Customer Specific Marketing

CHAPTER TWO

The two principles of

Customer Specific Marketing

In the previous chapter we saw examples of how customer behavior is influenced by the rewards offered, and how some food retailers have introduced customer specific pricing because they see it as an advance over their previous one price fits all strategy.

The first chapter was presented as a "flesh and blood" lead-in to the two principles of customer specific marketing which will be discussed in depth in this chapter. These two principles are:

1)    All customers are not equal.

2)    Behavior follows rewards.

We shall discuss them in turn.

1)All customers are not equal.

Customers buy different items when they visit a store. They spend different amounts. Some customers visit regularly, some infrequently, and some just once. Some were in your store today; others last shopped with you months ago. Some come because of your advertised specials, some come because its convenient, and others come because they prefer your total offering. Customers are different, and they yield different profits-and losses. Lets see how different our customers really are.

A look at five customers

A food retailer in the United States has a customer profile similar to that shown in Table 2-1. In this table, the five customers names each represent one-fifth of the customers in the database. The top quintile (20%) of customers, represented by Lucy Loyal, spends per week (SPW) about $53 with a gross profit of about 25%. Lucys shopping life with us is over seventeen years. This means that Lucy Loyal will spend this year about $2,756 ($53 x 52 weeks = $2,756) in our stores, for an annual gross profit of about $689 ($2,756 x 25% = $689).

Table 2-1: Customer Profile:

Stuart Split, representing the middle quintile of customers, spends about $8 per week (about $416 over the course of a year) with a gross profit percentage of 18%, yielding about $75 in annual gross profits.

Carol Convenience, representing the bottom quintile (comprising many convenience and occasional customers), spends over the course of 52 weeks, about $1 per week or about $52 in annual sales. With a gross profit percentage of 15%, this is about $8 in annual gross profit.

The other two customers, Russell Regular and Sherry Cherry, have results which fall in between those of the above three customers.

It becomes blindingly apparent that with a customer profile like this, charging the same price and offering equal benefits to all five customers not only doesnt make sense from an equity viewpoint, but also makes us extremely vulnerable! Any competitor with a better offer-bundle, in the form of a combination of lower prices and greater benefits aimed specifically at our Lucy Loyals, could steal these most profitable customers (whom we are currently over-charging to subsidize our Sherry Cherrys and Carol Conveniences).

Of course, this is what warehouse clubs have done over the past decade. They lured away a significant portion of the traditional retailers best (high spending) customers by offering them the lowest prices on large item purchases. The warehouse clubs focused on the high spending, high profit segment and left the low spending, low profit customers with the traditional retailers. Unable to fight back because of their inability to differentiate their offers easily, traditional retailers suffered.

But the justification for differentiating becomes overwhelming when we consider how much in sales and gross profits each of the customers in Table 2-1 contribute over their shopping lifetime. Lucy Loyal regularly shops in our stores for over seventeen years; Stuart Split about four years; and Carol Convenience about one and a half years.

This means that Lucy Loyal, our typical top quintile customer, spends about $41,340 over her shopping lifetime with us, providing about $10,335 in life time gross profits (L/T GP). This compares to Stuart Splits $1,664 in lifetime sales and $300 in lifetime gross profits, and Carol Conveniences lifetime sales and profits of about $78 and $12, respectively.

What a dramatic difference in sales and gross profits from customers who, traditionally, have all been charged identical prices! What a great opportunity it presents to a retailer to reallocate his advertising and promotional markdown monies in favor of his Lucy Loyals and Russell Regulars, and away from his Sherry Cherrys and Carol Conveniences, now that he has the information and tools to do so!

Yet, as you know, the practice of many food retailers has been just the opposite, with priority given to the convenience shopper. For example, a Carol Convenience can walk into most food stores, buy the specials (some of which may be below cost), and then go through the express lane receiving priority service, while the big spending, high profit Lucy Loyals wait in lines two or three customers deep!

Why have we treated customers the same?

Why, then, in the past have we treated customers all the same and offered them merchandise at identical prices? The answer, quite simply, is because we didnt have a cost-effective system to make different offers to our different customers.

But that has now changed-because technology has given us new tools. And as Daniel Burrus, the author of Technotrends, reminds us, "When the tools change, the rules change."

Now that the tools of retailing have changed, so too must the rules. And all customers are equal, the dictum of the past five decades of mass marketing, is the first rule to change. It is replaced by its antithesis: all customers are not equal!

