Wednesday, January 23, 2008

The Real Power Of Word Of Mouth

A firm’s most valuable customers are not those who buy the most; customers who refer new business are worth as much as the big spenders, or more. We've all been told that, but a new study, "How Valuable Is Word of Mouth?" (by Dr. Robert P. Leone of the Neeley School of Business at Texas Christian University and Dr. V. Kumar and J. Andrew Petersen, of the University of Connecticut) reveals the truth of it.

"Most companies with statistical models for customer valuation focus only on customer spending and don't factor in a customer's word-of-mouth value," says Dr. Leone. "We demonstrated that when companies try to ascertain how valuable individual customers are, it's not just about how much the customer spends but whether that individual can bring in new business."

Knowing which customers can potentially add the most to the bottom line is vital to the firm, he says. Broad-based marketing is expensive and inefficient. But detailed customer data can guide the content and timing of marketing pieces to segments of the customer base and achieve the greatest return on investment.

"But if a company creates a priority list of customers based solely on how much those customers spend, they risk focusing on the wrong individuals," says Dr. Leone. This is because high-volume spenders and good referrers are not generally the same people. And the value of the best referrers can far exceed that of the good spenders.

A year-long marketing campaign was directed at the affluents, advocates, and misers, offering incentives tailored to each of those three groups (but not to the champions). The goal was to encourage affluents to increase their referrals and thus become champions, advocates to increase spending to likewise become champions, and misers to become affluents, advocates, or champions by increasing spending or referrals or both.

The results were dramatic. Hundreds of affluents and advocates became champions, and throngs of misers upgraded into affluents, advocates, or champions.

The real return on investment, however, is even higher because the researchers did not include indirect referrals, which occur when referred new customers make referrals of their own.

If similar targeted marketing campaigns were to be directed at the telecommunication firm's 40 million other customers and the financial firm's 15 million customers, the profit potential could be staggering.

And, says Dr. Leone, future returns on marketing investments may be able to be improved even more.

"A new study we are conducting involves profiling customers who make a lot of referrals. We're looking for distinguishing characteristics such as demographics, profession, geographic area, and large social networks. Then we'll select other customers with similar profiles for targeted marketing with referral incentives," he says.

Dr. Leone concludes that companies with marketing efforts designed toward eliciting referrals should see much greater returns from their advertising expenditures than do companies relying on mass marketing.

"Mass marketing is very costly and inefficient, with low rates of response. But referrals from existing customers are personalized, so the odds of response are much greater," he explains. "The more targeted a company's marketing is, the more efficiently they can spend their marketing dollars."

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