Word Of Mouth Economics
We have been discussing that customer experience is different than satisfaction, and how these experiences directly impact loyalty. Based on their experiences with your company, customers and prospects can be segmented into Promoters, Passives, and Detractors. Promoters are highly willing to recommend you to another grower. Detractors will not recommend you and look for opportunities to criticize and speak poorly about your company. My goal this month is to help you understand the impact of this word of mouth (WOM) on your bottom line and energize you to take action on this aspect of your business.
For our case study, we will look at a hypothetical ag retailer with 1,000 customers. Of these customers, 500 are Promoters, 300 are Passives, and 200 are Detractors. His Net Promoter Score (NPS) is therefore 30%, which is fairly low. The average Net Present Value (NPV) of a customer is $10,000 (X = $10,000). Promoters typically purchase at a higher rate than average, but we will simplify the math.
- Promoters make seven positive comments and zero negative comments to other customers and prospects.
- Passives make two positive comments and one negative comment.
- Detractors make zero positive and eight negative comments.
It takes five positive comments to prospects to generate a new customer. Each negative comment from a Detractor neutralizes seven positive comments.
Promoters buy 2X the average customer. They buy at higher margins, have fewer bad debts, and defect at 0.5X the average rate of other customers, so their NPV excluding WOM is 3X the average customer.
Detractors have a negative NPV of negative 0.75X the average customer due to bad debts, complaints you need to service, and a short tenure. This excludes their WOM effect.
To explore the economic WOM of customers, we will ask three questions:
- What is the full value of a Promoter if customers generated by referral are worth 2X the value of an average customer?
- What is the value of a Detractor?
- What is it worth to convert a Detractor into a Promoter?
An Income Machine
The WOM effect from Promoter referrals is an incredible income machine. It takes five positive comments to generate a new customer, so each positive comment is worth $10,000/five or $2,000. Each new customer generated from referral however is worth $20,000 (2X the average). Therefore, each positive comment from a Promoter is worth $20,000/five or $4,000. Since each Promoter makes seven positive comments, a Promoter’s positive WOM is worth is worth $4,000 X seven = $28,000.
Now we add the Promoter’s NPV of $30,000 to the WOM value to arrive at the Promoter’s full value of $58,000. This turns the traditional approach to selling upside down, doesn’t it? Rather than prospecting for new customers, increase your NPS and let Promoters spread the good word about you. They purchase deeper into your bundle of products and services, are less price sensitive, and they make referrals.
To start the calculation of how Detractors hurt your business we begin with the average value of a customer, which is $10,000. Detractors have a negative NPV due to time-consuming complaints, excessive price sensitivity, and high turnover. We assume their negative NPV is 0.75X (the value of an average customer). The NPV of a Detractor is therefore -$7,500.
Unfortunately, the WOM effect with Detractors is larger than with Promoters. Each Detractor makes eight negative comments and each negative comment neutralizes seven positives. Therefore, each Detractor cancels out eight X seven = 56 positive comments. Since each positive comment is worth $2,000, the negative impact of Detractors is 56 X $2,000 or -$112,000. When you add the Detractors own negative NPV to WOM economics, the impact is -$119,500.
Some readers may think this example is untrue. I modified it from real-life consumer and business-to-business results, so I am confident in the validity. Most Detractors are created from the experience gaps they encounter during the process of doing business with a supplier. I suggest thinking of this as the estimated drag on your business by customers whose experiences were not met.
What is it worth to convert a Detractor to a Promoter? It is fashionable to suggest chronically disgruntled customers should be shunted off to competitors whenever possible. Other than for the most seriously toxic Detractors, this is a mistake. The first reason is because Detractors can give us insight into gaps in our service delivery that should be fixed. Second, they represent a large income opportunity if their problems can be addressed.
We have estimated that a Detractor costs the business -$119,500 through their own negative value and WOM. We have estimated that a Promoter is worth $58,000 including their positive WOM. So by converting a Detractor to a Promoter, the change in value to your business is the difference between these two numbers or $177,500.
Assuming differences in individual retailers, the numbers are a reasonable estimate of what is happening in your business today. Promoters will recommend you to another grower and generate increased revenue through their purchases and WOM. Detractors are a drag on your profitability.
The best way of taking the pulse of your business and beginning to focus on repairing service gaps that create Detractors is to directly measure your customers’ experience with you compared to competitors. AgKnowlogy has developed the Customer Experience Monitor to help retailers quantify, understand, and take action on the customer experiences that impact loyalty and profitability.
The stakes are too high to not measure how business results are created by how customers evaluate your performance against their priorities.