E-Loyalty: Your Secret Weapon on the Web

E-Loyalty: Your Secret Weapon on the Web

by Frederick F. Reichheld and Phil Schefter

Reprint r00410

JULY – AUGUST 2000

Reprint Number

The Dubious Logic of Global Megamergers R 0 0 4 0 5

Change Without Pain R 0 0 4 0 1

Stop Fighting Fires R 0 0 4 0 2

Starting Up in High Gear: R 0 0 4 0 3An Interview with Venture Capitalist Vinod Khosla

E-Loyalty: Your Secret Weapon on the Web R 0 0 4 1 0

Rocket Science Retailing Is Almost Here – Are You Ready? R 0 0 4 0 4

What Every Executive Needs to Know About Global Warming R 0 0 4 0 9

FORETHOUGHTCan You Patent Your Business Model? F00401When Bots Collide F00402Explaining XML F00403A Better Way to Crack China F00404Competitive Fitness F00405Venture Philanthropist F00406

HBR CASE STUDYEntrepreneurs Versus Executives at Socaba.com R 0 0 4 0 8

FIRST PERSONHarley’s Leadership U-Turn R 0 0 4 1 1

HBR AT LARGEWho Wants to Manage a Millionaire? R 0 0 4 1 2

BEST PRACTICEWaking Up IBM:How a Gang of Unlikely Rebels Transformed Big Blue R 0 0 4 0 6

BOOKS IN REVIEWThe New New Capital Thing R 0 0 4 0 7

PANKAJ GHEMAWAT

AND FARIBORZ GHADAR

ERIC ABRAHAMSON

ROGER BOHN

DAVID CHAMPION

AND NICHOLAS G. CARR

FREDERICK F. REICHHELD

AND PHIL SCHEFTER

MARSHALL L. FISHER, ANANTH RAMAN,

AND ANNA SHEEN MCCLELLAND

KIMBERLY O’NEILL PACKARD

AND FOREST REINHARDT

A CONVERSATION WITH Q. TODD DICKINSON

JEFFREY O. KEPHART AND AMY R. GREENWALD

EILEEN ROCHE

WILFRIED R. VANHONACKER

REGINA FAZIO MARUCA

MARGARET HANSHAW

REGINA FAZIO MARUCA

RICH TEERLINK

SUZY WETLAUFER

GARY HAMEL

WALTER KIECHEL

O YA LT Y M AY N O T B E T H E F I R S T

idea that pops into your headwhen you think about electroniccommerce. After all, what rele-vance could such a quaint, old-fashioned notion hold for a world in which customers defect at theclick of a mouse and impersonalshopping bots scour databases forever better deals? What good is asmall-town virtue amid the face-less anonymity of the Internet’s

global marketplace? Loyalty mustbe on a fast track toward extinc-tion, right?

Not at all. Chief executives at thecutting edge of e-commerce – fromDell Computer’s Michael Dell toeBay’s Meg Whitman, from Van-guard’s Jack Brennan to Grainger’sRichard Keyser – care deeply aboutcustomer retention and consider itvital to the success of their on-lineoperations. They know that loyalty

Copyright © 2000 by the President and Fellows of Harvard College. All rights reserved. 105

In the rush to build Internet businesses, many executives concentrate all their

attention on attracting customers rather than retaining them. That’s a mistake.

The unique economics of e-business make customer loyalty more important than ever.

by Frederick F. Reichheld and Phil Schefter

Your Secret Weapon on the Web

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E-Loyalty

is an economic necessity: acquiring customers onthe Internet is enormously expensive, and unlessthose customers stick around and make lots of re-peat purchases over the years, profits will remainelusive. They also know it’s a competitive necessity:in every industry, some company will figure outhow to harness the potential of the Web to createexceptional value for customers, and that companyis going to lock in many profitable relationships atthe expense of slow-footed rivals. Without the glueof loyalty, even the best-designed e-business modelwill collapse.

