This article is adapted from Mr. Hillstrom’s book, “Hillstrom’s Database Marketing: A Master’s Complete Method for Success.”
In the past 15 years, catalogers have transformed from print-based merchandisers to multichannel retailers. This revolution gave our customers tremendous power.
In 1990, a customer received a catalog, viewed several hundred pages of merchandise and read copy that detailed the benefits of buying the products. The customer kept copies of catalogs sent by numerous companies. She compared products and price, then made a decision to buy something. She filled out her order form, wrote a check for the purchase amount and mailed her envelope to the cataloger.
Two weeks later, merchandise arrived at her home. Alternatively, she called in her order via a 1-800 number, used her credit card and got merchandise in about a week.
Today, a similarly aged woman accesses the Internet to gain information about a potential purchase. She visits any search engine or price-comparison Web site and compares merchandise, price, shipping and handling across an array of companies.
Based on price, value, trust and delivery options, the customer chooses a company to buy the item from. She visits this company’s Web site. The customer chooses whether to buy that item online or to use the Web to have the item shipped to a retail store where she can pick it up on the way home from work. If she has the item shipped to her home, she expects it to be shipped in just a few days, and she expects to be able to return the item directly to a store.
Catalog, online and retail executives have responded to changes in consumer expectations, changes fueled largely by technology advances. The purchase behavior of consumers today differs from the controlled environment catalogers enjoyed in 1990. Executives responded to these changes by creating a multichannel environment that begins to address the needs of the consumer.
Business leaders are keenly aware of the difficulty in implementing a multichannel strategy that is appropriate for any given brand. Vendors and business leaders try hard to implement strategies that meet customer needs. Consequently, multichannel marketing discussions focus on aligning merchandise, systems, marketing and operational systems across the entire enterprise.
When deciding how to align all elements of a multichannel strategy, it is important to have metrics that thoroughly understand how customers behave. Multichannel discussions frequently consider how customers interact across channels (telephone, online, retail) or how customers respond to advertising. Executives should understand thoroughly the interrelated behavior of customers, channels, product classifications and advertising.
Multichannel strategies depend upon technology and systems infrastructure. Fortunately, an understanding of how customers, channels, product classifications and advertising interrelate is available today, using techniques that have been around for 10 to 20 years or more. Fully understanding customer behavior drives the multichannel strategies retailers will employ in the future.
What Are the Repurchase Rates of Your Customers Across All Products and Channels?
Executives should routinely monitor reporting that indicates the percentage of customers who bought within each product classification and channel last year and repurchased in the same product classification or channel again this year. This metric is called the “repurchase rate,” or “rebuy rate.”
For most business models, measuring repurchase rates on an annual basis is appropriate. Count the number of customers who purchased during a calendar year. Next, count how many of these customers bought again during the next calendar year. Divide this year’s customers by last year’s customers, and you have calculated the repurchase rate.
For example, assume that 1,000 customers bought from your company in 2004. In 2005, only 375 of the 1,000 customers purchased again. The repurchase rate is 375/1,000 = 37.5 percent. This metric should be calculated for your business, in total. Next, the metric should be calculated for each channel. Within each channel, the metric should be calculated for each product classification you have. Once these measurements are taken, classify each metric within one of three categories:
Acquisition Mode: Repurchase rates between zero and 40 percent.
Balanced Mode: Repurchase rates of 40 percent to 60 percent.
Retention Mode: Repurchase rates of 60 percent to 100 percent.
Why is it important to measure and categorize repurchase rates? Because your marketing strategy depends upon which category your business, channel or product classifications fall into. It is difficult to manage marketing strategy without understanding how customers interact with your brand.
Acquisition Mode implies that it is essential to continually find new customers for your business, channel or product classification. When fewer than 40 percent of last year’s buyers purchase again this year, growth happens if the customers who are lost are replaced with at least as many new customers. The executive must make it a priority to find new customers at an acceptable cost in order to grow.
Regardless of efforts to increase average transaction size or purchase frequency, the business simply won’t grow unless customer acquisition is the top priority of the marketing team. Businesses in Acquisition Mode have some loyal customers. More frequently, the customers are buying one to three times a year and then moving on.
