Clear information allowing comparison of suppliers ranked third with 10.6 %. All the others, such as combined gas and electricity, combined utilities, switching bonus, other discounts, were under 10 %. Let's note the high degree of uncertainty, probably coming from those who did not know at the time if they would switch or not. Broken down by sex, this survey indicates that female respondents were far more sensible to price and service (around 6 % higher than male). The younger age groups show a high degree of uncertainty that can be explained by the fact they are not often decision-makers and thus do not feel too concerned. The importance of service declines with the age. Disparities between working status are greater than in any other segmentation. Price is particularly decisive for part time group (82,9 %, 20 % more than full time workers). This information enables us to make a new customer profiling for each of the reasons that can lead to switch:

REICHHELD FREDERICK F., "The loyalty effect. The hidden force behind growth, profits, and lasting value", Harvard Business School Press, Boston 1996
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Price Service Information Combined gas and electricity Combined utilities Switching bonus Recommended offer through a non-utility Discounts on other products and services

Sex F F M M F F M F

Age 35-44 25-34 55-64 25-34 45-54 15-17 35-44 18-24

Working status Part Time Part Time Retired Retired Part Time Retired Full Time Part Time

Source: MarketLine International

After having considered these results, it is tempting to raise the problem of oversimplification often observed in such studies. It seems to us it is quite dangerous to say that price and only price is the determinant factor that explains most of switching behaviors. Price is a more complex notion than what we usually imagine. Price is an interaction of many different elements and is the result of a long personal process. It involves psychology as much as economy. Prices influence products as products influence prices. So we should not forget to consider all the elements when we "simply" speak of price. This concern is also relevant in the case of service because it is not necessarily clear what service means in customer's mind.

5. Barriers / Incentives
5.1. Barriers The main purpose of deregulation and opening of electricity market is to introduce competition in a domain that was until now in a monopolistic situation. But we now know some dysfunction may occur in a liberalized market and may be the sign competition does not work exactly as it should. Some of these barriers can also be due to other factors inherent to customers rather than to the market. Let's look at these barriers through practical examples. On the UK gas market, four barriers have been identified (Lias, 1997). These barriers force the suppliers to go out and win customers via direct channels. Barriers create inertia, mostly due to the risk perceived and to the low involvement of customers who have adopted a wait and see attitude. The first obstacle that slows customers down is ease. Customers ask themselves questions like "do I have to sign a contract", "are there a lot of documents and paper work", "do I have to pay an exit or entry tax"? The second difficulty is the level of simplicity. Is the contract clear and do I really see a difference with my old supplier? Am I going to save a significant amount of money? Will I see an improvement in the relations and a better understanding?

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Third, brand will be a handicap for newcomers and companies working outside of their usual perimeter. New entrants will lack, in customers eyes, the background and the experience other companies have built over the years in a rather complicated and technical domain. Customers will more easily trust brand they know. Finally, the reputation, created by the numerous errors some of the new entrants made, could cause prejudice to others. Still in UK, but this time on the electricity market, another research (MarketLine International, 1998) also approached the subject of barriers. People were asked to give the main reason responsible for not willing to switch electricity supplier. The answer is quite surprising. The reason 76.9 % of non-switchers invoked is just that they are happy with their current supplier. The second most popular answer, but far behind happiness, is the hassle caused by switching. 14.9 % of non-switchers do not want to be bothered by what they feel is a long and complex process. In fact, hassle should not be an obstacle since it is easily remedied as door-to-door or telephone sales people make most of the efforts on behalf of the customers; the problem is having the latter know of this service! The difference between male and female behavior is rather small. Male customers seem to be more preoccupied by the hassle caused (17.3 % vs. 12.7 %) while female seem a little happier (78.5 % vs. 74.7 %). Again, we observe small distinctions by age, the 65+ age group being the most satisfied and the 35-44 group most concerned about hassle (probably a time issue since it is at this age that family and work ask for a lot of time and energy). People working full time showed more concern about hassle (20.2 %), about twice as much as part time or retired. They are also less happy by 10 %. These people feel they don't have that much time available and don't want to waste time on choosing a new supplier. 5.2. Incentives Customers are waiting for the companies to give them good reasons to switch. These incentives can vary from one company to another, but in order to attract new customers or just retain the existing ones, they must be decisive in customers' mind. On the UK gas and electricity market, some suppliers propose to join a loyalty club that gives points and can later be used to reduce shopping bills. Energy providers have concluded alliances with all kinds of non-utility companies. This solution seems to be liked by customers because of its convenience. It looks like it is a win-win strategy since both side are taking some advantage out of this offer. Suppliers touch a larger population and at a much better price than what they could do on their own. In addition, they create a better retention rate and have found an ideal ally. Supermarkets are great candidates for alliances for a number of reasons. First they have stores nationwide and are visited by most of the population on a regular basis. The loyalty schemes provide a database and a mean for joining marketing initiatives. Finally, energy suppliers benefit from the stores "one-stop" principle. In the UK, it seems that energy companies try almost frantically to make alliances with non-utilities. These alliances concern airline companies (miles), credit card and financial service companies, media industry, building societies, and so on. We believe the arrival on the electricity market of new entrants such as non-utility companies will have an indirect impact on customer loyalty. The resulting side effect could lead customers to be more receptive to switching opportunities. These newcomers could carry a more "neutral" image and reputation in buyers' eyes and therefore speed up the switching process.