Differentiation is now accepted and expected

Customers have already accepted this new rule. They understand that customers are not equal and know that different deals for different customers make sense. In fact, because of their exposure to the proliferation of differentiated marketing practices already in our society (particularly in airlines, hotels and car rentals), customers not only accept it-but expect it.

Recently, one leading food retailer commissioned an external survey of its customers some months after introducing a frequent-shopper card. The company wanted to learn their customers thoughts about his new program. Two of the typical responses were:

"Quite right! You should reward your main shoppers, because they spend more!"

"I spend over $3,000 a year here! You should reward us for all of this!"

This companys customers were telling them that not all customers are equal and that they have accepted its direct implication of differentiated pricing.

Scott Ukrop, Vice President of Marketing, Ukrops Super Markets, Richmond, Virginia, tells us (in his speech in Chapter 12) of similar findings at his company. He said that:

Customers like to be treated like the individuals that they are. We were pleasantly surprised that our customers did not mind receiving different offers than those of their neighbors. This had been a major concern in our organization. Customers accepted the fact that the offers were based on their purchases.

Such comments should allay the fears of those retailers who have been taught from their very first day in retailing to treat every customer the same-regardless of their economic contribution to the company.

The bottom line-all customers are not equal

All customers are not equal. We must incorporate this fact in our business strategy by de-averaging our customers and our offers to them, both to recognize their diversity and to optimize our profitability. We should not hesitate to introduce differentiated marketing-it is already accepted and expected.

2)Behavior follows rewards.

Man is an economic animal in search of self importance. Thus, our behavior changes in response to the economic and "egonomic" (to use Faith Popcorns apt expression) rewards around us. We respond to positive rewards and avoid negative rewards.

This is abundantly demonstrated in our children. We continually influence their behavior with a mix of positive ("If you do this, Ill let you stay up late!") and negative ("If you do that, youll be grounded for a week!") rewards.

Consider how our own behavior is influenced by our desire to maximize our frequent-flyer miles total. We choose one airline over another. We accept longer layover times at airports to connect with our favorite air miles provider. We prefer our airline affinity credit card over the proprietary card when shopping at our local department store. We choose hotels and car rental companies that offer air miles on our preferred airline. And when we check in at airports, we take the initiative to ensure that our frequent-flyer number has been recorded. We dont wait to be asked-its in our self interest to ensure that our number is recorded!

Or consider this. How many of us let our magazine subscriptions lapse because we know that we will be offered an unbelievable, last-ditch, low subscription price 6-12 weeks after the subscription has lapsed? We have figured out that we will be rewarded for not renewing our subscriptions on time and have altered our behavior accordingly.

General Nutrition Center Inc., a chain of mall-based health stores, offers a Gold Card for an annual fee of $15.00, entitling members to 20% off their total purchases on the day they sign up and on the first Tuesday of each month. Want to guess which day of the month is the busiest? Its the first Tuesday!

We are like Skinners pigeons

B. F. Skinner, one of the twentieth centurys giants in the behavioral school of psychology, devoted his life to understanding how human behavior can be modified by altering the mix and value of the rewards in our lives. Like most psychologists, his early work was with laboratory animals, where one of his most celebrated successes was teaching pigeons to play table tennis through a series of positive reinforcements!

After several years of studying changes in customer behavior (drawing on the information in various retailers databases), Im sad to relate that we human beings are really a lot like those pigeons! We respond very readily to the changes in the reward structures around us! Indeed, our behavior changes in direct proportion to the increases and decreases in the size of the rewards offered.

Let me illustrate:

.        One caring retailer has a program which gives senior citizens 10% off any purchases they make on Mondays. When analyzing the customer database, we found that two-thirds (67%) of the senior citizens weekly spending at that company now occurs on Mondays. This is five times the rate of the other customers, who spend only 13% of their weekly total on Mondays. Behavior follows rewards.

.        One retailer offered a free turkey to customers spending an average of at least $50 a week in the two months prior to Thanksgiving. The result? The number of households spending over $50 per week skyrocketed 20% over the preceding year! Behavior follows rewards.

.        When one retailer announced that all advertised specials would henceforth be available only to customers presenting their cards, the percentage of company transactions on the card jumped 8% that very week. Behavior follows rewards.

.        Another retailer told his customers that 1% of their spending during the course of the year would be donated to the church of their choice. Result: the participating cardholders increased their annual spending more than 5%. Behavior follows rewards.

