What is Customer Loyalty? Part 2: A Customer Loyalty Measurement Framework

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Read about the development of the RAPID Loyalty Approach. Click image to download the article.

Last week, I reviewed several definitions of customer loyalty (see What is Customer Loyalty? Part 1) that are being used in business today. It appears that definitions fall into two broad categories of loyalty: emotional and behavioral. Emotional loyalty is about how customers generally feel about a company/brand (e.g., when somebody loves, trusts, willing to forgive the company/brand). Behavioral loyalty, on the other hand, is about the actions customers engage in when dealing with the brand (e.g., when somebody recommends, continues to buy, buys different products from the company/brand).  Generally speaking, then, we might think of customer loyalty in the following way:

Customer loyalty is the degree to which customers experience positive feelings for and engage in positive behaviors toward a company/brand.

This week, I will propose a customer loyalty measurement framework to help you understand how to conceptualize and measure customer loyalty. After all, to be of practical value to business, customer loyalty needs to be operationalized (e.g., bringing the concept of loyalty into the measurable world). Once created, these metrics can be used by businesses in a variety of ways to improve marketing, sales, human resources, service and support processes, to name a few. First, I will present two approaches to measuring customer loyalty.

Measurement Approaches

There are two general approaches to measuring customer loyalty: 1) objective approach and 2) subjective (self-reported) approach.

1. Objective measurement approach include system-captured metrics that involve hard numbers regarding customer behaviors that are beneficial to the company.  Data can be obtained from historical records and other objective sources, including purchase records (captured in a CRM system) and other online behavior. Examples of objective loyalty data include computer generated records of “time spent on the Web site,” “number of products/services purchased” and “whether a customer renewed their service contract.”
2. Subjective measurement approach involves “soft” numbers regarding customer loyalty. Subjective loyalty metrics include customers’ self-reports of their feelings about the company and behavior toward the company. Examples of subjective loyalty data include customers’ ratings on standardized survey questions like, “How likely are you to recommend <Company> to your friends/colleagues?”, “How likely are you to continue using <Company>?” and “Overall, how satisfied are you with <Company>?”

Figure 1. Companies with higher levels of customer loyalty experience accelerated business growth.

While I present two distinct customer loyalty measurement approaches, there are likely gradients of the subjective measurement approach. On one end of the subjective continuum, ratings are more perceptually based (what is typically used today) and, on the other end of the subjective continuum, ratings are more behaviorally based that more closely approximate the objective measurement approach. The objective/subjective dichotomy, however, provides a good framework for discussing measurement approaches.

Before continuing on the measurement of customer loyalty, it is useful to first put customer loyalty in context of how it impacts your business. Generally speaking, companies who have higher levels of customer loyalty also experience faster business growth (See Figure 1).  While I argue elsewhere that the customer loyalty metrics you use depend on your business needs and the types of behaviors in which you want your customers to engage, understanding how customer loyalty impacts business growth will help you determine the types of loyalty metrics you need.

Three Ways to Grow a Business: Retention, Advocacy, Purchasing

Figure 2. Business models illustrate that there are three ways to grow your business. Top Model is from Reichheld,1996; Bottom model is from Gupta, et al. 2006. Click image to enlarge.

Let us take a look at two business models that incorporate customer loyalty as a key element of business growth and company value (See Figure 2). The top graph is from Fred Reichheld and illustrates the components that drive company profit. Of the components that contribute to company profits, three of them reflect customer loyalty: retention (measured in years), advocacy (measured as referrals) and expanding purchasing (measured through increased purchases).

Similarly to Reichheld’s model, Gupta’s Customer Lifetime Value model focuses on customer loyalty as a mediator between what a company does (e.g., business programs) and the company value (see graph on the bottom of Figure 2). Again, customer loyalty plays a central role in understanding how to increase firm value. Improving 1) retention behaviors, 2) advocacy behaviors and 3) purchasing behaviors will increase company value.

