Herding Cats: Why 35% more repeat-purchase loyalty leads to the same share.

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1 Page 1 of 7 ANZMAC 2009 Herding Cats: Why 35% more repeat-purchase loyalty leads to the same share. Charles Graham, Ehrenberg Centre for Research in Marketing, London South Bank University. grahamca@lsbu.ac.uk Abstract New long-term consumer panels (six years of reporting) reveal a paradox in competitive markets; on average, frequently purchased brands lose a third of their loyal customers over five years, yet tend to maintain their relative market share within just a few points over the same time. This startling extension of the leaky-bucket concept (Ehrenberg, 1988; East & Hammond, 1996) confirms that even in the long run, loyalty is less important to a brand s performance than the number of people buying it. Keywords: Customer Loyalty, Ehrenberg, Metrics, Dirichlet, Retention.

2 ANZMAC 2009 Page 2 of 7 Herding Cats: Why 35% more repeat-purchase loyalty leads to the same share. Introduction The leaky bucket refers to a deviation from the NBD-Dirichlet model (Goodhardt, Ehrenberg and Chatfield, 1984). In common with many stochastic models of market structure, the Dirichlet assumes unchanging consumer buying probabilities, and therefore constant levels of repeat purchase, from period to period. Although almost unbelievable, implying as it does that competitive brand support has no permanent effect, categories do mostly remain in equilibrium at least over a few quarters (Bass and Pilon, 1980; Dekimpe & Hanssens, 1995a; Ehrenberg, Hammond & Goodhardt, 1994a; Srinivasan and Bass, 2000). The model therefore fits empirical data well both in repertoire and subscription markets (Sharp & Wright, 2002), and accurately describes buying behaviour across continents and cultures (Bennett, 2003). Nevertheless a constant underlying dynamic, the erosion of repeat-purchase loyalty, is known to produce an important deviation from the stationarity assumption. This is of considerable importance to practitioners considering retention or acquisition strategies. Our paper presents two findings; first we confirm that approximate share equilibrium extends far beyond the few quarters so far examined in the literature. We then show that despite such apparent stationarity, a typical brand can expect to retain only two thirds of its loyal customers over five years. This reveals a customer churn that is ignored in the Dirichlet assumptions despite its usual goodness of fit. Since erosion appears to be constant, the implication is that marketers must work hard at customer acquisition constantly, and for the long term, just to maintain share. Repeat Purchase in Established Competitive Markets Purchasing in FMCG markets is typically anything but fast moving. Consider two consecutive periods, perhaps two quarters. Many of those buying a brand in one quarter, especially heavier buyers, purchase the brand again in the next, but many more do not do so. These non-buyers have not necessarily defected. They are just lighter buyers who have purchased the brand before, and will most likely return to it in subsequent quarters. In stationary markets their place is taken in quarter two by a similar number of light buyers returning from earlier quarters. While many of these will not in turn repeat at quarter three, they will usually repeat in later quarters. A brand s market share thus relies on a constant pool of its consumers. Although every buyer has an independent but steady propensity to purchase, this may not necessarily manifest in each period. Nevertheless, if the pool is sampled at regular intervals, the proportion of buyers repeating from the previous period remains constant. This is in effect the Dirichlet assumption too. The deviation arises because the pool, (or bucket as Ehrenberg refers to it) leaks a little: underlying buying propensities are not absolutely steady. Rather, as some buyers drip out, new ones replace them, although it is a feature of market stationarity that the leak and the replenishment are roughly in balance, churning 6% over two non-adjacent quarters (Ehrenberg, 1988) or 15% over four consecutive quarters (East & Hammond, 1996).

