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# Customer Expectations of Service

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```									     DSE7100 Managing Service Operations

Managing Customer Loyalty

Dr. Xiande Zhao
Department of Decision Sciences and Managerial
Economics
Tel. 2609-7650
Email: xiande@baf.msmail.cuhk.edu.hk
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Outline
 Assessing the value of a loyal customer
 Targeting the right customers
 Analyzing and managing the customer base
 Building customer loyalty
 Customer Relationship management (CRM)

2
What is Life Time Value of a Customer?

The Life time value of a customer is the net
present value of the total profit contribution
made by a customer if the customer stays with
your company during the expected life time of
using this company’s services

3
Calculating the life time value of a customer?

4
Formula for calculating customer lifetime value (CLV) :

Where:
N = the number of years over which the relationship is calculated
= the margin the customer generates in year .
= the cost of marketing communications or promotions targeted to the
customer in year .
r = the retention rate (     is the survival rate for year a)
i = the interest rate.
AC = the acquisition cost.

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Life time Value Analysis for Frequent Buyers of a mail catalog company:

one      Two    Three   Four     Five    Six    Seven   Eight
A     Margin on each purchase            \$10      \$10     \$10     \$10     \$10     \$10     \$10     \$10
.
B     Survival rate                      100%     75%     56%     42%     32%     24%     18%     13%
.
C     Cost of mailing catalogs           \$6       \$6      \$6      \$6      \$6      \$6      \$6      \$6
.
D     Total expected profit per          \$14      \$10.5   \$7.9    \$5.9    \$4.4    \$3.3    \$2.5    \$1.9
.     customer
E     Net present value of profits per
.     customer (discount rate applied)   \$12.7    \$8.7    \$5.9    \$4      \$2.8    \$1.9    \$1.3    \$0.9
F.    Cumulative profits per customer
(net of acquisition costs)         \$(4.8)   \$3.9    \$9.8    \$13.8   \$16.8   \$18.5   \$19.8   \$20.7

In line F, the cumulative profits per customer are determined in Year One by
subtracting the acquisition costs (\$17.5) from the net present value of profits.
In subsequent years, the net present value of profits is added to the previous
year’s cumulative profits per customer.
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Life time Value Analysis for Occasional Buyers

one     Two     Three    Four    Five
A. Margin on each purchase             \$16      \$16      \$16     \$16     \$16

B. Survival rate                       100%     50%      25%     12.5%   6.25%
C. Cost of mailing catalogs            \$6       \$2       \$2      \$2      \$2
D. Total expected profit per           \$10      \$7       \$3.5    \$1.75   \$0.88
customer
E. Net present value of profits per
customer (discount rate applied)    \$9.1     \$5.8     \$2.6    \$1.2    \$0.5
F.   Cumulative profits per customer
(net of acquisition costs)        \$(8.4)   \$(2.6)   \$0      \$1.2    \$1.7

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 How to make customer loyal?

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Can we improve the loyalty of all type of customers?

 No. It is impossible!
 Some customers can not be satisfied, given the service level and pricing
that the organization is capable of offering or
 Some customers are just not worth serving because they are too difficult
to please or unable to decide what they want
 Heavy users who buy more frequently and in large volume are more
profitable than occasional users
 Service investment across all customers groups will not yield similar
returns and are not equally advantageous to the firm
 Different profitability segments are likely to deserve different level of
resources
 Target and serve those customers whose needs it can meet better than its
competitors in a profitable manner
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Can we improve the loyalty of all type of
customers?
 Acquiring the right customers can bring in long-term revenues,
continued growth from referrals and enhanced satisfaction from
employees.
 Attracting the wrong types of customers typically results in costly
churn, a diminished company reputation, and disillusioned
employees
 The firms that are highly focused and selective in their acquisition
can grow faster in the long term than those who acquire customers
blindly.
 Loyalty leaders are picky about acquiring only that right types of
customers. They do not focus on number of customers instead
focus on the value of the customers.
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Targeting the right customer

 Finding customers who have a good fit with the firm’s capabilities
 Choosing to serve a portfolio of several carefully selected market
segments and building and maintaining their loyalty

13
Targeting the right customer

 Factors to be considered:
 How customers needs relate to such operational elements such
as speed, quality, the times when service is available, the firm’s
capacity to serve many customers simultaneously, and the
physical appearance of the service facilities.
 How well the service personnel can meet the expectations of
specific types of customers
 Whether the company can match or exceed competing services
that are directed at the same type of customers

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Targeting the right customer

 Selecting an appropriate mix of customers to reduce the risks associated
with market and macroeconomic conditions
 In professional services, the mix of business attracted may play an
important role in both defining the firm and providing a suitable mix of
assignments for staff members at different levels in the organization.

