-Specific Strategies Customer retention: A usage segmentation and customer value approach Received (in revised form): 19th November, 2001

Art Weinstein PhD is Professor of Marketing in the Wayne Huizenga Graduate School of Business and Entrepreneurship at Nova Southeastern University, Fort Lauderdale, Florida. He teaches graduate courses in customer value, international marketing, managerial marketing and research, and market segmentation. He has consulted for Bayer, Hewlett-Packard, Intel, Motorola, Novartis, and many other organisations. Dr Weinstein is the author of three books — ‘Market segmentation’, ‘Defining your market’, and ‘Designing and delivering superior customer value’, and more than 50 scholarly articles/papers on marketing strategy.

Abstract This paper discusses how companies should develop a customer retention focus and initiatives to maximise long-term customer value. Specifically, it examines the importance of customer retention; conceptualises an integrated customer value/retention model; and explains how usage segmentation can assist in relationship-building, retention strategy and profit planning. A brief case history of Fast Industries, a specialty plastics manufacturer, illustrates these ideas in practice. Implications for marketers and customer value managers are offered and research directions for scholars working in retention marketing are identified.

Custom Research, Inc. (CRI), a their time, energy and resources chasing Minneapolis-based (USA) marketing new business. While it is important to research firm was able to cut its find new to replace lost customer base in half yet triple its business, grow the enterprise and expand revenues and double its profits over a into new markets, this goal should be ten-year period ending in 1998. This was secondary in importance to the main accomplished by practising individualised objective — keeping customers and ‘surprise and delight’ marketing for three enhancing customer relationships. For dozen high-volume/high-margin clients example, in France, customer retention is (CRI’s core partners), hand-picking and critical in the mobile phone market; growing profitable new accounts operators have large customer acquisition (averaging $200,000 annually), and expenditures and lose more than 30 per Art Weinstein 2 Nova Southeastern systematically eliminating more than 100 cent of their subscribers annually. The University, Huizenga low-volume/low-margin customers.1 profitability of customer retention School, 3100 SW 9th Avenue, Fort Lauderdale, strategies can be determined by industry FL 33315 USA. retention rates, usage segmentation and Tel: 954-262-5097; WHY FOCUS ON CUSTOMER creating and measuring long-term Fax: 954-262-3965; RETENTION? 3 e-mail: [email protected]. customer value. edu Most companies spend a majority of In an analysis of switching behaviour

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in service industries, Keaveney found that Later, Reichheld advised firms to ‘be service-oriented factors such as core picky’ because a ‘truly humble company service problems, service encounter knows it can satisfy only certain failures, inconvenience, response to failed customers, and it goes all out to keep service and other issues accounted for them happy’. Vanguard was cited as an about 70 per cent of the reasons why exemplary organisation in this regard. customers defect (pricing strategies only Targeting long-term investors rather than accounted for 17 per cent of the day traders, Vanguard’s service:expense switching behaviour).4 Once marketers ratio (0.3 per cent) was one-quarter of realise that customers leave organisations the industry average (1.2 per cent).6 primarily due to service reasons, these While a study by Marketing Metrics, a issues become highly controllable from New Jersey (USA) firm, notes that the firm’s perspective. corporations spent 53 per cent of their Frederick Reichheld, of Bain & budget on customer retention, there is Company, is a leading consultant on still concern that most effort is spent on loyalty management. In his book,‘ The wooing new customers, or the great loyalty effect’, he builds a strong case for ‘one-night-stand’. A vice president at emphasising employee retention and that firm urged marketers to look at this customer retention in business. Service figure with scepticism. He noted that the companies must retain the best personnel definition of retention marketing is so to win and keep good customers — the broad that databases, satisfaction surveys average company loses about half of its and couponing can qualify as retention employees in four years. He notes that it activities (often such initiatives do not is impossible to build a loyal bank of target existing high-value customers); customers without a loyal employee base. compensation and promotions are Reichheld also shares these important generally based on demonstrating statistics on the significance of customer short-term profits (transaction business) at retention:5 the expense of longer-term paybacks; and retention is viewed by many companies — on average, US corporations lose half as the ‘fad of the week’.7 In reality, 80 of their customers in five years per cent or more of marketing budgets — a typical company has a customer are often earmarked for getting new defectionrateof10–30 per cent per business (or less than 20 per cent for year keeping customers). A preferable — raising the customer retention rate by approach may be to invest at least 75 per 5 per cent can increase the value of cent of a company’s marketing budget on an average customer (lifetime profits) activities and by 25–100 per cent customer retention strategies. — Lexus has repurchase rates more Conventional wisdom suggests that it than20percenthigherthan costs at least five times more to get a Infiniti. While Lexus only accounts new customer than keep an existing one. for 3 per cent of Toyota’ssales,it Some other ‘well accepted beliefs’ contributes 30 per cent toward their regarding customer relationship profits management are that companies should: — State Farm determined that a 1 per cent increase in customer retention — treat individual customers as assets will increase its capital surplus by (portfolio management techniques can more than $1bn over time. be useful in this context)