.        One retailer introduced an employee discount program based on household spending. Both the number of employees using a card and their total spending jumped more than 20% over the previous year. Behavior follows rewards.

Reward the behavior you seek

Quite simply, if behavior follows rewards, then we must reward the behavior we seek-and not the opposite, as occurs too often. The promotional activity of department stores over the past forty years illustrates this well. With their one-day sales, weekend sales, week-long sales, end-of-season sales, and other similar promotions, they taught customers not to shop in their stores unless they were having a sale! In other words, they were rewarding customer promiscuity rather than long-term loyalty (which, we assume, is what they really desired). This contradictory behavior is called the folly of rewarding behavior A when we really want behavior B!

Applying the principle

Our first task as retailers in applying the principle that behavior follows rewards is to ask ourselves two questions:

1)    What customer behavior are we currently rewarding?

2)    What customer behavior do we wish to reward?

To assist in answering these questions, consider:

.         Do we want customer loyalty or promiscuity?

.         Do we want better or more customers?

.         Do we want high or low spending customers?

.         What is more important to us-increased sales or increased profitability?

.         What changes in behavior are required to hold onto more of our good customers and lengthen their average stay with us?

.         Of the behaviors we have chosen as our goals, which are the most profitable ones to be rewarding?

The bottom line-behavior follows rewards

The principle that behavior follows rewards isnt new, of course. Its as old as recorded history. However, what is new for retailers is that with a customer database we can make different offers to different customers, measure the changes in behavior, and then refine our offers accordingly.

As retailers, after we have set our corporate goals, we must review our existing customer reward structure and consider how it can be changed to better reward the customer behavior that moves us closer to our chosen goals. Its folly to do otherwise! In essence, we must water what we want to grow. But first, we must decide what we want to grow!

Achieving success

Like everything else in life, success is based upon the application of sound principles. The greater the application, the greater the success. Customer specific marketing is no different. The more you embrace customer specific marketing and base your business strategy on its two principles-all customers are not equal and behavior follows rewards-the better will be your results. In other words, to achieve great success, you must make customer specific marketing the core strategy.

Too many companies introduce frequent-shopper card programs and dont see any profit improvement. Usually, this is because they are just that-programs, and not a change in core strategy. To succeed with customer specific marketing, it must become central to your business-it cannot be an add-on to an existing marketing program. It means abandoning a host of existing marketing practices. It means focusing resources on the gathering of customer data so that you can make intelligent, differentiating decisions. It means re-engineering your marketing strategy-indeed, ultimately, your whole organization.

The other ingredient for success

Embracing customer specific marketing as your core strategy is the first ingredient for success. The second is the practice of differentiation. As all customers are not equal, it is logical that our offers should be different for different customers. The next chapter is devoted to this single idea.

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CHAPTER FOUR

Think, and act, strategically

Too many retailers practice puppet strategies. They permit their competitors to jerk their strings, to dictate their marketing strategy. For example, when a competitor introduces double or triple coupons or a senior citizens program, they do likewise. They monitor competitors advertisements and agonize when they are eclipsed by a penny or two on a bananas or ground beef promotion. Rather than give their customers a different choice from their competitors, these companies are offering just an echo. They are but puppets, whose actions are determined by their competitors.

One contributing factor to this common business behavior is the lack of customer information. Without such information the retailers eyes are focused on his total sales figure. He has no idea what impact his mimic responses are having on the sales and profitability of his individual customer segments-on his loyal customers, his split customers, his occasional and promiscuous customers, or his new customers. Or the impact these mimic responses have on the churn and turn of his customer base.

Fortunately, this is changing. Companies that understand their customer dynamics are switching from being puppets to being puppeteers because they are measuring-daily, in some cases-the impact and results of their differentiated marketing strategies.

Pulling their own strings

One food retailer, up against some of the toughest and finest competitors in this country, switched from puppet to puppeteer over a year ago. Its management team now controls its own strings because they measure the effect of each decision on their customers. Recently, I had the privilege of asking the three top executives of this company what they had learned since switching to customer specific marketing. Heres what they told me:

.         "Now we don't mind telling customers the reason some of them get better deals than others. Today, when a customer approaches us on the store floor and asks why she didn't get a special offer like her neighbor and then goes on about how much she has shopped in the store, we quietly take her across to the PC at our service counter, scan her card and find out what her shopping history has been. Usually, we find there has been minimal activity, so we say, in a nice way, Well, maam, Im sorry but it appears that you have not been using your card very much because theres only one entry here in the last four or five months. The customer then usually becomes flustered and says, But I shop here a lot anyway! So we quietly say, We really would like you to use your card so that we can give you these special offers we are making to our good customers. As you know, the more a customer spends with us, the better the offers become, and using your card is the only way we can know this. And-this is something new for us-we dont then turn around and give her the deal, which we would have done before the introduction of our program. The bottom line is that we are no longer trying to be all things to all people and trying to satisfy all customers in all circumstances. Information is now an extremely powerful tool for us!"