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Analyzing and Managing the Customer Base

customers.
 Develop long term, cost effective links with customers for mutual
benefits of both parties, but these efforts need not necessarily target all
the customers in a firm with the same level of intensity
 Develop different tiers of customers who have quite different service
expectations and needs and different levels of profitability

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The Customer Pyramid:

Creating and Serving
Profitable Customers

17
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The Customer Pyramid
 The Platinum Tier
 describes the company’s most profitable customers,
 typically those who are heavy users of the product, not overly
price sensitive, willing to invest in and try new offerings, and are
committed to the firm.

 The Gold Tier
 differs from the Platinum Tier in that profitability levels are not
as high, perhaps because the customers want price discounts that
limit margins.
 They might not be as loyal to the firm even though they are heavy
users in the product category – they might minimize risk by
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working with multiple vendors rather than just the focal company.
The Customer Pyramid                             (Cont’d)
 The Iron Tier
 contains customers that provide the volume needed to utilize the
firm’s capacity
 but whose spending levels, loyalty, and profitability are not
substantial enough for special treatment.

 consists of customers that are costing the company money.
 They demand more attention than they are due given their
spending and profitability, and
 they are sometimes problem customers – complaining about the
20     firm to others and tying up the firm’s resources.
Tiering Customers in the Retail Real Estate
industry
 the amount of time it takes to buy/sell a home (which represents
the opportunity cost of time and other commissions to the
realtor);
   customer motivation to purchase/sell (especially high with
relocations);
   price sensitivity of buyers, which may lead them to negotiate a
lower rate with the realtor;
   likelihood of repurchase; and
   referral potential.
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Platinum customers:

• those who pay full commission on a home costing \$500,000
or more;
• are motivated to purchase within the next six months;
• have purchased more than two homes in the past;
• and are members of social or professional networks that
make them candidates to refer other high-end buyers.

22
Gold customers:
•    purchase homes in the \$250,000-\$600,000 range but are more
price sensitive than the top tier.
E.G. some Gold customers want to negotiate on the commission
or have the realtors pay points at closing.
•Some of these customers buy homes that are in the same price
range as Platinum customers but their price sensitivity reduces
their profitability.

• are likely to refer others, but the types of customers to be
referred are not as valuable to the firm as those the Platinum
customers refer.

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Iron customers:
•    buy homes in the \$100,000-\$250,000 range, and include
retirees, young professionals, and families.

• the young professionals have higher lifetime value potential and
therefore market to them differently than they market to others in
this group.

• Young professionals who purchase homes at the upper end are
tagged as potential Gold customers and moved to that category
approximately five years after the purchase of a home.

•   are relocations from other areas and are pressed to buy homes
quickly, making them good prospects for the company despite
home prices that are lower than the top two tiers.
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•   are shoppers rather than buyers.

•   Some Lead customers spend as long as two years
looking at homes, calling upon realtors to show them
homes when they have free time

•   While they might be looking at homes in all price
ranges, the homes they buy are likely to be under
\$100,000.

•   these clients are often dissatisfied with what they see,
making them less likely than other tiers to send
qualified referrals to the company.
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Summary:

While the real estate company is still refining the criteria for the
tiers. They view the sorting into levels as invaluable in
qualifying current and potential clients, and are developing
different programs for reaching and serving them differentially.
They have recently developed an “expectations assessment
tool” that attempts to decide the appropriate customer tier upon
making the contract with the buyer or seller.

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in the Marketing Research Industry

One of the most respected marketing research firms
learned in the mid-nineties that it didn’t pay to treat all
clients alike.