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Others have given welcome cash back incentives. This tactic may be quite dangerous since nothing guarantees that the new customer will stay loyal long enough to pay off the investment. This solution is risky in a world in which people are used to take advantage of this kind of deals and run away at the first occasion. They will also respond to your competitors' incentives! A research led by MarketLine International in UK focused on the additional components a company can offer as an incentive. Beside the traditional supply package containing price, tariff structure, service undertakings and dual or combined fuel discounts, suppliers can offer incentives linked to non-utility companies. Three main methods have been used: Offering a preferential price or tariff to an affinity group. This method is most suitable for financial services, banks, insurance, charities, unions, and media. Continuous reward schemes and sign-up cash bonus. These methods are most suitable for supermarkets and high street stores with reward schemes. Sign-up vouchers. Suits to any company, but especially charities, unions, high street stores, energy goods, retailers, and building societies. Usually used when transactions are less frequent. The main package has been thought over again too. Suppliers offer price reductions and time-of-day tariff options since most of the competition is based on this matter. The margins being already so tight, no real significant drop is expected (some say it will be below 10 % and probably even below 5 % for domestic electricity). This explains why companies try to offer lower bill by playing with tariff options. Reduction is expected through the offering of a tariff closely related to consumption pattern. In this system, prices vary according to the load profile of customer. The problem is that the more complicated the tariff and the more complex and expensive is the meter. Other tariff options such as tariffs on payment method (see below) and on overall consumption will also aim to reduce customer electricity bill. Product based tariffs will focus more on people having strong believes about environment (green tariff) or wanting to save the British coal industry (Eastern's Lionheart) for example. Payment options are also being considered as a key for customer acquisition and retention. Both sides particularly appreciate direct debit. Suppliers incur a far lower credit risk and billing costs are lower. Customers see their transaction simplified and do not have to bother about their monthly bill any more. Since the costs are lower, direct debit users are often offered a lower price. But what are the figures for direct debit? 26.8 % already use this method and 32.7 % stated they would be happy to switch to direct debit to save money while 26.2 % stated they would not switch. The main reason for this refusal is the fear that electricity companies have access to their bank account. Another trend has emerged some time ago with the offer of dual or combined fuel packages. Many companies have chosen the option to offer gas and electricity. Some have even linked gas and electricity so tight that they offer a price reduction only if customers take both products. The range of offers is very wide, but in any case, the goal the suppliers are aiming at is to acquire and keep customers by offering them an easier solution to their energy problem. They bet on time saving, ease, effort reduction, and unique interlocutor in order to do most of the job for the customer. But in a rather short-term perspective this advantage could be substantially annihilated since most of competitors are on their way to offer dual-fuel.

