Use Discounts for Customer Retention?

The following is from the March 2009 Drilling Down Newsletter.  Got a question about Customer Measurement, Management, Valuation, Retention, Loyalty, Defection?  Just ask your question.  Also, feel free to leave a comment. 

Want to see the answers to previous questions?  Here’s the blog archive; the pre-blog newsletter archives are here.

Q:  Most CRM experts agree that discount is a terrible way to attract new customers.  They seem to all agree that these “transaction buyers” are money-losing customers and have no loyalty.

A:  I think using discounts profitably for customer acquisition depends a lot on your “Brand Personality” and your business model.  That said, often people screw this up and attract the wrong kind of customer.

Q:  But, I have seen a  lot of different opinions on the use of discounts to increase loyalty and retention among current customers.  I have seen experts contradicting themselves on this subject saying that discount is a terrible way to reward gold customers or to move up customers to a “better segment” and after some time they contradict themselves mentioning a successful discount case study (points are a common method used).  Jim, what is your opinion about using discounts as a weapon in a retention program?

A:  First, we have to define “discount”.  Price discounts have the effect of reducing margins, but so do “better service” ideas like “VIP phone lines” and loyalty programs.  So you can take your discount on the top line or the operational line, the fact is it costs money to provide good service to best customers in hopes of keeping them.  I mean, what’s the $10 million you spent on a CRM system?  Choose your poison, it costs money to retain customers.

The real question is this – can you make money doing it, in any of the above cases.  If by giving a customer a discount I increase their overall profitability, in excess of what I lose on a discount, then I made money.  Same with the costs of a loyalty program, a rebate program, a newsletter, a special room, a lead management system, etc.

End of story. Whatever you do, it has to make more money, or it’s silly.

Problem is, most people don’t know how to *measure* any of this properly.  This is the topic of the Chapter in the book “Expense and Revenue You May Not Be Capturing” (Ch 29).

Discounts aren’t bad by themselves.  What screws people up is not offering them at the right time to the right customers with the right value of the discount or operational expense.

Discounting to best customers can be very dangerous – something most people don’t know, let alone measure correctly.  You can lose money very, very quickly.  I often rail against this; you have to understand subsidy costs and how to measure them or you get burnt very quickly.  I got burnt for over $1 million in a single promotion doing this – and it was the exact same promotion I made over $1 million on 6 months earlier.  Difference?  LifeCycle stage of the customer.  Or, if you prefer, the process of dis-engagement.

Here’s a real world example.  *ACTIVE* (engaged) HSN customers spent about $320 a month, buying 8 $40 items.  If I send them a coupon for $10 off, they spend $310 buying 7 items at $40 and one $40 item at $30, so I lose $10 *plus* the cost of the promotion.

This is subsidy cost.  They would have bought anyway, and I let them do it for $10 less.  Said another way, this is the “Pull” effect – some people will buy without any Marketing at all.  These folks are overwhelmingly active best customers, those who are “engaged” and have interacted with you Recently.

Perhaps you have put brand new products up on your web site and found they are selling even before you promote them at all?  This would be evidence of engaged customers, and the value of those sales is the tangible result of the “Brand  Engagement” your company has created (at least for the week or month).

So, the $10 per customer sale loss represents a devaluation of the Pull value embodied in your Brand, Service, Products, and Execution.  It literally is equal to the amount of loss you sustain by “over-Marketing” to a customer who is loyal and already engaged.

I suspect it is this issue – known as subsidy cost – that draws the ire of the experts who are saying “discounts are a terrible way to reward gold customers”.  They are correct.

The best – meaning most profitable – way to reward loyal customers is with non-discount aspirational offers that drive loyalty.  These offers could be anything from simply thanking them for their business (surprising how well this can work if done correctly) to highly specialized services or access to the company.

Now, if I take this same group of HSN customers and send them a coupon for $10 off any purchase over $50, they spend $400 for the month, and increase of $80 from the average of $320.  Why?  Because on that coupon transaction, the average transaction value is $120 – 3x higher than the average without a coupon.  Did I make money on this campaign?  You betcha.  At an average 30% operationally loaded margin, I spent $10 to make $24 ($80 increase x 30%) – a profit of $14 on the transaction before promotional costs.

The same discount of $10 to the same customer segment can generate completely different behaviors.  The trick is to understand  these behaviors through careful testing and measurement using control groups to measure the real net lift in profits.

So now, let’s change customer segments, move later in the LifeCycle to Lapsing customers, those who are on their way to defecting.  These are customers who have stopped visiting or purchasing and have not had interactions with you Recently.

Lapsing HSN customers don’t respond well to $10 off $50 coupons – it’s too late in the LifeCycle, average price falls over time and they won’t “buy up”, the average purchase price won’t rocket to $120 from $40 like it will with active customers. 

But if you look at what they like to buy (category affinity), and send them a $10 off coupon for a specific category, and tell them when you’re going to have a cool show on that category, you make a ton of money on the promotion.  Why?  Because a huge number of them buy when they wouldn’t have (as demonstrated by the lack of buying behavior in the control group), and a few “restart” as active customers who continue to purchase for several months – the “re-engaged“.

Different segment, different timing, same offer that lost money with active customers generates profits with Lapsing customers.  How do you know when a customer is Lapsing, when you should switch from $10 off $50 to $10 off a specific category?  You test it; a Recency analysis and test is a great place to start with this idea, full story here.

You can also take advantage of known LifeCycle purchase transition behaviors.  Many best customers start out buying in one category and then switch to another; you can run a simple analysis to discover these patterns.  Many moderate value customers simply never make the transition.  But if you know there is a “likelihood” of the transition and help it along a bit, you can turn a moderate customer into a best customer with a well-timed category discount.

At HSN, a 60 day old “average customer” who started buying in jewelry, if sent a $10 off jewelry coupon, loses you money.  Why?  They already have enough jewelry, response is low, they are at the end of the LifeCycle for the category.  You net no “lift” – they just spend $10 less that month.  But if you send them a 20% off fashion coupon, you make a ton of money over the next 90 days.  Why?

Because if you study HSN best customer buyer behavior, you find they start in jewelry and migrate themselves to fashion.  So what you are doing here is taking a moderate buyer and “helping” them to discover a category with a high likelihood of long-term satisfaction.

You’re modifying the LifeCycle.  Instead of defecting, a portion of them become heavy fashion buyers – the longest LifeCycle, highest margin customers.  You may lose money on the first fashion purchase.  But you end up converting a bunch of them to a new higher margin product line where they will continue to purchase for years.

Over time, you continue to refines segments and discounts until you optimize the entire system for maximum profitability; you are using the LifeCycle to manage margins by applying discounts very precisely.  Example of this can be found here: The Discount Ladder.

Every business I have done marketing / customer analytics for works the same way.  But for interactive, these effects are amplified and become very significant.  This is one reason why interactive is different, and why it’s a bad idea to treat interactive like offline – say, by blasting out the same e-mail to every customer.

So yes, discounts can be bad.  But they can be very good.  They are the ultimate motivator, and so are very effective.  You just have to know the who, when, and what of using them.

Jim

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2 thoughts on “Use Discounts for Customer Retention?

  1. Hi Jim,
    Your post sounds really interesting. Discount is one of the promotional tool that is being used by various firms. Discounts usually attracts a good number of customers. But I think that to retain old customers , discounts may work sometimes but not always. If a customer is loyal to you price change does not matter a lot to him/her. Its about the quality of product and services given to the customer that matters. There are even customers who never buy a product if it is given in discounts.

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