Balanced Mode may be the most enjoyable category for an executive to manage. When the repurchase rate is near 50 percent, many levers exist to fuel growth. The business leader must continue to drive customer acquisition activities to replace all the customers that are lost each year.
In addition, the business leader has the chance to increase repurchase rates, annual purchase frequency or average transaction size. All of these strategies can be managed within Balanced Mode. Success can happen by improving any one metric. Wild success can happen by improving repurchase rates, purchase frequency, average transaction size and customer acquisition at the same time. Shortcomings in one area can be offset by improvements in other areas. This is a fun type of business for an executive to run.
Retention Mode occurs when more than 60 percent of last year’s buyers purchase again this year. In this category, the executive will be hard pressed to increase retention rates, so strategies need to include increasing annual purchase frequency or average transaction size. If customers can be acquired at a profitable rate, growth is also achievable.
Wal-Mart and McDonald’s fit into this category. Each business retains the vast majority of its customers on an annual (or monthly) basis. Without opening new stores, these businesses must grow by stealing market share, creatively expanding into new product lines or by providing services that meet customer expectations.
Classifying each business, channel and product classification into one of these three segments is essential if an executive wishes to identify the appropriate marketing levers to grow the business.
How Do Brands, Channels and Product Classifications Interact With Each Other?
Once the executive understands customer file dynamics surrounding the repurchase rate, it becomes essential to measure how brands, channels and product classifications interact with each other. By understanding how customers migrate across business units, the executive has the tools to grow her business in an efficient, profitable manner.
Four dynamics amply explain how customers migrate across businesses, channels and product classifications. Let’s explore each dynamic.
Isolation represents a situation where competing brands, channels or merchandise divisions do not interact with each other. For instance, Dell sells computers to both businesses and consumers. It is possible that customers who buy computers for their business visit Dell for that reason, whereas customers who buy computers for their home do not have the job responsibility to buy computers for their business.
In this situation, the business-to-business and business-to-consumer executives at Dell operate in Isolation Mode. These leaders need to ensure that each business unit markets in a manner that benefits the brand. However, they can act in a largely independent manner because their customers are independent of each unit. Executives who run business units in the Isolation Mode depend largely upon their own strategies for success or failure because customers from other units are unlikely to cross-shop another business unit.
Equilibrium represents a business model where customers freely shop across brands, channels or product classifications, regardless of purchase history. Management teams responsible for models in the Equilibrium Mode depend upon each other for success.
If one business unit, brand, channel or product classification is failing, customers are not being fed to the other businesses. If one leader is struggling, all other leaders may struggle as a result. Conversely, another executive might be doing a great job of driving her business. The other executives benefit by the success of this leader.
Large department stores frequently operate under Equilibrium Mode. At Target or Wal-Mart, executives in charge of apparel, toiletries, electronics, lawn and garden, automotive, grocery and home furnishings share customers. A customer who bought toiletries in the past may be equally likely to buy from any other product classification in the future.
Transfer represents a customer dynamic that must be understood clearly for a business to achieve its potential. Under Transfer Mode, a brand, channel or product classification transfers its customers to another brand, channel or product classification.
For instance, Barnes & Noble is well known for selling books. However, other products are sold at Barnes & Noble: music, movies, magazines, even coffee. Books may be the reason a customer enters the store. Once the customer trusts Barnes & Noble after buying several books, she may purchase a movie or enjoy a latte. The book product classification transfers its customers to other product classifications.
In this example, the other product classifications (music, movies, magazines, coffee) may not be responsible for cultivating their own customers. Instead, they depend upon customers who buy books. If the executive who manages books does an excellent job, then the executives responsible for the other product classifications are set up for success. The book executive bears a larger share of responsibility than the other executives because he must recruit loyal customers who will transfer to other product classifications.
In our multichannel environment, this is the most important customer dynamic to understand. The interaction among catalog, online and retail channels must be understood in order to determine the appropriate marketing strategy. Does the catalog channel operate in Isolation Mode, Equilibrium Mode or Transfer Mode? The dynamic that the catalog operates under determines its place within a company.