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Table 1 Usage segmentation categorisations

Heavy, medium, light, former and non-users (A,B,C,D,X) Heavy half segmentation (80/20 rule) Users versus non-users Competitive users Loyal (degree) versus non-loyal customers Product/service applications by user group Adopter categories — innovators, followers, laggards, lead users Geographic comparisons — customer penetration indices, growth

— create valid estimates of customer users and former users. By classifying lifetime value customer accounts based on usage — be willing to fire unprofitable frequency and variety, companies can customers.8 develop effective and profitable strategies for retaining and upgrading customers. Philip Kotler, the internationally As Table 1 shows, there are many highly renowned professor at Northwestern informative, low-cost applications of University, states that the key to usage analysis that should be considered customer retention is customer by management. satisfaction. He notes that satisfied For example, a hotel may grade customers: customers based on the number of rooms booked annually. The key accounts are — stay loyal longer A1 users — these are large organisations — talk favourably about the organisation that reserve thousands of room nights — pay less attention to the competition and conference facilities. A2 customers — are less price sensitive also book a high volume of rooms — offer service ideas to the organisation without the conference arrangements. A — and cost less to serve than new third category of heavy users is the A3 customers.9 account — this is a solid, loyal customer that generates hundreds of room nights, annually. Four descending usage levels of B customers (B1 to B4) are considered USAGE ANALYSIS AND medium users. Finally, five types of C CUSTOMER RETENTION accounts (C1 to C5) represent light Segmenting markets by consumption users. The C5 guest may only visit the patterns can be quite insightful for hotel once a year. understanding the customer mix. Land’s By classifying customers into usage End and LL Bean use ‘customer purchase categories, management can design patterns to compute the probability of appropriate strategies for each market purchase for each of the merchandise segment. The objective is to move lines. Armed with this information, these customers up the ladder, where possible. firms send the customer only those The implication of usage analysis is that catalogues for which the calculated all customers are not equal — some (the purchase probability exceeds a threshold heavy users) are clearly more valuable value.’10 than other categories. For example, Differentiated marketing strategies are McDonald’s Corporation actively targets needed for various user groups — ‘super-heavy’ users. These customers are first-time users, repeat customers, heavy typically male, aged 18 to 34 and eat