3 Page 3 of 7 ANZMAC 2009 It has not yet been established for how long this balance is maintained, or if erosion has an eventual influence on brand share change. Until now it has not been possible to examine this relationship in FMCG markets. Individual repertoire buying and long inter-purchase cycles make it hard to identify true defectors in standard three-year panel data, especially where aggregate results remain stationary. This means that although retention is considered an important loyalty metric by practitioners and consultants (e.g. Reichheld, 2003), there are no benchmarks in consumer goods markets. Here managers must usually consider Share of Category Requirement or Purchase Frequency instead. The specific questions we address are: What is the level and temporal extent of market share stationarity? What is the normal extent and shape of erosion? Is a link discernible between erosion and brand growth or decline? If so, does erosion eventually cause a violation of the Dirichlet assumptions? Answers may lead to a FMCG retention norm and add to understanding of loyalty. Long-Term Equilibrium is the Norm For this study our data have been provided by Taylor Nelson Sofres UK, and are of a new design, consisting of the continuous and recent purchasing record of nearly 4,000 UK households, compiled between 1999 and 2005 (six years). A range of quarterly marketing metrics has been extracted for eighteen frequently purchased categories covering 140 well-known brands. Our approach is one of replication and extension of empirical generalisation and categories have been selected that differ widely in purchasing style, with average quarterly market penetrations ranging from 95% to just 11%, and average category purchasing frequencies from more than twice a week to less than once a month. Nevertheless it is remarkable that all categories remain in approximate equilibrium over the entire 26 quarters; 75% of the sample (106 brands), remain within three share points of their mean year one quarterly share, while only nine brands changed by more than six share points (seven gained and two lost over one point annually on average). Such long-term stationarity is an important finding in itself (Graham, 2009), while continuous reporting now allows detailed examination of customer retention and defection in repertoire markets for the first time. Erosion and Maintenance of Repeat Purchase Loyalty To demonstrate the principle of erosion we next examine repeat purchase levels for Lynx, a typical brand in the UK male deodorant category with an approximately constant mean quarterly share. Our data now allow a strategic perspective, and so we work here with the average quarter within each year as an annual comparator, and this has the added benefit, following East & Hammond (1996), of smoothing out any promotional and seasonal fluctuations which might confound the main patterns. Table 1 shows two repeat-purchase measures. The first, the average quarterly repeat, is a frequently-used loyalty metric reflecting the proportion of a brand s buyers in one quarter who repeat in the next. It is astonishing that this remains so steady not just over a few quarters, but over six years, yet it is convincing support for the earlier stationarity finding, seen in the steady average quarterly market share. The predicted

4 ANZMAC 2009 Page 4 of 7 quarterly repeat from the Dirichlet (not shown) is also 41%, which demonstrates the model s accuracy. The third row shows a different story however. Here we have identified households who purchased during an average quarter in Year 1, and then compare their average quarterly repeat proportion over the subsequent five years against this initial, rather than the preceding quarter. Several points need to be made. Table 1: Six-Year Erosion of Repeat-Purchase Loyalty for a Well-Known Brand in the UK Male Deodorant Category Year 2 Year 3 Year 4 Year 5 Year 6 Six Year % % % % % Erosion % (Y2-Y6)/Y2 Avg. Quarterly Repeat Avg. Quarterly Repeat on Y % Acquisition Source: TNS Superpanel First, as expected we can see that this does not hold steady, but declines over the period, so that by year 6 the brand has lost almost a third (31%) of its original Year 1 loyal customer base. This importantly extends Ehrenberg, (1988), East et al. (1996) and Wright & Riebe, (2009). Second, despite this drastic leakage, since quarter on quarter repeats hold steady (as does the market share), Lynx must be attracting new buyers to maintain the constant level in the pool. The difference between the two rows is therefore the proportion of new repeating buyers acquired. Third, the rate of erosion does not, as predicted in East et al., tail off but continues to decline steadily to Year 6, giving little indication that it might slow down. All this implies a continuing and expensive struggle to support the brand through customer acquisition where retention is commonly suggested to be the less costly route (Reichheld, 2003). Nevertheless, the brand also demonstrates a steady and substantial market share over the period, and so it is not clear whether in losing a third of its loyal customers Lynx has performed badly, has retained a similar proportion of repeat buyers to brands of a similar size, or has in fact done well. In our data, three quarters of brands examined, including Lynx, are stationary, so it is important to discover if this pattern of erosion is normal. It would also be interesting to know what part, if any, erosion plays in the growth or decline of the exceptional, non-stationary brands. Any major emerging patterns might provide benchmarks and further understanding for managers about retention and acquisition, and we next report findings generalising from the data, before concluding with a brief discussion. Replication & Extension of Repeat-Purchase Loyalty Patterns Table 2 shows the results of extending our approach from a single brand to the top five brands in each category, and thence to all eighteen categories in our data. For a typical brand in a usual quarter, about a third of its customers will be returning from the previous quarter. The number itself is not new, but the time frame is: purchasing propensities appear to remain stationary over at least six years, up to three times longer than previously reported. However, the underlying quarter on quarter-one metric shows a steady and continuing erosion of repeat purchase for all brands, which