Over the past two years, we have been studying e-loyalty with our colleagues at Bain & Company.We have analyzed the strategies and practices of

many leading Internet com-panies, evaluated the designsand workings of their Websites, and surveyed thou-sands of their customers.What we’ve uncovered maycome as a surprise. Contraryto the common view thatWeb customers are fickle bynature and will flock to thenext new idea, the Web is

actually a very sticky space in both the business-to-consumer and the business-to-business spheres.Most of today’s on-line customers exhibit a clearproclivity toward loyalty, and Web technologies,used correctly, reinforce that inherent loyalty. If ex-ecutives don’t quickly gain the loyalty of their mostprofitable existing customers and acquire the rightnew customers, they will face a dismal future cater-ing to the whims of only the most price-sensitivebuyers.

We’ve heard new-economy pundits argue thatthe Internet has overturned all the old rules of busi-ness. But when it comes to customer loyalty, theold rules are as vital as ever. Loyalty is still aboutearning the trust of the right kinds of customers –customers for whom you can deliver such a consis-tently superior experience that they will want to doall their business with you. The Web does, however,raise new questions and open new opportunities:

it places the old rules in a new context. Our goal in this article is to describe that context and its implications.

The Economics of E-Loyalty Ten years ago, Bain & Company, working with EarlSasser of Harvard Business School, analyzed thecosts and revenues derived from serving customersover their entire purchasing life cycle, and we pub-lished the results in this magazine. (See “Zero De-fections: Quality Comes to Services” in the Sep-tember–October 1990 issue.) We showed that inindustry after industry, the high cost of acquiringcustomers renders many customer relationshipsunprofitable during their early years. Only in lateryears, when the cost of serving loyal customers fallsand the volume of their purchases rises, do relation-ships generate big returns. The bottom line: in-creasing customer retention rates by 5% increasesprofits by 25% to 95%. Those numbers startledmany executives, and the article set off a rush tocraft retention strategies, many of which continueto pay large dividends.

When we applied the same methodology to ana-lyzing customer life-cycle economics in several e-commerce sectors – including books, apparel, gro-ceries, and consumer electronics – we found classicloyalty economics at work. In fact, the general pat-tern – early losses, followed by rising profits – is ac-tually exaggerated on the Internet. (See the exhibit“Customer Life-Cycle Economics in E-Com-merce.”) At the beginning of a relationship, the out-lays needed to acquire a customer are often consid-erably higher in e-commerce than in traditionalretail channels. In apparel e-tailing, for example,new customers cost 20% to 40% more for pure-playInternet companies than for traditional retailerswith both physical and on-line stores. That meansthat the losses in the early stages of relationshipsare larger.

In future years, though, profit growth acceleratesat an even faster rate. In apparel e-tailing, repeat cus-tomers spend more than twice as much in months24–30 of their relationships than they do in the firstsix months. And since it is relatively easy for Webstores to extend their range of products, they cansell more and more kinds of goods to loyal cus-tomers, broadening as well as deepening relation-ships over time. The evidence indicates, in fact,that Web customers tend to consolidate their pur-chases with one primary supplier, to the extent thatpurchasing from the supplier’s site becomes part oftheir daily routine. This phenomenon is particularlyapparent in the business-to-business sector. For

106 harvard business review July–August 2000

E-Loyalt y : Your S ecret Weapon on the Web

Frederick F. Reichheld is a director emeritus of Bain &

Company and a Bain Fellow. He is the author of The

Loyalty Effect (Harvard Business School Press, 1996) and

the forthcoming Building Loyalty in the Age of the Inter-

net (Harvard Business School Press, 2001).

Phil Schefter is a vice president in Bain’s Boston office

and a leader in the firm’s e-commerce practice.

Price doesnot rule the Web;trust does.

example, W.W. Grainger, the largest industrial sup-ply company in the UnitedStates, discovered that long-time customers, whose vol-ume of purchases throughGrainger’s traditional branch-es had stabilized, increasedtheir purchases substantiallywhen they began usingGrainger’s Web site. Sales tothese customers increased attriple the rate of similar cus-tomers who used only thephysical outlets.