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there three to five times a week, planning subsequent customer accounting for 77 per cent of its sales.11 attraction/conquest marketing efforts. In business and professional service The marketing information system, the markets, the best customers may be database, plays a pivotal role in customer identified as key accounts based on analysis and decision making. customer ranking (eg the 100 most For unprofitable customers (many C important customers), minimum sales accounts), the company often needs to volume level (eg $1m in annual business) find new ways to serve them more or market share (eg an annual account effectively. Technology such as ATM exceeds 1 per cent of the total business). machines can be used in this regard. The Pareto Principle or 80/20 rule is Quarterly contact through newsletters insightful in this context. In a typical and direct mail or access options such as business approximately 80 per cent of charge free telephone numbers and sales come from about 20 per cent of websites maintains adequate customers and generally, about 80 per communication with low-volume users. cent of sales come from 20 per cent of In some cases, it is even desirable to the goods or services offered. It is sever the relationship with unprofitable essential to defend this core business base customers. since heavy users (A accounts) are A good understanding of customers’ primary targets for key competitors. purchasing patterns helps firms keep These highly profitable customers require customers and gain a larger share of frequent advertising, promotions, sales their business. Share of customer (a calls and ongoing communication efforts. customer retention measure) has Strategy Consulting Inc.’s usage analysis supplanted market share (a customer revealed that 26 per cent of its business attraction objective) as the relevant (long-term clients) accounted for 84 per business performance dimension in cent of its profits. In addition, 22 per many markets. Share of customer can cent of its revenues (mergers and be adapted by industry and goes by acquisitions) yielded 87 per cent of its such names, among others, as share of profits. Operational projects (33 per cent care (healthcare), share of stomach (fast of its revenues) were found to be a food) and share of wallet (financial losing proposition for the company; and services). For example, if a company is subsequent inquiries in this area were able to increase a customer’s share of farmed out to specialist consultancies.12 business from 20 per cent to 30 per Medium users (B customers) form the cent this can have a dramatic impact solid foundation of a business. Revenue on market share and profitability. enhancement strategies such as Recency, frequency and monetary cross-selling or value-added services can value (RFM) analysis is a helpful tool in be used to keep these customers satisfied evaluating customer usage and loyalty and grow their business. Telephone calls, patterns. Recency refers to the last e-mail and occasional sales calls are service encounter or transaction; suggestedinordertostayintouchwith frequency assesses how often these this group. By knowing who the better customer contact/company experiences customers are (the As and Bs) — occur; and monetary value probes the through geographic, demographic, amount that is spent, invested or psychographic and benefit research — a committed by customers for the firm’s profile of ‘typical users’ is established. products and services. A few years ago, This information is very helpful in this author purchased about $75 worth of

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Customer Attraction

Customer Customer Business Shareholder Loyalty Value Value Satisfaction Performance

Customer Retention

Figure 1 The Customer Retention/Value Model

brochure materials from a direct about how to ‘hold’ heavy users and key marketing firm for a one-time consulting accounts, upgrade light and medium project. This eager vendor immediately users, build customer loyalty, understand placed the author in the preferred buying motives to meet/exceed customer category and began sending expectations, use appropriate selling him expensive catalogues about every strategies for each targeted usage group, three weeks without any follow-up win back ‘lost’ customers, and learn why orders. RFM analysis tells us that this is non-users are not responding to a value not sound marketing practice since this proposition. company essentially treats all one-time triers as ‘best’ customers. Note that this transaction scored poorly on all the A CUSTOMER VALUE AND critical RFM dimensions: recency (three RETENTION MODEL plus years ago); frequency (a single Marketing managers know that it is purchase); and monetary value (relatively critical to deliver superior value to their low). customers, this ensures business A more effective strategy is to classify profitability. The proposed customer customers via usage analysis (as value/retention model offers a good way previously described) and design of conceptualising the key relationships differentiated marketing approaches for among the core elements (eg customer each target market. In sum, usage satisfaction, loyalty, business performance) analysis can greatly assist customer thatcreatevalueinanorganisation(see retention activities. It is useful to think Figure 1).

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The underpinnings of the model regression techniques in the service There has been much debate among sector found that a 5 per cent increase in practitioners and scholars as to what it satisfaction produces a 3 per cent increase takes to keep long-term customers and in continued use (.6) and a 2.5 per cent how organisations can maximise value. increase in recommending (.5); and, a 5 An integrated customer retention per cent increase in use results in a 2 per framework proposed by researchers in cent increase in recommending (.4).17 the global automobile industry lends Based on the above insights, a partial support for the customer five-element approach to creating value/retention model. Johnson and long-term customers should include colleagues explain that customer value components on value, satisfaction, loyalty, affects which in retention and profitability. This turn affects customer loyalty and straightforward perspective is reflected in ultimately customer retention. They add the proposed customer value/retention that loyalty increases with customer model. satisfaction at an increasing rate. In addition, these authors recommend that customers should be segmented by level Discussion of satisfaction prior to planning retention Providing superior customer value is the strategies.13 Further research in the car starting point in the horizontal customer industry using a sample of Volkswagen profitability chain (Figure 1). It is based customer club members in Germany on a sound mix of quality, service and found that customer satisfaction has a price (QSP) and the image, innovation strong impact on customer retention, and and intangibles (the three Is). These ultimately, economic goals.14 elements enable organisations to attract Another German study, in the mobile and keep customers. Companies should cellular telecommunications market, segment markets via demographic, showed empirical evidence of causal psychographic and usage approaches to linkages from customer satisfaction to locate new customers that find the firm’s customer loyalty to customer retention.15 value proposition appealing. Similar thinking guides Hellier’smodel Business firms typically use account which was tested in the insurance size and industry as a basis for identifying services sector. Relevant links here and targeting markets. While these data include perceived value (quality is a are readily accessible, they often provide component of this), customer satisfaction, little insight about how specific goods loyalty and switching costs, and and services are actually used by the repurchase intent. Additional product and customer. Therefore, product application brand preference factors are reported as segmentation should be considered as a intervening components between value-generating tool. The marine satisfaction and repurchase intentions market is a case in point. A fabric (retention).16 manufacturer may provide basic acrylic The SURe model states that as fabrics for power and sailboat covers as satisfaction (S) increases, the likelihood well as higher-value, custom-designed that customers will continue to use (U)a seat covers for inside the boat.18 service increases as does the likelihood of A one-time buyer is really a try-er, the customer recommending (Re)the rather than a customer. To move beyond service provider to another potential the transaction stage, organisational customer. Multi-industry research using experiences must meet or, preferably,

