Regardless of the approach, customer attrition cannot be ignored. If a company devotes all of its resources to growth, while failing to protect its base, a downward spiral of “one step forward and two steps back” can ensue. Conversely, a company taking a status quo approach, pursuing neither growth nor retention, will instead be internally focused and become the victim of aggressive competitors. The result can be an unpleasant war of attrition. In either case, the result is continued low growth and shrinking margins. In this time of slow growth, the company that focuses on customer loyalty and increasing customer retention will reap significant rewards.
The Reward of Customer RetentionStudies have shown that it costs five times more in selling expense to gain a dollar of new customer sales than it does to retain an existing dollar of sales. This fact alone should compel companies to try to increase retention rates. This is particularly true for a low-growth industry with declining margins. The added cost associated with replacing lost customers in an increasingly competitive market can be a significant drain on profits. A well-run $100-million coatings company with an annual customer attrition rate of 10% would realize an increase in earnings before interest and taxes (EBIT) of over $1,000,000 by reducing the attrition rate to 8% (see table).
It is clear that customer retention is important. The challenge is to make it a corporate reality. To increase customer retention, a company must understand why customers change suppliers and, more importantly, why they continue to purchase a particular company’s product.
Why Do Customers Change?Conventional wisdom holds that most customers switch suppliers because of price. This belief drives suppliers to engage in price wars in an attempt to get or keep business. These actions lower prices and profits, but seldom increase customer satisfaction. In reality, price is rarely the primary reason for change — it is simply an easy excuse.
Lost customers fall into two categories: the dissatisfied customer and the forgotten customer. The dissatisfied customer has experienced a problem with the product or service that has not been resolved. For the OEM customer, quality problems might include inconsistency from batch to batch, or specific application issues like solvent popping or craters. Service dissatisfaction, particularly for industrial coatings, often results from late deliveries, poor technical service, or the sales staff’s failure to fully understand the customer’s needs.
Forgotten customers are the ones who feel that they have been taken for granted or that they are no longer important. These are often smaller customers. These customers can often be very profitable and should not be ignored. Forgotten customers feel that the supplier doesn’t care about their needs and concerns, and is only interested in getting the next order.
The underlying reason leading customers to change suppliers involves a lack of communication. The supplier has failed to understand true customer value, has failed to demonstrate how value is generated or — more often than not — both. Value is what drives purchase decisions. When you understand customer value and respond accordingly, you have loyal customers. When you fail to do so, you have customers who buy — and leave — on price.
What is Customer Loyalty?Customer loyalty is not customer satisfaction. Customer loyalty is achieved by matching your offering to the underlying customer value. Over half of customers say that they were satisfied with their supplier prior to switching. In many cases, satisfaction surveys are only useful in identifying customers who are extremely dissatisfied. No insight is provided to identify those lukewarm customers who are in danger of switching. These “satisfied” customers can be easily lured away by competitors. Even worse, they may start to demand price concessions because they view your product as a commodity and are no longer aware of the unique value it provides.
Customer loyalty is not about product attributes or features. In today’s technology-driven world, product attributes or features are often substituted for customer values. In truth, attributes only lead to loyalty if they satisfy some inherent customer need that corresponds to the values of the customer. Stated simply, neat features are worthless if they do not increase customer profits. They simply add cost. To make matters worse, they are costs that cannot be recouped because the customer does not value the attributes, and therefore won’t pay for them.
E-coat for automotive OEM commands among the highest margins in the industry. This type of coating represents a technological breakthrough that adds value all along the chain — from coating supplier to the end customer. The benefit of added corrosion resistance is something the coatings customer will pay for, because the car buyer values a car that will not rust through. Thus, e-coat adds profit for the automotive OEM and the dealer.
Contrast e-coat with powder coat. While powder coating represents a similar technological improvement, in most cases, it only adds value to the coater. It reduces the cost of environmental compliance. However, powder coating does not change the nature of the coated product so that the end customer will pay more for it. The result is that powder coatings have become a commodity for many applications and margins are among the lowest in the industry.
A side benefit to understanding true value is that you understand what is not valued. Those qualities and services that are not essential can be eliminated. The result is lower cost and a focus on what is really important. Orr & Boss works with clients in two ways to eliminate non-valued effort. First, quality function deployment (QFD) is used to identify the product attributes or services that provide the most value to the customer. Second, sales personnel are trained to work with customers to identify what is valued and to be proactive in responding to changes in customer value.
Customer loyalty cannot be bought. You may get customers in the door with price promotions but you cannot keep them on that basis alone. Customers that are gained solely on the basis of price will be lost on price the next time a competitor has a sale.