In addition to purchasingmore, loyal customers alsofrequently refer new cus-tomers to a supplier, provid-ing another rich source ofprofits. Referrals are lucra-tive in traditional commerceas well but, again, the Inter-net amplifies the effect, sinceword of mouse spreads evenfaster than word of mouth.On-line customers can, forexample, use e-mail to broad-cast a recommendation for a favorite Web site todozens of friends and family members. Many e-tail-ers are now automating the referral process, lettingcustomers send recommendations to acquaintanceswhile still at the e-tailers’ sites. Because referredcustomers cost so little to acquire, they begin togenerate profits much earlier in their life cycles.

EBay is one e-commerce leader that is reaping theeconomic benefits of referrals from loyal cus-tomers. More than half its customers are referrals.“If you just do the math off our quarterly financialfilings,” CEO Meg Whitman recently told the WallStreet Journal, “you see that we’re spending lessthan $10 to acquire each new customer. The reasonis that we are being driven by word of mouth.” EBayhas even found that the costs of supporting referredcustomers are considerably lower than for thosebrought in through advertising or other marketingefforts. Referred customers tend to use the peoplewho referred them for advice and guidance ratherthan calling eBay’s technical support desk. In effect,loyal customers not only take over the function ofadvertising and sales, they even staff the company’shelp desk – for free!

The combination of all these economic factorsmeans that the value of loyalty is often greater on theInternet than in the physical world. For all compa-

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Consumer electronics /appliances

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Groceries

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harvard business review July–August 2000 107

Customer Li fe -Cycle Economics in E-Commerce


nies doing business on the Web, the implication isclear: you cannot generate superior long-term prof-its unless you achieve superior customer loyalty.

A Matter of TrustTo gain the loyalty of customers, you must firstgain their trust. That’s always been the case, but onthe Web, where business is conducted at a distanceand risks and uncertainties are magnified, it’s truerthan ever. On-line, customers can’t look a salesclerk in the eye, can’t size up the physical space of a store or office, and can’t see and touch products.They have to rely on images and promises, and ifthey don’t trust the company presenting those im-ages and promises, they’ll shop elsewhere. In fact,when we asked Web shoppers to name the attri-butes of e-tailers that were most important in earn-ing their business, the number one answer was “aWeb site I know and trust.” All other attributes, in-cluding lowest cost and broadest selection, laggedfar behind. Price does not rule the Web; trust does.

When customers do trust an on-line vendor, theyare much more likely to share personal informa-tion. That information enables the company toform a more intimate relationship with customers,offering products and services tailored to their indi-

Source: Bain & Company and Mainspring

vidual preferences, which in turn increases trustand strengthens loyalty. Such a virtuous circle canquickly translate into a durable advantage overcompetitors.

Amazon.com, for example, has come to domi-nate the on-line book market by creating the mostreliable and trustworthy Web site in the business.Millions of customers feel comfortable letting Ama-zon store their names, addresses, and credit cardnumbers in its ordering system. The resulting con-venience – customers can make repeat purchaseswith just one click – has become a critical competi-tive edge. It’s one of the biggest reasons customerskeep coming back – to buy not just books but alsoCDs, videos, hardware, and myriad other products.If customers didn’t trust Amazon, if they feared thattheir credit card numbers might be compromised or that they might be deluged with a torrent of spam,they would never share their personal information,and the company would quickly lose its privilegedposition. The company understands the value oftrust very well. In 1999, when the media revealedthat Amazon was accepting compensation frompublishers for its purportedly independent book re-views, it reversed course immediately. It realized itwas putting its most important asset at risk.

Another exemplary company that uses trust asthe foundation for loyalty is the Vanguard Group.The fastest growing mutual fund company over thepast decade, with more than $500 billion in assetscurrently under management, Vanguard has pouredmore than $100 million into the development of itsWeb site. Unlike many of its competitors, Vanguarddoesn’t use the site to hype its products. Rather, ituses its on-line presence to inform and educate itscustomers – even when that means leading themaway from a purchase. When you click throughVanguard’s pages, you are often warned against investing in certain funds. You may, for example,receive a message advising you that one fund is ap-proaching its dividend distribution date and sug-gesting that you postpone investments to avoid in-curring tax liabilities. Or you may see certain fundsflagged because their recent performance has beenparticularly strong. The descriptions of such high-fliers usually bear a note of caution from CEO JackBrennan warning that recent returns may not besustainable in the future. That’s quite a contrastfrom most fund companies, which lure investors byaggressively promoting the returns of hot funds.