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exceed the buyer’s expectations. Repeated apparent. First, the key variables and incidents of high satisfaction are sought their relationships to one another are through the effective utilisation of clarified.Thisprovidesstrategicguidance relationship marketing strategies, leading to management. Secondly, it stresses to higher customer loyalty. According to long-term relationships (retention) but Fredericks, Hurd and Salter, there is a still realises that some customer defection significant difference between customer and attrition will occur so customer satisfaction and loyalty. They view the attraction must remain a priority. Thirdly, former as a largely passive customer the model is interfunctional and condition while the latter requires an systematic — it ties marketing objectives active or proactive relationship.19 to the big picture, the financial situation. Loyalty, in turn, (which results from This is consistent with the the quality of the customer-company recommendation that new marketing relationship) leads to improved business models should focus on customer performance. Furthermore, the ability to profitability as a function of retention.23 retain customers results in increased Two telling examples of the impact of market values. The vertical customer customer retention on business retention chain shown in Figure 1 performance are: indicates that, ideally, loyal new customers are retained for many years. — a one-tenth of a percent of the US Research has shown that companies automobile industry is worth $2.5bn24 may expect loyal customers to range — a 2 per cent increase in customer from about 40–75 per cent depending on retention yields the same profitasa the sector; loyalty, however, does not 10 per cent reduction in overhead.25 necessarily equate with exclusivity.20 Based on diversified packaged goods markets, Ehrenberg adds that ‘loyal’ CASE APPLICATION: FAST buyers are not always truly loyal. He INDUSTRIES explains that repeat buying and other Fast Industries is a plastics manufacturing loyalty measures vary little and are company located in Fort Lauderdale, generally in line with market share.21 Florida (USA). The company is the Hence, he concludes that consumer world’s largest producer of label holders behaviour can be predicted on the basis and serves leading retail store chains ofpenetration(theproportionofbuyers including Wal-Mart, Target, CVS Drugs within a designated time period) and and Michael’sCrafts. average purchase frequency of items (the Fast Industries is undergoing a average number of times these buyers transformation from a smaller family-run buy the item in the period).22 manufacturing company to a more Feedback loops are also depicted in professionally structured, staffed and the customer value/retention model. managed organisation. Because of the Good value secures customers over the recognition that customer retention is long term. Similarly, customers (both more important than customer attraction, new and existing ones) want to maintain much effort was spent ensuring that Fast’s relationships with well-respected most valuable customers perceived this organisations that have high market change as positive and were more likely values. to remain a customer. Two strategic The customer value and marketing initiatives which played a central role in implications of the model are readily the new marketing strategy were the

