What Loyalty? High-End Customers are First to Flee

Businesses that offer their customers the highest levels of service might like to believe that all their efforts to pamper and please will pay off with an extremely loyal following.

But as new research from Harvard Business School demonstrates, the customers you think are your best and most loyal are likely to be the first to cast you aside when a challenger to your service superiority barges into the market.

"Our results suggest that this is due to increasing expectations for service in these markets—the longer a firm has held a service advantage in a local market, the more sensitive are its customers to it service levels relative to those of competitors," says Harvard Business School's Dennis Campbell. In other words, you reap what you sow.

In How Do Incumbents Fare in the Face of Increased Service Competition? , Campbell, fellow HBS professor Frances X. Frei and doctoral student Ryan W. Buell explore this dance between service levels, customer loyalty, and competitive strategy. The study drew on extensive data gathered from a large US domestic bank operating in more than 20 states from 2002 to 2006.

In addition to proving what earlier models only hinted at—that new challengers offering high levels of service can siphon off the best customers of long-standing incumbents—the researchers learned something else: Firms rated lower in service quality are more or less immune from the high-end challenger.

These findings suggest that before mounting a counterattack on a competitor's incursion, it's important to understand your customer priorities and your business's place along the service cost continuum. In some cases it can be advisable or even necessary to invest in a response. In other cases, you may as well save your money, according to the researchers.

The study also concluded that even though high-end customers can be fickle, a company that sustains a superior service position in its local market can attract and retain customers who are more valuable over time.

"One prescription from all of this is that managers should avoid service complacency—or the tendency to rely on preexisting service advantages—and invest more in proactively increasing relative service levels when they're faced with even the potential threat of increased service competition," says Campbell.

Differences across markets
Customers and companies trade off between price and service. "Every customer has his or her own level of service sensitivity," says Buell. "There's a sorting process that takes place within the market so that customers end up with the combination of price and service that works best for them."

Companies, too, attempt to find the right balance between service level and price, but these calculations can vary widely. While some companies offer a consistent level of service across all locations, others alter service offerings according to the opportunities presented by the local markets. The bank studied by the researchers, which operated in 644 geographically isolated markets, offered different levels of service quality depending on location.

"It highlights that there are huge differences from market to market in what types of customers you attract and retain," Buell says.

In one market, the company may be at the top of the service scale and attract "high maintenance" customers who tend to be less satisfied and complain more than customers in a market where the firm occupies a lower-level service niche.

Consider Sheraton Hotels. In a market where Comfort Inn is a competitor, Sheraton might be the high-service option. But in another market Sheraton might be up against Ritz and Four Seasons, making it the more budget-conscious alternative.

"You can imagine," says Buell, "that the customers the Sheraton attracts in the first market compared to the second market are very different, and that the entrance of a high-service competitor in one market would affect the Sheraton very differently than it would in the other."

Is a standardized service-level strategy better than one that varies by market? There is something to be said for and against both approaches.

While there are certainly cost benefits to service standardization (Buell cites McDonald's as an example), the drawbacks can outweigh them if you're serving a customer group that doesn't want or need a particular service.

"If you occupy different service spaces in different markets, as was true with the bank we studied, you'll be using the same strategy to serve customer groups that are systematically different from market to market," says Buell.

The banking industry's rich array of data made it a prime subject for such a study. "Banks maintain customer data at a very fine grade level, and the government captures competitive data, so we have a very good picture of when competitors enter and exit markets and what the composition of a market is at any one time," says Buell. Third parties also track service quality (J.D. Power in this case). And because banking is a service that touches almost everyone, its customer group is diverse, making the study's results applicable to other service industries, such as hotels.

Teasing apart customer satisfaction
Buell's general research agenda considers how firm-level decisions affect customer actions and firm performance. He is continuing to collaborate with Campbell and Frei on a research project that explores different parts of a bank's operating system to determine the degree to which each transaction affects customer satisfaction.

"Past research has shown that the employee, the kind of transaction, the location, and the market can all affect customer perceptions," Buell says. "But no work has disentangled what percentage…is related to each of these factors. This will in turn indicate to what degree operating managers can control customer satisfaction. Essentially, we're looking at the entire operating system and drilling down to determine which factors are most important for driving perceptions of service quality."

This article was provided with permission from Harvard Business School Working Knowledge.