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We until now have listed what kinds of incentives were available on the market. Let's look at the customer point of view. What incentives will he/she react to? The figure below confirms what we had already guessed. Cash back is the preferred customer solution but it does not mean a company should do it at any cost. As discussed earlier, both sides should be winning on the long term when such a deal is concluded.

6. Conclusion
The reading of those researches made on liberalized utility markets leads us to make a series of final comments. First, and as a residue of the monopolistic situation that characterized the electricity industry for years, we discover we know very little about our customers. We miss the essential. Not only what his needs are, how he reasons when he has to make a complex decision, but even who he is. It is therefore urgent to build databases gathering the most relevant information on customers. These information can then be treated and used to refine our positioning and really work toward the creation of value for our customers, and consequently for ourselves. Measures have to be taken as soon as possible since the years preceding the opening are essential to consolidate the position and the image of the company. Once the market is liberalized, everything goes very fast. It is true a wait and see attitude can be observed in the first months, but as the trend takes off, it becomes harder to inverse the tendency. With the fall of the psychological as much as the real barriers starts a real struggle for survival. The reasons invoked for switching were first price (two third) and then service (one third). These results are confirmed in a number of studies but are not satisfactory enough. They suffer from a simplification effect and too often forget to correlate these factors with other elements. A service can be cheap or expensive, but always in comparison with what is offered, with what guarantees you get. So let's not resume everything to price just because it is convenient to do so. Barriers exist. The more persistent are in customers' mind. Customers have a lot of presumption (that are sometimes not only presumptions!) due to the fact electricity has a long history. But what is important is that companies have the tools to guide, help, and do most of the work in order to facilitate customer's life. And if suppressing the barriers is not enough, companies can always fight customers' inertia by sending incentives. The options are numerous and they range from cash back incentives, tariff offers, combined fuel packages, to alliance to non-utility companies. But let's forget that these actions should always result in long-term benefits, for customers as much as for electrical companies; and this is not an easy task when margins on electricity sales shrink as they do in fully open markets.

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30

29.3 27.2

25

20

% 15

10

5.9
5

5.7 4.2 2.4 2.4

No ne of th es e

1.8
Do na tio n to sc ho ols

1.4
Ch ari ta bl e do na tio

1.1
Fi na ncisu al pp se ly rvi ce s

0.5
In su ra nc e co m pa

Ca sh ba ck on sw itc hi ng

Du alfu el dis co un t

Sh op vo uc he rs

Ba nk su pp ly

Su pe rm ar ke t loy alt

Hi gh str loy ee alt t y st or

Source: MarketLine International

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BIBLIOGRAPHY
BRITISH GAS, "Residential gas. Relation between customer satisfaction and likelihood of switching gas supplier", December 1997 ELECTRICITY ASSOCIATION, "European & overseas relations. Switching supplier and customer loyalty in the UK electricity market" KOBER MAGNUS & HJELLE ANN-KRISTIN, "Electricity market survey 1997", NVE, August 1997 KOBER MAGNUS & HJELLE ANN-KRISTIN, "Supplier change January 1998", NVE, January 1998 LIAS ALAN (Managing director Beacon Gas Limited, Presentation by), "What has made domestic customers switch? Analyzing the critical success factors for profitably attracting new customers", European Utilities Conference, November 1997 MARKETLINE INTERNATIONAL, "Domestic electricity competition. Customer attitudes in the UK domestic electricity market", 1998 MOORE KATHERINE, "Split affinities", Utility Week, 16/page 20-21, January 1998 MOORE KATHERINE, "Talking tactics", Utility Week, 20/page 14-16, March 1998 OFFER, "Competition in supply", OFFER Annual Report, 1996 REICHHELD FREDERICK F., "The loyalty effect. The hidden force behind growth, profits, and lasting value", Harvard Business School Press, Boston 1996 UK GAS REPORT, "Marketing: Tesco teams up with ENERGI to offer gas customer loyalty points", 102/page 12-13, February 1998 UNIPEDE, "Conference on Customers & Markets", Speeches & Slides, Lisbon 1998

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