Vanguard understands that building trust leads tomore enduring relationships – and more profits –while a quick sale may simply leave a customerfeeling cheated. Says Brennan: “Trust is our num-ber one asset at Vanguard. We recognize you can’t


buy trust with advertising or salesmanship; youhave to earn it – by always acting in the best inter-ests of customers. We didn’t design our Web site to sell more products and services. We designed it toeducate our customers and provide better and moretimely information and advice so they can makebetter decisions.”

Vanguard goes against the grain of common Webstrategy in another way: it makes it difficult forcustomers to access its site. Account holders mustfirst apply for a password, which, instead of beingdelivered immediately via e-mail, is mailed fromheadquarters to ensure confidentiality. Then, to ac-tually enter the site, customers have to upgrade to a 128-bit browser that is compatible with the sophis-ticated encryption technology Vanguard created toguard account information. Downloading thebrowser can take an hour or more. “Sure, the 128-bit encryption security requirement can be a has-sle,” says Brennan, “but we believe it is the rightway to protect our customers’ assets.” The strategyis paying off. Vanguard’s site already accounts for40% of the company’s interactions with customersand, for all its quirkiness, has received numeroushonors, including the Webby Award for site design.

In addition to generously rewarding trust, the Internet opens new opportunities to build trust.Everyone knows, for example, that communitiesflourish on the Web. Less understood is how thetrust built up in such communities can be trans-ferred to the companies that host them. Again,eBay provides a great example. In the past, fearsabout reliability and fraud prevented the exchangeof used merchandise among strangers from devel-oping into a big business. But eBay used the uniquecapabilities of the Web to establish and enforcerules of engagement. Buyers and sellers rate eachother after every transaction, and the ratings areposted on the site; every member’s reputation thusbecomes public record. EBay further reduces cus-tomers’ risks by automatically insuring the first$200 of each transaction, thus insulating sellersfrom unscrupulous buyers, and it will hold moneyin electronic escrow until the buyer is satisfiedwith the merchandise received. In a sense, eBay isusing the Internet to bring small-town rules oftrust to the most challenging of markets – a globalnetwork of strangers. And it is reaping the rewardsof its members’ loyalty.

Focusing on the Right CustomersWhen many executives and entrepreneurs look atthe Web, they see an opportunity to break free fromone of the core constraints of the traditional busi-


encourages customers to discuss their needs with thebranch employees who can simplify the choices. Andbecause Grainger recognizes that customers have totrust employees in order to cede power over their pur-chases, it carefully trains its people to act in their cus-tomers’ best interests, not to simply maximize the salescommission or branch profitability.

When Grainger moved to the Web, its already stag-gering selection of products more than doubled. Thecustomer who clicks onto Grainger’s site will find aquarter of a million different products – the equivalent

of a 10,000-page catalog. Without skillful presen-tation, this welter of information would

be overwhelming. But Grainger hastaken pains to simplify and speedproduct searches so customers canclick onto only those options thatinterest them. And for thousands ofits best accounts, the company hasintegrated customer-specific pric-ing on-line, which further simpli-fies the shopping experience.Grainger knows the Web pro-vides infinite possibilities fornew products and services, butit also knows that customerswill trust only a vendor thatdemonstrates a deep under-

standing of their particular needsand that helps them navigate the vari-

ous choices and trade-offs.


How Grainger Helps Customers Make Sense of Complexi t y

The Web creates an almost infinite set of product andservice possibilities, freeing companies from all sorts oftraditional limitations, including location, shelf space,and the product knowledge of salespeople. But with thefreedom to do more comes the temptation to do toomuch. Companies can present so much information andso many choices that customers are left confused andfrustrated.