Customer Loyalty Measurement Framework: Operationalizing Customer Loyalty

Our loyalty metrics need to reflect those attitudes and behaviors that will have a positive impact on company profit/value. Knowing that customer loyalty impacts company profits/value in three different ways, we can now begin to operationalize our customer loyalty measurement strategy. Whether we use an objective measurement approach or a subjective measurement approach, our customer loyalty metrics need to reflect retention loyalty, advocacy loyalty and purchasing loyalty.  Here are a few objective customer loyalty metrics businesses can use:

• Churn rates
• Service contract renewal rates
• Number/Percent of new customers
• Usage metrics – frequency of use/visits, page views
• Sales records – number of products purchased

Here are a few subjective customer loyalty metrics businesses can use:

• likelihood to renew service
• likelihood to leave
• overall satisfaction
• likelihood to recommend
• likelihood to buy different/additional products
• likelihood to expand usage

Figure 3. Customer Loyalty Measurement Framework: You can measure emotional (e.g., advocacy) and behavioral loyalty (e.g., retention and purchasing) using different measurement approaches (e.g., subjective and objective).

Figure 3 illustrates how these loyalty metrics fit into the larger customer loyalty measurement framework of loyalty types and measurement approaches. Each of the customer loyalty metrics above falls into one of the four quadrants of Figure 3.

It is important to point out that the subjective measurement approach is not synonymous with emotional loyalty. Survey questions can be used to measure both emotional loyalty (e.g., overall satisfaction) as well as behavioral loyalty (e.g., likelihood to leave, likelihood to buy different products). In my prior research on measuring customer loyalty, I found that you can reliably and validly measure the different types of loyalty using survey questions.

Looking at the lower left quadrant of Figure 3, you see that there are different ways to measure advocacy loyalty. While you might question why “likelihood to recommend” and “likelihood to buy same product” are measuring advocacy loyalty, research shows that they are more closely associated with emotional rather than behavioral loyalty. Specifically, these questions are highly related to “overall satisfaction.” Also, factor analysis of several loyalty questions show that these three subjective metrics (sat, recommend, buy) loaded on the same factor. This pattern of results suggests that these questions really are simply measures of the customers’ emotional attachment to the company/brand.

I have include the metrics of “level of trust,” “willingness to consider” and “willingness to forgive” as emotional loyalty metrics due to their strong emotional nature. Based on what I know about how customers rate survey questions. I suspect these questions would essentially provide the same information as the other questions in the quadrant. That, however, is an empirical question that needs to be tested.

Subjective vs. Objective Measurement Approach

While companies have both objective and subjective measurement approaches at their disposal, surveys remain a popular approach to measuring customer loyalty. In fact, surveys remain the cornerstone of most customer experience management programs.

Companies use customer surveys to measure customer loyalty rather than solely relying on objective metrics of customer loyalty because: 1) Customer surveys allow companies to quickly and easily gauge levels of customer loyalty, 2) Customer surveys can provide rich information about the customer experience that can be used to more easily change organizational business process and 3) Customer surveys provide a forward look into customer loyalty.

RAPID Loyalty Approach

I have conducted research on the subjective approach to measuring customer loyalty over the past few years. Based on the results of this research, I developed the RAPID Loyalty approach that supports the three ways businesses can grow their business: Retention, Advocacy and Purchasing loyalty.  The RAPID loyalty approach includes three metrics, each assessing one of three components of customer loyalty:

• Retention Loyalty Index (RLI): Degree to which customers will remain as customers or not leave to competitors; contains loyalty questions like: renew service contract, leave to competitor (reverse coded).
• Advocacy Loyalty Index (ALI): Degree to which customers feel positively toward/will advocate your product/service/brand; contains loyalty questions like: overall satisfaction, recommend, buy again.
• Purchasing Loyalty Index (PLI): Degree to which customers will increase their purchasing behavior; contains loyalty questions like: buy additional products, expand use of product throughout company.

Each of the RAPID loyalty indices has excellent measurement properties; that is, each index is a reliable, valid and useful indicator of customer loyalty and is predictive of future business growth. Specifically, in a nationwide study asking over 1000 customers (See Figure 4) about their current network operator, each loyalty index was predictive of different business growth metrics across several US network operators (Alltel, AT&T, Sprint/Nextel, T-Mobile, and Verizon):

Figure 4. The RAPID Loyalty indices (ALI, PLI and RLI), each predict different types of business growth.