5 Page 5 of 7 ANZMAC 2009 by the final year averages 35%, nearly six times the loss identified in Ehrenberg (1988). Substantial erosion thus appears to be a marketing fact of life. Table 2: Comparison of Repeat Purchase Loyalty Measures: Average Quarterly Repeats for 90 Brands in 18 Categories, Year-on-Year & Year-on-Year-1 Year 2 Year 3 Year 4 Year 5 Year 6 Six Year % % % % % Erosion % (Y2-Y6)/Y2 Avg. Quarterly Repeat Avg. Quarterly repeat on Y % Acquisition Source: TNS Superpanel At the same time it is clear that since long-term stationarity is also the norm, a typical brand should maintain its repeat-levels by acquiring new customers, although this crucial mechanism needs further investigation. Evidence of a double jeopardy effect in defection is reported in repertoire markets (East and Hammond, 1996) and in subscription markets (Sharp, Riebe & Dawes, 2002; Wright and Riebe, 2009), and in our data too there is a strong negative correlation (r = -0.96) between market share and erosion, indicating that bigger brands not only have more customers, but also retain them better. Table 3 shows the average quarterly market shares for each of the top five brands in Year 1 and Year 6. The overall picture is of approximate stability, but the underlying movement is of the second and third brands closing on the first, whilst the smaller brands are making no headway. Erosion is very highly correlated with market share in both years, and the fact that the association is more marked by year six indicates that there may be a connection between change in share and retention. This too needs further investigation. Table 3: The Relationship Between Market Share & Erosion Erosion Year1/6 Average Quarterly Market Share % % Year 1 Year 6 1st Brand nd Brand rd Brand th Brand th Brand Correlation Like East and Hammond earlier, with the exception of market share we have so far found little evidence of a substantial relationship between erosion and any other factor; for example it could be possible that given more opportunities to switch, buyers might do so. Our categories cover both frequently and very infrequently bought goods but weight of purchase is only weakly associated (r = 0.3) with erosion. Similarly, associations with changes to overall category penetration (r = -0.3), market concentration (r = -0.1), and change in market concentration (r = -0.5) are also weak.

6 ANZMAC 2009 Page 6 of 7 It appears that erosion and acquisition continues to be a consistent, pervasive empirical fact (East and Hammond, p.169), but more substantial over time than previously seen, and of a different shape than previously thought. Having arrived at new benchmarks for the long-term scale of erosion and for differences attributable to market share, we next discuss their implications. Discussion From our continuous panel data we have shown that brand shares mostly remain in equilibrium not just for a few quarters, but for at least six years. Underlying this apparent stationarity a substantial but regular change takes place as the number of repeating customers for any brand declines by a third on average, and is replaced by a similar number of new buyers. The new buyers are assumed to have similar propensities to those that have defected since all other metrics remain stable, but more work is now needed to investigate the changes across light, medium and heavy buyers, and over the demographic mix. It might be assumed that where a brand s share grows or declines, customer acquisition and erosion have fallen out of balance. Early evidence presented here however suggests that all brands erode in line with their market share. A hypothesis for further investigation might be that the proportion of repeating buyers, in line with other loyalty norms, has less impact on share change than the number who buy at all in any period. For marketers there are three implications from the findings presented. First, since erosion appears inevitable and substantial, marketing expenditure must be directed towards constant customer acquisition rather than retention. Repeat purchase will erode inevitably (and conforming to the Law of Double Jeopardy), so the priority must always be to maintain brand penetration from period to period in order to counteract the effects of competitors actions. Second, it seems unwise to focus this activity on any particular, tight customer segment, heavy users or 100% loyal buyers for example. The evidence shows that the erosion is not targeted, and nor is the acquisition. Apart from a few heavy buyers, most consumers are light users, and the buyers of other brands who occasionally buy you. Marketing activities should therefore be broadly targeted, designed to remind all your recent and not-so-recent buyers that you are still around, and just as good as ever. Since this is an extremely large target, the objective can be achieved even with a low strike rate. The third implication concerns the nature of that objective. Rather than growth, brand maintenance is a more realistic expectation. Markets are in equilibrium for the most part so brand shares may fluctuate but are extremely unlikely to grow permanently. That doesn t mean that most marketing budgets are wasted, or that marketing strategies are usually ineffectual. On the contrary, in the face of the ferocious competitive forces experienced in established markets, nudging enough consumers back to the brand in order to maintain quarterly share will be like herding cats. It will certainly call for all the expertise and creativity available.

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