The business-to-business powerhouse W.W. Graingerhas spent a lot of time thinking about how to help customers make sense of complex offerings – both in itsphysical network of branches and on itsWeb site. One of Grainger’s coreadvantages is the breadth ofits selection – it can deliverany product a companyneeds when it needsit. Totaling some 4,000pages, Grainger’s tra-ditional paper cata-log includes almost90,000 maintenanceand repair products.Many customers, how-ever, find the catalog morethan a little daunting. Theylike to have the choice of twoor three different motors withthe same power rating, but theyreally don’t want to choose froma list of 20. The company therefore

ness world: the need for focus. Because a Web site isaccessible to any on-line customer anytime, any-where, there is a huge temptation to try to attract asmany potential buyers as possible. That temptationis reinforced by the vast up-front investments insite development and process design that compa-nies often have to make in launching an e-business.Executives presume that these fixed costs shouldbe amortized over as many customers as possible.So they become caught up in a frenzy of indiscrimi-nate customer acquisition, gauging their success bythe sheer number of page views, unique visitors,

and sales they rack up. The fact that careful cus-tomer selection has always been a foundation ofbusiness success gets completely ignored.

A lack of focus makes building loyalty muchmore difficult. Customers want Web sites that aresimply designed, fast to load, and easy to use, butthe broader the array of customers a company at-tempts to serve, the more complex its site in-evitably becomes. In trying to be all things to allpeople – to accommodate all levels of technical ex-pertise, all service requirements, all price sensitivi-ties, and all degrees of brand preference – it must

constantly add new features and functions. As itdoes, its site becomes slower to load and more com-plicated to use. Customers flock in but, confused bywhat they find, they rarely return. (See the sidebar“How Grainger Helps Customers Make Sense ofComplexity.”)

An indiscriminate approach to customer acquisi-tion also undermines profitability – a fact that is often overlooked in e-commerce, as investors andexecutives focus their attention on traffic statistics.The simple arithmetic of loyalty economics makesit clear that in most Web businesses, customersmust stay on board for at least two to three yearsjust for a company to recoup its initial acquisitioninvestment. Yet we found that a large percentage ofnew customers – up to 50% in some sectors – defectbefore their third anniversary with an e-commercesite. Any company pursuing a strategy of grabbingcustomers as quickly as possible without regard totheir potential for long-term relationships is in for a very bad surprise – as are its investors. (See the ex-hibit “The High Cost of Low Loyalty.”)

Vanguard’s experience reveals the wisdom of fo-cus. It has created both strong customer loyalty anda substantial cost advantage through its highly dis-ciplined approach to attracting customers. The com-pany concentrates on individuals with long-terminvestment horizons who appreciate the low-cost,

low-churn advantages of index fund investing –Vanguard’s specialty; it has honed its marketingand customer acquisition activities to cater to thatsegment. Its relentless focus has allowed it to main-tain an overwhelming cost advantage: its expensesas a percentage of average assets run at 30 basispoints versus 120 for competitors. Vanguard spends,for instance, only about one-tenth of what competi-tors do on advertising, yet it adds new customersfaster than most of them due to word-of-mouth rec-ommendations. It also minimizes its operatingcomplexity by investing only in those features andproducts that appeal to its target customers.

In moving to the Web, Vanguard has been carefulnot to dilute its focus; its site is tailored to theneeds of its core customers. Vanguard.com’s bro-kerage arm, for instance, does not provide the kindof sophisticated trading capabilities other on-linebrokerages offer. The company made a consciouschoice to forgo the business of speculators in order

to cater to its traditional, more conservativeclients. The typical Vanguard brokerage customer,who trades only three or four times a year, wouldsimply be confused by the complex informationscreens that day traders demand.

