Why increased customer satisfaction isn’t always good for business
Increased customer satisfaction and enhanced customer experience isn’t necessarily a driver for increased customer lifetime value, and doesn’t always lead to better profitability
In a previous blog post I argued that the future value of a company’s customer relationships should form the basis for profitability analysis, with Customer Lifetime Value (CLV) as the key number to track. To analyze and improve profitability we therefore need to understand the drivers of CLV.
In this blog post I want to elaborate on an interesting topic regarding these drivers that often becomes a source of discussion: Increased customer satisfaction and enhanced customer experience isn’t necessarily a driver for increased CLV, and doesn’t always lead to better profitability. In some cases, the effect on profits can even be negative. How can this be?
Where does the money come from?
It is quite common, and maybe even intuitive, to consider customer satisfaction and customer experience as drivers for increased profitability. This is often also an underlying premise when commercial companies use aggregated measurements like Customer satisfaction (CSAT) and Net Presenter Score (NPS) to evaluate business performance. In order to explain why this in some cases isn’t correct, we need to start with a basic question: Where does the money that determine a company's profit come from?
The profitability of a single customer is a result of how much money the customer spends minus the cost to serve the customer, and these numbers usually vary across the customer base. A rule of thumb, illustrated by the Stobachoff curve below, states that only 20% of customers contribute to actual profitability, while the remaining 80% could be considered break-even or are running at a loss.
For the purpose of CLV-modeling, it’s not the historical customer profitability that matters, but rather the customer’s future profitability potential. Low-profitability customers with a large potential are often the most interesting customers to invest in. The customer profitability analysis should therefore also say something about potential.
Are happy customers more profitable?
So, with the acquired knowledge about your customers, how can you then increase profitability? Simply put: You can make the existing customers spend more money or you can reduce the cost to serve them. You can also grow your total customer base by acquiring new (and profitable) customers.
Let us for now limit ourselves to the income generating side of the equation. There are several ways to increase income, but the most resource effective way is to increase spending from existing customers, by targeting the so-called share of wallet. The share of wallet is defined as the amount of a customer's total spending in a given product or service category that is captured by your company. But to be able to increase the share of wallet we need to know that the customer actually has more money to spend. This is where the link to customer satisfaction and experience comes in.
If we focus on improving the experience for customers that already spend all their available funds at our company, they might be happier, but not more profitable (of course we need to work with retention, but that is a different story). And even worse; what if we at the same time make other customers less happy, and they end up spending less money? This is exactly what happened to the American retail giant Walmart back in 2008, when they ended up losing market shares and revenues despite investing heavily to improve customer satisfaction.
You can read more about the Walmart-example and the abovementioned argumentation in an excellent book and HBR article co-written by CSI advisory board member Tim Keiningham. The authors also propose a whole new way of estimating profit, well worth a read.
What does this mean for the design of customer experiences?
The typical service design approach starts with the needs and desirability of the customer. But if profitability is what you aim for, I believe you need to understand the economic potential of your customer base before service design efforts are initiated.
Customers have different profitability potential and should be segmented accordingly. Increased profitability is achieved by targeting improvements for customers with the largest economic potential.