• RLI was the best predictor of future churn rate
• ALI was a good predictor of new customer growth
• PLI was the best predictor of Average Revenue per User (ARPU) growth

The bottom line is that there are three general ways to grow your business: keep customers coming back (retention), recommending you to their friends/family (advocacy) and expanding their relationship with you by buying different products/services (purchasing). To increase company profits/firm value, it is imperative that you measure and optimize each type of customer loyalty. Falling short on one type of customer loyalty will have a deleterious effect on company profit/firm value.

State of Customer Loyalty Measurement

In an informal online poll taken during a talk, Asking the Right CX Questions (part of CustomerThink’s Customer Experience Summit 2011), I asked participants about their CEM program loyalty metrics. While a little over 75% of the respondents said their company uses advocacy loyalty measures, only a third of the respondents indicated that their company uses purchasing loyalty measures (33%) and retention loyalty measures (30%).

Benefits of Measuring Different Types of Customer Loyalty

It appears that most companies’ customer loyalty measurement approach is insufficient. Companies who measure and understand different types of customer loyalty and how they are impacted by the customer experience have several advantages over companies who narrowly measure customer loyalty:

• Target solutions to optimize different types of customer loyalty. For example, including retention loyalty questions (e.g., “likelihood to quit”) and a purchasing loyalty questions (e.g., “likelihood to buy different”) can help companies understand why customers are leaving and identify ways to increase customers’ purchasing behavior, respectively.
• Identify key performance indicators (KPIs) for each type of customer loyalty. Identification of different KPIs (key drivers of customer loyalty) helps companies ensure they are monitoring all important customer experience areas. Identifying and monitoring all KPIs helps ensure the entire company is focused on matters that are important to the customer and his/her loyalty.
• Obtain more accurate estimates of the Return on Investment (ROI) of improvement initiatives. Because ROI is the ratio of additional revenue (from increased loyalty) to cost (of initiative), the ROI of a specific improvement opportunity will depend on how the company measures customer loyalty. If only advocacy loyalty is measured, the estimate of ROI is based on revenue from new customer growth. When companies measure advocacy, purchasing and retention loyalty, the estimate of ROI is based on revenue from new and existing customer growth.

The primary goal of CEM is to improve customer loyalty. Companies that define and measure customer loyalty narrowly are missing out on opportunities to fully understand the impact that their CEM program has on the company’s bottom line. Companies need to ensure they are comprehensively measuring all facets of customer loyalty. A poor customer loyalty measurement approach can lead to sub-optimal business decisions, missed opportunities for business growth and an incomplete picture of the health of the customer relationship.

Summary

Customer loyalty is a very fuzzy concept. With various definitions of customer loyalty floating around in the literature, it is difficult to know what one is talking about when one uses the term, “customer loyalty.” I tried to clarify the meaning of customer loyalty by consolidating different customer loyalty definitions into two general customer loyalty types: emotional loyalty and behavioral loyalty.

Additionally, I discussed two measurement approaches that companies can utilize to assess customer loyalty: objective measurement approach and subjective measurement approach.

Finally, I offered a customer loyalty measurement framework to help companies think about customer loyalty more broadly and help them identify customer loyalty metrics to help them better measure and manage different types of business growth: acquiring new customers (Advocacy), retaining existing customers (Retention) and expanding the relationship of existing customers (Purchasing).

One of the biggest limitations in the field of customer experience management is the lack of a coherent set of clearly defined variables with instruments to effectively measure those variables. When we talk about customer loyalty, we talk past each other rather than to each other. To advance our field and our understanding of what procedures and methods work, we need precision in ideas and words. One way to start is to clearly define and measure constructs like customer loyalty. While customer loyalty is one such vaguely defined and measured variable, our field is full of others (e.g., customer engagement, employee engagement). I hope I was able to provide some clarification on the notion of customer loyalty, both in its meaning and its measurement.