In identifying which customers to attract – andwhich to avoid – the first step is to clearly assess thedifferent categories of on-line customers. Contraryto a common perception, the majority of on-lineshoppers are not out to score the absolute lowestprice. The largest single segment of on-line cus-tomers, we found, are seeking convenience aboveall else. They want to do business with a site thatmakes their lives easier, and they are willing to paymore for that convenience. Price rational but notprice obsessive, they also have a strong inclinationtoward loyalty. After all, returning to a familiar siteis much more convenient than scouting out a newone. Another large group of customers are influ-enced primarily by brand. They, too, are looking forstable, long-term relationships. If a company as-sumes that the customers it is losing to dot-comsare motivated solely by price – and thus not worthdefending – it is probably mistaken.

The way a site is designed and marketed has alarge impact on the types of customers it attracts.Our research reveals that the mix of customer seg-ments varies widely among Web competitors with-

in the same market; some sites at-tract a rich mix of loyalty-orientedcustomers and others primarily at-tract the price butterflies who flitfrom site to site seeking bargains. Inthe grocery business, for example,75% of one leading company’s new

customers are relationship-averse bargain hunters,while 75% of a direct competitor’s new customersare convenience- and brand-driven shoppers.

The loyalists we surveyed found sites mostlythrough referrals. The butterflies, by contrast, re-ported that they were lured by promotional dis-counts and general advertising. In the grocery seg-ment, for example, the best butterfly bait seemed tobe untargeted banner ads. If a Web company isspending most of its marketing dollars on indis-criminate banner ads and on-line coupons, with lit-tle investment in building communities and pro-moting referrals, it is probably building long-termlosses into its customer base.

Learning About LoyaltyWhile the Internet may seem like an anonymousspace, in reality it is far easier to track customers,their purchase histories, and their preferences on-



If a company assumes that the customers it is losing

to dot-coms are motivated solely by price – and thus

not worth defending – it is probably mistaken.

line than in a traditional business setting. Cus-tomers in bricks-and-mortar stores leave no recordof their behavior unless they buy something – andeven then the data are often sketchy. But in virtualstores, their shopping purchase patterns are trans-parent. Every move they make can be documentedelectronically, click by click. If a customer exits aWeb site when the price screen appears, it’s a fairbet that he’s price-sensitive. If he jumps from pageto page without ever initiating a transaction, he’sprobably frustrated at being unable to find what hewants.

By providing such rich data, the Internet offerscompanies unprecedented opportunities for gettingto know their customers in depth and for customiz-ing offerings to meet their preferences. Very fewcompanies, however, are actually doing much to realize that potential. We found that less than 20%even track customer retention rigorously, let alonetry to systematically learn from customer defectionpatterns. Instead, they are fixated on building theirWeb capacity and increasing their visitor counts,click-throughs, and on-line sales. As a result, theyoverlook opportunities for upselling and cross-sell-ing and end up capturing a much smaller share ofcustomers’ overall purchases than they might have.Research shows, in fact, that the average Web siteachieves less than 30% of its full sales potentialwith each customer.1

America Online is an exception. It meticulouslymeasures customer loyalty and purchase patternsand uses that information to guide its decisionsabout strategy, marketing, and site design. To thecasual observer, the company’s approach to cus-tomer acquisition may seem like a carpet bombingof free diskettes, but the approach is based on acareful analysis of the retention rates and life-cycleeconomics of different customer segments. Thecompany conducts many small-scale tests of cre-ative customer-acquisition programs, but it investsheavily only in those that are likely to bring in cus-tomers whose long-run revenues justify their acqui-sition cost.

When AOL upgraded its software from version 3to version 4, data on customer behavior informedmany of its technological decisions. For example,AOL had been carefully monitoring the root causesof calls to its customer support center, and it madeimprovements to the new software, such as makingthe help menu easier to use, that solved the prob-lems generating a large percentage of the calls. AOLknew that handling fewer calls would reduce itssupport costs, but that was not its primary impetus.Its core goal was to enhance the convenience of itsservice – and thus strengthen its appeal to and its


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Typical acquisit ion cost per customer

The High Cost of Low Loyalt y

Consumer electronics /appliances


Groceries

Apparel

Source: Bain & Company and Mainspring

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Years to break even

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Percent of customers who defect before the break-even point

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hold on convenience-driven customers. The com-pany also analyzed the drivers of customer loyaltyin creating the upgrade. It had found that customerswere much more likely to maintain their accountswhen AOL was part of their daily routine, so it en-hanced the software’s calendar and schedulingfunctions and its stock-portfolio tracking service.As customers have increasingly used AOL to man-age their day-to-day lives, the service has becomemuch more sticky.