The last customer dynamic is called Oscillation. Under Oscillation Mode, brands, channels or product classifications transfer customers to each other in a cyclical manner. Consider the automotive industry. A customer buys a new car. The new car sales division transfers the customer to the service division. Over the next several years, the service division must do a great job of taking care of the customer. At some point, the customer is ready for a new car, so the service division transfers the customer back to the new car sales division. If sales and service do their job well, then the customer oscillates between each division.
Integrating Repurchase and Customer Dynamics
In my book, I describe case studies from a fictional company called Buddies. This company markets dog toys, treats and doggie T-shirts through an e-commerce-enabled site and operates one small retail store. Buddies has been in business three years.
After three years, Buddies retains just over 40 percent of the customers who purchased the prior year. This means Buddies operates on an inflection point between Acquisition Mode and Balanced Mode. To continue growing, it must acquire as many customers as possible, in a cost-effective manner. But as the business matures, it will enter Balanced Mode. Raising purchase frequency and average transaction size will become more important as the business matures.
Within each product classification, toys, treats and doggie T-shirts, customers have different repurchase rates. Customers buying from all three classifications have a 70 percent repurchase rate. Customers purchasing from two of the classifications have a 46 percent retention rate. Customers purchasing from just one classification have a 33 percent retention rate.
It is crucial to understand how the three product classifications interact with each other. Customer dynamics can be understood by measuring how last year’s customers migrate in the next 12 months.
Let’s look at customers who bought only dog toys last year. Among those who repurchased, 65 percent purchased only dog toys in the next 12 months. Only 3 percent purchased only dog treats. Only 2 percent bought only doggie T-shirts. The remaining 30 percent purchased from multiple product classifications. Dog toys operates in Isolation Mode, because its customers tend to repurchase dog toys again next year.
A different dynamic occurs for doggie treat customers. Twenty-three percent of those who repurchase buy only dog toys next year. Twenty-four percent of the repurchasers buy only doggie treats next year. Twenty-three percent of repurchasers buy only doggie T-shirts next year. Twenty-eight percent of repurchasers buy from multiple product classifications next year. Clearly, doggie treats operates under the Balanced Mode. Customers who purchased doggie treats last year are equally likely to shop anywhere next year.
Doggie T-shirts operate under yet another mode. Among those who repurchase, 50 percent purchase only toys. Twenty percent buy only treats. Twenty percent buy only doggie T-shirts. Ten percent purchase from multiple product classifications. Clearly, doggie T-shirts operates under Transfer Mode. Customers who buy from this classification tend to migrate to toys in the next year, with some migrating to treats.
The executive in charge of each of these product classifications must employ different strategies to be succeed. The leader of the toys division has a good chance of being successful. She can acquire her own customers, knowing they tend to stay loyal to toys. She knows that treats buyers are likely to cross over and buy from her product classification. She knows that doggie T-shirt buyers are most likely to migrate to toys in the next year. This leader could fund customer acquisition activities in the doggie T-shirt division, because those customers eventually will migrate to toys.
The executive in charge of doggie treats has fewer options. His customers tend to shop across all classifications in the future. His strategy must be to acquire new customers constantly. Some doggie T-shirt buyers will purchase treats in the future, so there is some dependence upon the T-shirt executive for success.
The executive in charge of doggie T-shirts has no choice but to acquire many new customers. Toys buyers are unlikely to cross over and purchase doggie T-shirts. Treats buyers will cross over and buy doggie T-shirts. Most important is that doggie T-shirt buyers do not stay loyal to doggie T-shirts. The buyers transfer to other classifications. Therefore, the doggie T-shirt executive must recruit new buyers constantly. She cannot depend upon the other executives to help fuel her business.
Putting It All Together
The analytical tools that support retention metrics and customer dynamics have been used for decades. The concepts of isolation, equilibrium, transfer and oscillation are not new to database marketing. However, these techniques are underused in today’s multichannel environment. The tools of the past are directly applicable to today’s business challenges.
When coupled with concepts like life-tables, multi-year simulations, lifetime value, experimental design and rolling 12-month files, database marketing can serve as the foundation for your multichannel business. Integrating these techniques into multiyear simulations gives clarity into where your business is heading. The marketing strategy for each brand, channel and product classification becomes self-evident when using this framework. Database marketers have a responsibility to drive business strategy by applying these time-tested analytical concepts to their specific business problems.