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80/20 principle and the value assessment of Fast’s overall relationship proposition. with all accounts plus a future forecast The 80/20 principle was integral in and recommended strategy was determining the focus and location of developed. What was perhaps unique Fast’s most important customers. about this analysis was that it sought to Although there are over 2,000 retail describe the strategic position of business chains in the USA, due to variations in relationships in terms of the value the number of stores and size of stores proposition. per chain, it was estimated that about 90 Through the sound application of of them will purchase 90 per cent of the strategic marketing principles rooted in store fixtures components that Fast can segmentation and customer value, Fast offer. Currently, Fast does business with Industries is now designing and delivering 30 of these retailers and for each of these superior products/services to its most key accounts delivering superior important customers. And it is working customer value is a top management well. It is projected that this customer priority. retention strategy will have a significant Next, the value proposition was impact on profitability for the year 2001 utilised to determine the exact nature of with revenues increasing by 20 per cent each customer’s relationship with Fast. and profits increasing by 25 per cent. Since there are four basic providers of value to a customer (price, service, quality and image), each customer was CUSTOMER RETENTION surveyed by their respective sales CHALLENGES FOR MARKETERS representative on exactly why they do AND RESEARCHERS business with Fast and what aspects of Developing a sound and profitable value were derived from doing business customer retention strategy must be a with the company. Using an internally top priority for managers to compete designed strategic assessment form based successfully in today’s marketplace/space. on the value proposition, it was found Segmentation and customer value are that no relationships with Fast were major strategic weapons that can be used based on image or price alone, but that to assist in this endeavour. From a service and quality were laden with segmentation perspective, a differentiated further nuances. Service to one customer approach to target marketing based on might mean high levels of in-stock usage segments and key account orders. To another it might mean ease in management are two important initiatives placinganorder.Toyetathirditmight to implement. be constant attention from a sales Marketers must realise that all representative. Quality as a criterion can customers are not the same. Clearly some be broken down into components as users are much more important than varied as the product’s engineering and others — these are the A customers or design, on-time delivery, and/or correct heavy users. This target market requires packing or billing of the product. special attention via resource investment, A second assessment tool was a dedicated sales/support personnel, time SWOT analysis conducted at commitments, etc. The B customers or individualised and aggregate levels. medium users often provide the core Information about strengths, weaknesses, base for corporate accounts. Strategies for opportunities and threats was gathered keeping and growing these customers from each strategic customer. An must be designed. The C customers or

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light users should be served in example, the typical costs of value-added, cost-efficient programmes such as plastic card-based (bar coded, magnetic telephone call centres or websites. Key and smart) programmes are 0.5–1per account management should be reserved cent of sales with breakeven points for the top tier of the A customer class. averaging 5–7 per cent of sales.26 Individualised marketing plans should be Customer retention as a construct prepared for these clients, a relationship implies long-term measurement. manager/team assigned, and one-to-one Therefore, typical cross-sectional research marketing should be implemented. is only going to be of limited value to Customer value concepts can further management in gauging the effectiveness illuminate the complex process of of their strategies for keeping and retaining customers. Conceptualisation/ upgrading customers. In contrast, operationalisation and measurement are although it is more costly and difficult to critical challenges faced by practitioners monitor, longitudinal data are preferable and scholars. The definition of what for marketing information and insight constitutes customer value is often purposes. Ensuring valid and reliable unclear. It goes well beyond price and measures are critical in the research quality and must include various service process. Panel/syndicated reports and dimensions as well as perceived image, sophisticated databases can be most useful innovativeness and intangible offerings in this context. such as specialised knowledge and time savings. While most companies spend a SUMMARY majority of their resources on conquest Companies that deliver superior value marketing (ie getting new business), the to customers on an ongoing basis are services marketing literature clearly able to keep them over the long term. demonstrates the value of investing in This is essential for establishing a customer relationship building and customer retention focus. By retention. Customer satisfaction should maintaining consistently high levels of be analysed for both individual service customer satisfaction and loyalty, encounters/transactions and ongoing customer defection becomes less likely. series of service opportunities. At a This results in enhanced business minimum, each service experience performance and increases shareholder should be judged as to whether it value. Usage segmentation and exceeded, met or failed to meet relationship marketing are the key customers’ expectations. strategies to obtain the desired results Loyalty must be carefully evaluated, of retaining more customers, getting too. At the extreme, a company may better customers, upgrading customer have total or no loyalty from a customer. relationships, and using existing High, medium or low loyalty can be customers as advocates for acquiring determined via relationship strength, new customers. switching patterns and share of the customer’s business. Numerous business Acknowledgement performance measures should also be The author thanks Robert Fast, Vice President of Fast obtained to gather strong evidence of Industries, for contributing the case application. In sales and profitability (ie revenues, addition Norapol (Paul) Chinuntdej is acknowledged for his research support in this project. This paper builds market share, net present value, payback on ideas presented in ‘Maximizing value through periods, customer lifetime value etc.). For retention marketing’ (Chapter 8) in the book

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