Dell Computer is another company that hasmade the measurement of customer behavior acornerstone of its e-business strategy. The com-pany set up a customer experience council, report-ing to a corporate vice chairman, to oversee its

measurement efforts and its loyalty-building pro-grams. Senior executives from each of the compa-ny’s major business lines and functions participatein the council. In a recent interview, council mem-ber and senior vice president Paul Bell explainedthat Dell looks to apply the same rigor to trackingcustomers as most companies do to tracking finan-cial results: “Every public company tells share-holders how it’s doing every quarter, but few com-panies have a set of metrics that measure thecustomer experience from month to month, quar-ter to quarter [as we do].”

After studying data on customer retention, thecouncil found three key drivers of loyalty: order ful-fillment, product performance, and postsale serviceand support. It then identified the best summarystatistic for each driver. For order fulfillment, itchose “ship to target,” which measures the per-centage of orders delivered to the customer on timewith complete accuracy. For product performance,it picked “initial field incident rate,” which mea-sures the frequency of product problems encoun-tered by customers. For service and support, itchose “on-time, first-time fix,” which measuresthe percentage of problems fixed on the first visit bya service rep who arrives at the time promised.

The council set up systems to track each statis-tic, and the performance data are updated daily andshared with all employees. In addition, aggressiveimprovement targets have been established foreach measure, and management bonuses are tied totheir fulfillment. Dell tracks many other aspects

of service performance and customer response, ofcourse, but by focusing its organization on the threesummary measures, it has simplified its goals andcreated a rallying point for employees. In 1999, theprogram achieved a 15% rate of improvement, andsimilar gains are expected in the future.

Another metric tracked by most loyalty leaders is the lifetime ownership cost of their products orservices. Dell, for example, calculates all the costsits customers incur in shopping for, ordering, in-stalling, operating, servicing, and disposing of com-puters and necessary software – whether those costsare paid to Dell or to other parties. That informationguides the company’s investments in new productsand services; Dell places a high priority on invest-

ments that create new revenuestreams for the company while re-ducing customers’ overall ownershipcosts and thus strengthening theirloyalty. An example of such an in-vestment is the Dell Auction site,where customers can sell their out-dated equipment. The auction bene-

fits the customer while generating fees for Dell. The real value of tracking measures of loyalty is

that it allows companies to see beyond today’s fadsto the underlying drivers of business success. Instudying repurchase patterns at leading Web sites,we found that the five primary determinants of loy-alty don’t consist of technological bells and whis-tles, but rather old-fashioned customer-service ba-sics: quality customer support, on-time delivery,compelling product presentations, convenient andreasonably priced shipping and handling, and clearand trustworthy privacy policies. Of course, the drivers of loyalty will vary for each business andwill evolve over time. But executives who don’t setclear loyalty targets and measure their progress willinevitably drift toward weak retention performanceas their organizations focus their energy in less pro-ductive areas. The long-term economic conse-quences of such a passive approach to e-loyalty willbe dire.

The Big PictureMany companies have been tempted to split theirWeb businesses from the rest of their operations –in hopes of cashing in on investors’ enthusiasm fordot-coms or of making it easier to attract the kindof talent required to manage Web activities. In theshort run, such a strategy may create benefits; overthe long run, however, it is likely to erode customerloyalty. After all, when a customer does businesswith a company, she doesn’t distinguish between a



Grainger does not view the Web as a way to reduce

costs by bypassing its commissioned sales force. It

pays commissions no matter which channel is used.

transaction on the Web and one in a physical storeor branch – they are both elements of her total expe-rience with the company. Leaders like Vanguard,Dell, and Grainger understand that loyalty is deter-mined by the full range of their interactions withcustomers, and they consciously integrate their op-erations to produce a seamless, quality experience.