.         "We are no longer trying to take customers away from our major competitor. Our focus is to make money on the customers who are already shopping with us!"

.         "We have overcome the fear of differentiating our customers."

.         "Our good customers are no longer subsidizing our occasional shoppers. Rather, its vice versa."

.         "We no longer watch every competitor's ad every week." (The Vice President of Marketing said that every Sunday morning he used to rush down to get the morning papers to see all of his competitors ads! He doesn't do that anymore.)

.         "Weve found that only the cherry pickers complained about our new rules, and then it was only a handful of them."

.         "Our good customers love being appreciated!"

.         "With such a program, a company can't continue offering an Every Day Low Price program, honoring competitors coupons, meeting competitors prices, having a Senior Citizens program, and so on. You must focus entirely on this new way of marketing!"

This company, now a global leader in the practice of differentiated marketing, has seen a remarkable improvement in its profitability and is now a dedicated practitioner of initiating and differentiating, rather than imitating. It no longer cedes control of its destiny to its larger competitors, despite its competitors deeper pockets. These executives now confidently pull their own strings because their customer information has demonstrated that their differentiation strategy is paying off!

Information-based retailing

Just as the nature of military strategy is changing from brute power to information-based electronic weaponry, so, too, is the nature of retail strategy changing. Retailing, like war, is fast becoming an electronic battlefield! Customer information and customer knowledge are now part of our arsenal.

Does a retailer who knows who his customers are, how often they shop, how much they spend on each visit, and when they start-and stop-shopping with him, have an advantage over his competitors who are without this information? Of course he does! Its comparable to sailing at night without a compass. Quite simply, a retailer today sailing without a well-utilized customer database is headed for the shoals of second class performance or the depths of disaster!

Information provides enormous leverage. Our objective should be to lever our insights and knowledge more effectively than our competitors do. The intelligent use of information is now a competitive advantage to those who use it to drive their businesses.

Change the terms of engagement

One successful way to jump ahead in a stable or stagnant situation is to change the terms of engagement. Nelson defeated the French at Trafalgar when he surprised them by changing from traditional side-by-side naval warfare to cutting through their ships and blasting their unprotected bows and sterns. A great deal of military, and business, success has occurred as a result of changing the terms of engagement.

Even in the movies we see this vividly portrayed. One of my favorite examples is when Indiana Jones, in The Raiders of the Lost Ark, is confronted in a narrow Cairo street by an imposing black-hooded, scimitar-twirling thug! Things look bad for Indiana-really bad! But after assessing the situation, Indy nonchalantly steps back, pulls a pistol from his belt and shoots his potential assailant. He changed the terms of engagement from what his opponent had in mind! He changed the nature of the battle to suit his strengths.

So, too, are the early practitioners of differentiated marketing changing the terms of engagement in their marketplaces. They are changing the nature of the battle to suit their new weaponry-customer information. And like Lord Nelson and Indiana Jones, they are experiencing decided success! Their advantage, of course, will not last forever. Their competitors will learn the power of this new form of marketing and adopt it for their own use. In the meantime, however, like the early possessors of gunpowder, their technological advantage is tipping the marketing balance of power in their favor. Their challenge, of course, is to sustain their newly gained advantage.

Hi-Lo operators are vulnerable

Over the past forty years, two primary pricing strategies have been prevalent among traditional retailers: High-Low, or Hi-Lo, pricing and Every Day Low Price, or EDLP, pricing. We are now witnessing the third wave of retail pricing-customer specific pricing-which is superior to the two traditional formats.

Consider the typical Hi-Lo retailer today with his large number of advertised and unadvertised specials requiring in some companies up to 1,500 price changes a week in each store! In addition, he often has 1,000-4,000 items reduced and listed as Temporary Price Reductions (TPRs), ranging from a few cents to a few dollars off regular price. In addition, he may offer discounts on all items in various categories, such as 40% off all greeting cards. For good measure, he may also offer double coupons and possibly honor, in true puppet style, his competitors ad prices and coupons.