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What factors should be considered in
tiering the customers?

• Dollar amount for the project

• Experience and expertise in marketing research project

• the willingness to be a research partner and commit to
an annual budget.

• Price sensitivity

• Willingness and ability to be a reference
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Platinum customers
•    were defined as large accounts that were willing to plan a certain
amount of research during the year.

•    The timing and nature of this research could be anticipated, making it
easy for the research firm to smooth supply and demand.

•    The Platinum clients tended to stay with the company and were willing
to try new services and approaches developed by the research firm.

•    Therefore, they bought across research service types and had minimal
sales costs averaging only 2-5%.

•    They were willing to serve as references for the firm and were loyal to
the firm.
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Gold customers:

• had similar profiles except that they were more price
sensitive, inclined to spread their research budgets across
several firms.

•   While they were large accounts and had been customers
for multiple years, they were not willing to plan for a year in
advance even though the marketing research firm would
give them better quality if they did.

• They provided referrals but on an ad hoc basis.
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Iron customers
• were moderate spenders and conducted research on a project
basis, sending out requests-for-proposals whenever they were
conducting studies.

• They were looking for the lowest price and often did not allow
sufficient time to perform the jobs.

• Because they had no overall plan, projects came in at any time

• Selling costs were high because the firm continually kept in
personal and mail contact hoping to move these Iron customers
31     up the Pyramid.
• Spent little on research, conducted isolated projects that were
usually of a “quick and dirty” nature.

• Selling costs were highest in this group since advertising and
almost all speculative presentations were targeted to these
accounts and salespeople had to spend multiple visits to get them.

• Once they became clients, the maintenance cost is high because
they didn’t understand the process of research.

• They often changed projects mid-stream and expected the firm to

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absorb the costs.
When Should a Firm Use the Customer Pyramid?
 When service resources, including employee time, are limited.
 When customers want different services or service levels.
 When customers are willing to pay for different levels of service.
 When customers define value in different ways.
 When customers can be separated from each other.
another level.
 When they can be accessed either as a group or individually.

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Customer Alchemy
 Customer alchemy is the art of turning less profitable customers

into more profitable customers.

 It can take place at any tier along the Customer Pyramid, but is

more difficult at some levels than at others.

 For example, it is very difficult to move Lead customers up to

Gold or Platinum tiers, and it is often necessary to “get the Lead
out” rather than try to move those customers up.

 If the decision is made to keep Lead customers, the strategies

used are typically different than those used at other tiers.

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Turning Gold into Platinum

   Became a Full-Service Provider
   Provide Outsourcing
   Increase Brand Impact by Line Extensions
   Create Structural Bonds
   Offer Service Guarantees

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Turning Iron into Gold

 Reduce the Customer’s Nonmonetary Costs of Doing Business

 Become a Customer Expert through Technology
 Become a Customer Expert by Leveraging Intermediaries
 Developing Frequency Programs

 Create strong Service Recovery Programs

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   Raise Prices
   Reduce Costs

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 How to build customer loyalty?

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1. Build a Foundation for Loyalty

• Segment the market to match customer needs and firm
capabilities
• Be selective; only acquire customers who fit the   core
value proposition
• Manage the customer base via effective tiering of service
• Deliver quality service

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2. Create Loyalty Bonds

• Deepen the relationship
 Cross-selling
 Bundling

• Give loyalty rewards
 Financial rewards
 Non-financial rewards
 Higher tier service levels
 Recognition and appreciation

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2. Create Loyalty Bonds
 Build higher level bonds
      Social
      Customization
      Structural bonds

 Transforming Discrete Transactions to Membership
Relationships

   Airline Frequent flyers programs
   VIP cards for hotels, restaurants
   Shopping cards

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How do customers perceive loyalty reward program?
 Brand loyalty vs deal loyalty
 How do buyers value rewards?
 The cash value of the redemption rewards
 The range of choices among rewards
 The aspiration value of the rewards
 Whether the amount of usage required to obtain an award place
it within the realm of possibility for the consumer
 The psychological benefits of belonging to the program
 How soon can benefits from participating in the program be
obtained?