Customer loyalty is about a relationship between the customer and the supplier, a relationship where the supplier takes the time and effort to understand what the customer really needs to be successful. Oftentimes, when the true value is understood, new and unique means of meeting the need can be developed. This extra effort will lead to greater profits. Just as customers will not pay for product features or services that they do not value, they will pay a premium for those that they do.
A recent Orr & Boss study found that most small residential paint contractors, those with fewer than five full-time painters, do not value on-site delivery. A company catering to that customer segment who has invested in on-site delivery will not be able to recoup that cost — it has no value to the customer. Just as bad as the lost capital is the opportunity cost. The money spent on the delivery service could have been invested in services valued by the customer that would have led to added income.
How Is Customer Value Determined?Understanding customer value is easy to describe and difficult to implement. You simply have to ask the customer what is important. Satisfaction surveys are interesting, and they may provide valuable information, but they will not define customer value. At best a satisfaction survey will indicate how well you are meeting the goals that you think are important. They will not tell you where the customer places importance. This requires much more work, and actually talking to the customer.
At a macro level, targeted customer interviews and focus group meetings can provide insight into customer value. The best source of information, however, is at the point of direct customer interface. This may be a salesperson, store manager, or another company representative. Two types of information need to be collected. The first type is the “gotta haves.” These are the features or services that must be present for the supplier to be considered a viable choice. The second type of information is the “wants.” This is where your offering can be differentiated and not just be a commodity.
Commercial architectural paint contractors were the focus of a recent Orr & Boss value determination project. This study revealed that the contractor “gotta haves” were the usual technical attributes of architectural paint. The coatings had to meet certain performance specifications for the job. Technical properties in and of themselves were not seen as differentiative. Similarly, the paint purchased had to be priced competitively, but not the lowest priced. What these contractors really wanted was time. Those interviewed stated that they would be willing to pay a premium for products or services that reduced the time required for them to complete a job. They were looking for the lowest applied cost, not just the lowest priced paint. A company can use this type of information to tailor their offering to their clientele. The result will be increased loyalty and increased retention.
It is important to note that, for the customer interface to be an effective means of information gathering, four conditions must exist. These are: the representative must be trained to ask the right questions, it must be easy for the customer to provide feedback, the information must be compiled and internalized, and the customer must see action on his wants and needs. The last item is particularly true for customers on the verge of changing suppliers. A dissatisfied customer who has his concerns quickly and thoroughly addressed will become one of your most loyal customers. A customer whose concerns are not addressed will become one of your greatest detractors and is unlikely to ever be a customer again.
The Prize of LoyaltyThree significant benefits result from increased customer loyalty. The primary benefit is increased customer retention. As previously documented, increased retention rates can significantly improve a company’s bottom line. Second, customer loyalty makes additional purchases much more likely. A merely satisfied customer might shop around for various products and sundries. A loyal customer is inclined to purchase as much as possible from one source, regardless of price.
This leads to the third benefit, insensitivity to price variation. When you deliver exactly what the customer desires and have built a relationship with the customer, price becomes a much lower priority. As a result of increased sales per customer and reduced price sensitivity, it has been estimated that long-term specialty chemical customers add over 25% more profit to the bottom line than do short-term ones.
Independent paint dealers represent a valuable customer segment for many coatings companies. Orr & Boss research conducted for the National Paint and Coatings Association’s upcoming U.S. Paint & Coatings Market Analysis (2000-2005) has revealed that brand image with consumers is the major factor driving the dealer’s choice of primary brand. In fact, the largest single reason offered by dealers who were contemplating switching brands was that the paint line they carried no longer had the brand equity it once did. If the brand of paint could not generate customer traffic, the technical attributes and company service were meaningless. A dealer who saw value in the company name would be less likely to switch over small problems and would be willing to pay more for the paint. Conversely, a dealer who did not believe that the brand name was providing value would be less hesitant to switch, would be more demanding and would be more cost conscious.
ConclusionIn today’s competitive environment, coatings companies cannot afford to ignore their greatest assets — their customers. It is easy to assume that price drives all buying behavior, but that’s simply not the case. A company that makes the effort to understand true customer value can reach beyond customer satisfaction to customer loyalty. Customer loyalty in turn will reduce lost business, increase sales to existing customers and reduce price sensitivity. In a marketplace of low growth, price wars and product commoditization, customer loyalty can be the key to continued success and income growth.
For more information, contact Orr & Boss Inc., 44450 Pinetree Drive, Plymouth, MI 48170; phone 734/453.3033; or visit www.orrandboss.com.