Apart from the high cost of operating this strategy (including advertising, markdowns, executives tied up in weekly meetings, store labor, and inventory overages), this Hi-Lo retailer gives the same special prices to anyone who walks into the store-his regular customer, his competitors loyal customers, convenience shoppers who never even saw his newspaper ad, and one-time shoppers.

This traditional Hi-Lo operator is now highly vulnerable to a differentiated marketer who can, armed with customer knowledge, offer a superior price package, but only to regular, higher spending customers. This attracts profitable customers away from the Hi-Lo operator who, in turn, replaces the lost high-profit sales by increasing his advertising, thereby attracting more of the low-profit, promiscuous shoppers in the marketplace. This, in turn, causes margins and profits to decline further. At the same time, the differentiated marketer is reducing advertising costs because he now knows of the low profitability and loyalty of the promiscuous shoppers who are attracted, like moths, by the seductive flame of heavy print advertising.

EDLP operators are vulnerable, too

In contrast, an EDLP operator has lower operating costs than a Hi-Lo operator because he advertises less, has fewer specials, and, therefore, requires less labor. His point of difference is that he offers customers lower shelf prices every day.

Many EDLP operators have resisted the change to customer specific marketing. The two most common reasons offered have been, "We want to have the lowest prices for all of our customers," and "We dont want to add any costs or complexity to our business."

These arguments are no longer sound because:

.         The EDLP operator cant gather any detailed customer data. Therefore, he cant learn his customer composition or its underlying dynamics. His decision-making is still based on assumptions and not on facts, which places him at a competitive disadvantage.

.         The EDLP operator charges his best and worst customers the same price. Even if his cost level is significantly lower, he is vulnerable to a differentiated marketer because he is charging his $10,000 a year customer identical prices to that of his $100 a year customer; he is charging the same prices to the customer with an $80 transaction that he does to a customer with a much less profitable $8 transaction!

Thus, the differentiated marketer can target and win over the EDLP operators best customers by offering, for example, a quarterly discount to high spending customers. Or the differentiated marketer can straddle the prices of the major image items of the EDLP operator by having a lower price for cardholders and a higher price for non-cardholders. This puts the EDLP operator in an awkward competitive position. If he responds by matching the cardholders lower price, the move costs him more because some of the differentiated marketers sales are to non-cardholders and carry a high gross profit. If the EDLP operator matches the higher price, he loses his price image. And by staying at his existing price, his price image is compromised.

.         The EDLP operator can be beaten on benefits. Because he knows who his best customers are, the differentiated marketer can offer these highly profitable customers non-economic benefits and privileges (which he cant afford to give to all customers). Of course, the EDLP operator, without customer information, cannot respond in a cost-effective manner.

.         Differentiated marketing does not have to be complicated. As described earlier, one leading EDLP operator, Food Lion, has already started moving to a differentiated marketing strategy. The companys tiered pricing strategy is simple and inexpensive to operate. Yet it provides a vehicle for the company to gather customer data and skew rewards in favor of their higher spending customers.

For these reasons, it seems inevitable that EDLP operators, like Hi-Lo operators, will be forced to move to differentiated marketing.

Think, and act, strategically

As blunt-spoken General George S. Patton once said: "The best way to neutralize a competitors heartbeat is to change the rules of play." The practitioners of customer specific marketing are doing just that-by being puppeteers, not puppets!

As we conclude the first section of the book, it appears obvious that the question that all retailers today should be asking themselves is not if, but when, should they embrace customer specific marketing? When should they adopt this information-rich marketing approach which will allow them to truly think, and act, strategically?

About the author...

Brian Woolf is a global leader in loyalty marketing. In addition to writing three definitive works on the subject, Measured Marketing: A Tool to Shape Food Store Strategy, Customer Specific Marketing, and Loyalty Marketing: The Second Act, he spends his time helping retailers develop and strengthen their loyalty programs.

The techniques and metrics he has developed have become guiding principles for those operating some of the worlds most successful programs. He is the President of the Retail Strategy Center, and is a frequent speaker at conferences in the US, Europe and Japan.

Prior to his total commitment to loyalty marketing, his corporate roles included Deputy Managing Director of Progressive Enterprises, a major New Zealand retailer; Chief Financial Officer of Food Lion, a leading US food retailer; and President of One Price Clothing, a women's discount apparel chain. He has an M.Com. (Economics) from Auckland University, New Zealand, and an MBA from the Harvard Business School.

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