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3. Reduce Churn Drivers
• Conduct churn diagnostic and monitor declining/
churning customers
 Proactive retention measures
 Reactive retention measures
• Put effective complaint handling and service
recovery processes in place
• Increase switching costs

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 What are some of the major causes of customer
service switching?

44
Service Failure and Recovery
 Core Service Failure (44%)
 Service Mistakes
 Billing Errors
 Service Catastrophe
 Service Encounter Failures (34%)
 Uncaring
 Impolite
 Unresponsive
 Unknowledgeable
 Response to Service Failure (17%)
 Negative Response
 No Response
 Reluctant Response
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Value Proposition
 Pricing (30%)
 High Price
 Price Increases
 Unfair Pricing
 Deceptive Pricing
 Inconvenience (21%)
 Location/Hours
 Wait for Appointment
 Wait for Service
 Competition
 Found Better Service

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Others
Involuntary Switching
 Customer Moved
 Provider Closed
Ethical Problems
 Cheat
 Unsafe
 Hard Sell
 Conflict of Interest

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The Wheel of Loyalty

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COMMON CRM APPLICATIONS
Data collection. The system captures customer data such as contact
details, demographics, purchasing history, service preferences, and
the like.
Data analysis. The data captured is analyzed and categorized by the
system according to criteria set by the firm. This is used to tier the
customer base and tailor service delivery accordingly.

Sales force automation. Sales leads, cross-sell and up-sell
opportunities can be effectively identified and processed, and the
entire sales cycle from lead generation to close of sales and after-
sales service can be tracked and facilitated through the CRM system.
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COMMON CRM APPLICATIONS
 Marketing automation. Mining of customer data enables
the firm to target its market. A good CRM system enables
the firm to achieve one-to-one marketing and cost savings.
This results in increasing the return on investment (ROI)
on its marketing expenditure. CRM systems also enable
the assessment of the effectiveness of marketing
campaigns through the analysis of responses.

Call center automation. Call center staff have customer
information at their fingertips and can improve their service levels
to all customers. Furthermore, caller ID and account numbers
allow call centers to identify the customer tier the caller belongs to,
and to tailor the service accordingly.
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TEN STEPS TO SUCCESSFUL CRM STRATEGY
1. Establish measurable business goals, and clarify the exact
objectives to be achieved with the CRM solution.
2. Technology is only a means to achieve the desired goals.
Therefore, in order to implement CRM successfully, both the
responsibility of designing and implementing the system
3. Get executive support up-front, as CRM projects are
strategic initiatives. Therefore, they must get active support
from top management.
4. Let business goals drive functionality. If a feature of the CRM
system does not generate obvious and direct benefits to the
company, do not include such a feature in the configuration
decision.
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TEN STEPS TO SUCCESSFUL CRM STRATEGY
5. Minimize customizations, as they are often costly
and time consuming, and are a complex
component of a CRM implementation.
6. Use trained and experienced consultants who are
well-trained and certified by the software providers,
as this will help to save time and money.
7. Actively involve end users in the solution design to
reduce the possibility of confusion and alienation
with the CRM system.

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TEN STEPS TO SUCCESSFUL CRM STRATEGY
8. Invest in training to empower end users, as providing
sufficient and necessary training is critical to success in
CRM implementation..
9. Use a phased roll-out schedule, as it enables users to learn
step by step. Most focused on a specific CRM objective or
function, and is designed to obtain certain desirable
outcomes in a reasonable amount of time.
10.Measure, monitor, and track the system’s effectiveness with
the thought of increasing its performance continuously.
Companies that benefit the most from CRM applications
usually set benchmarks for their business processes,
identify the performance metrics against those processes
and measure the effect of the CRM application on the
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metrics.

   Reichheld, F. E. and Sasser, W. E. Jr., “Zero Defections: Quality
Comes to Services”, Harvard Business Review, September-
October 1990, 105-111
   Zeithaml, V. A., Rust, R. and Lemon, K. N. “The Customer
Pyramid: creating and serving profitable customers”
California Management Review, Vol. 43, No. 4. Summer
2001, 118-142
   “Implementing services marketing, Chapter 12 in
   Service Marketing in Asia by Lovelock etc

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