In this view, the Web becomes, to borrow aphrase from Vanguard’s Jack Brennan, “a tool, not a strategy.” Its unique capabilities are used to im-prove communications with customers, to enhanceorganizational learning about customers’ needs andincrease responsiveness, to reduce customers’transaction costs, and to enhance convenience – allof which are vital for developing strong and durablerelationships. But these capabilities are not exer-cised in isolation. They are plugged into the fullrange of corporate capabilities.

When an employee of one of Dell’s corporate cus-tomers needs to order a computer from Dell, for ex-ample, chances are good that one of Dell’s morethan 2,000 direct sales representatives has alreadyworked face-to-face with the company’s purchasingstaff to hammer out pricing schedules and hard-ware and software configurations. The individualemployee is thus free to place the order over thephone, on the Web, or through the mail, whicheveris most convenient, and can subsequently draw onthose channels, in any combination, to check on theorder’s progress or to ask questions. And when themachine arrives, it doesn’t have to be routed throughthe company’s IT help desk to have inventory tagsapplied or software configured – Dell has alreadydone that. If there’s a technical problem, the em-ployee or a corporate technician can access cus-tomized diagnostic and prescriptive information onthe Web or over the phone with a Dell technician.This exceptional integration of customer service iswhat distinguishes Dell from the competition andmakes life much easier for the customer.

Grainger is another company that seamlessly in-tegrates its Web channel with its traditional busi-ness. It has spent more than $75 million to build itshighly successful Web operation, which now trans-acts more sales than all but a handful of other busi-ness-to-business sites. Customers clearly appreciatethe site’s 24-hour availability – nearly one-fourth ofGrainger’s Web orders come in during times whenits branches are closed. But Grainger does not viewthe Web channel as a way to reduce costs by bypass-ing its commissioned sales force. Rather, it payssales commissions no matter which channel isused. That way, the sales reps will always direct cus-tomers to the most convenient channel. Grainger’sgoal is to earn an ever-higher share of each cus-



tomer’s business – and because it never loses sight of the overall customer experience, it is succeed-ing. Its customers are increasing their Web pur-chases at more than double the rate for the overallindustry.

Home Depot, which most people view as a purelybricks-and-mortar retailer, has also done an exem-plary job of integrating the Web with its traditionalbusiness. Because small contractors are one of thecompany’s most profitable segments, its Web sitefocuses on serving these customers better. Contrac-tors can check the Web to see if their orders areavailable for pickup at the store, thus saving them-selves (and store personnel) both time and aggrava-tion. While this new Web capability does not di-rectly generate more revenues, it does increase thevalue delivered to a group of highly profitable cus-tomers and thus increases the likelihood thatthey’ll continue to buy from Home Depot. Integra-tion strengthens loyalty.

Nothing but the TruthIn the end, loyalty is not won with technology. It iswon through the delivery of a consistently superiorcustomer experience. The Internet is a powerfultool for strengthening relationships, but the basiclaws and rewards of building loyalty have notchanged. By encouraging repeat purchases among a core of profitable customers, companies can initi-ate a spiral of economic advantages. This loyalty effect enables them to compensate their employeesmore generously, provide investors with superiorcash flows, and reinvest more aggressively to fur-ther enhance the value delivered to customers.

What is changing is the pace at which these eco-nomic rules are playing out, and the speed withwhich companies must improve their products andservices if they hope to keep customers loyal. Cus-tomers’ tolerance for inconsistency and mediocrityis rapidly disappearing. In the past, convenient storelocations, aggressive sales forces, and a general lackof information shielded companies from the penal-ties of providing anything less than the best productand service quality; customers were loyal by neces-sity, not choice. Thanks to the Internet, thoseshields have been dismantled. Customers can com-pare suppliers in real time, all the time. Building superior customer loyalty is no longer just one ofmany ways to boost profits. Today it is essential forsurvival.

1. See Sarabjit Singh Baveja, “Making the Most of Customers,” IndustryStandard, February 28, 2000.

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E-Loyalty: Your Secret Weapon on the Web

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