The Advantage of Digital Loyalty Networks

Though experiments and pilots have yielded some promising results, examples of sustainable collaborative partnerships are few and far between. The reason: Most collaborative initiatives tend to treat all customers alike. But all customers are not equal. The key is to discern and differentiate among the most profitable. And then manage these customers as a network, leveraging the power of the Internet to build loyalty.

By Robert E. Sabath and Himanshu Kumar -- Supply Chain Management Review, 3/1/2001

Relationship-mania has engulfed the supply chain. Customer empowerment, extended enterprises, open cultures, new technologies, efficient exchanges, and shared information have opened the door and shoved even the most hesitant corporations toward the new paradigms of collaboration and customer focus.

Unfortunately, however, there has been a lot of motion but very little movement. Although virtually every organization has become enraptured with the pop science of customer-centricity, very few have reaped the promised benefits. In the midst of all of this, we've overlooked the untapped synergy between collaboration and customer differentiation.

Collaboration is lauded as the new magic of the supply chain relationship. New organizations have sprung up to promote collaborative supply chains and customer partnerships. Experiments and pilots have yielded exemplary results, but sustainable collaborative partnerships are extremely rare. Although concepts such as collaborative planning, forecasting, and replenishment (CPFR) have been successfully modeled, these concepts have not proven scaleable and have not gained wide acceptance, despite the significant amount of press they have received.

Simultaneously, millions of dollars are being invested in building processes to nurture customer intimacy. We hear that the era of the customer is here: Customers will run our businesses. The advent of e-commerce has promoted the vision of companies customizing to segments of one—where the customer is the indisputable focus of every action of every company. Such a prognostication would have us believe that customers, whatever their peculiarities, will pit companies against each other in ferreting out the best deals available in the marketplace. Companies are advised to deal with the realities of the coming customer revolution, to take the fickleness of customers as a given, and to formulate strategies and tactics to cope with it profitably. Better still, the proponents exhort companies to exploit this eventuality while the rest of the competition is still reeling from it. Long-term survival, they would have us believe, will be ensured by companies fawning over every customer, pampering them, and ministering to their every need.

These popular arguments are fraught with fundamental flaws. Great collaboration and powerful customer intimacy rarely coexist. And even where they do, not even one in seven companies is able to capture the basic benefits of orchestrating the two sides. Also, companies that focus exclusively on customers (in other words, have a customer-centric or loyalty focus) are not the most competitive based on key performance metrics, including shareholder return.

Why have companies fallen headlong for this siren song of customer-centricity and collaboration? We believe that it's because that song is emotionally appealing. Who can argue with the "customer-is-king" chant? Customers, after all, are why companies exist. It makes ample sense, then, that focusing on customers and making them an inextricable part of a company's activities will make the company more profitable. Similarly, who can argue with the virtue of collaboration? Everyone agrees that all of a company's stakeholders are working toward the same goals. Why, then, treat each other as enemies? Why not cooperate, collaborate, and share the riches? After all, who would argue with the premise that animosity is a bad thing and that cooperation and collaboration are good things?

If all of this is true, why are the results of customer-centric initiatives so disappointing? How is it that a company can know what every customer desires and have the capabilities and partnerships to deliver on those desires but still have no assurance that it can make it happen profitably? Though the collaborative approaches may be new, they contain an underlying flaw that has a very long history. That flaw lies in the assumption that all customers are created equal, a notion with a distinct one-size-fits-all ring to it. Very often this notion of "equality-for-all" manifests itself in common ways of addressing the needs of every customer. Such a strategy is untenable in the long run and can certainly sound the death knell for companies.

A company's raison d'être is to maximize the wealth of its shareholders. To do this, it must maximize the use of the resources at its disposal. A company achieves this goal by focusing on the productive, effective, and efficient use of resources both to create and to meet the demands of the marketplace (customers). However, companies that try to satisfy each and every customer perfectly find that, in reality, they are satisfying the least profitable/lowest potential customers the same way they are the most profitable ones. In other words, companies are expected to hone their creation and delivery mechanisms (that is, their supply chains and their demand chains—or their value networks) to satisfy the most demanding customers. Very often this leads them to apply that same standard of service to cater to the needs of every one of their customers.

There is just one little glitch. We all know that companies have limited resources. We also know that only the most efficient and effective deployment of these resources will ultimately result in achieving the corporate objective of maximizing shareholder wealth. How do companies perform this delicate balancing act of not only satisfying customers but also maximizing the effective use of their resources?

Leading academics and practitioners have proposed numerous solutions to the challenges posed by the unrelenting, insatiable customer. The latest thinking revolves around the concept of collaboration, or Collaborative Commerce (C-commerce). The proponents argue that building strong relationships with the stakeholders in one's value chain and collaborating to provide a unified response to customer demands is the best approach to meet the demands of the marketplace. Collaboration will result in optimizing the use of resources throughout the value chain. It also will infuse the value chain with the agility—flexibility and responsiveness—needed to meet the stringent demands of a fickle customer.

Proponents of such a customer-centric philosophy believe that initiatives such as C-Commerce will be the emerging e-business models over the next five years. C-Commerce is characterized as a Web-centric, recombinant "click-and-mortar" business approach. In this model, companies fluidly create and reconfigure relationships in a dynamic environment and share intellectual capital as well as risk with their channel partners to enhance the operations and expand the opportunities of the extended enterprise.¹

We strongly agree that collaboration will continue to be critical to competitiveness. However, we believe that collaboration in and of itself will not suffice to make companies competitive. The reason is simple: It does not address the fundamental question of which customers are the most profitable to serve.

To quote from our comprehensive study, Digital Loyalty Networks: e-Differentiated Supply Chain and Customer Management:

"This approach of constructing demand-driven networks of customers, distributors, manufacturers, and suppliers ... often means that most customers are offered similar products and services at similar prices, delivery times, and service levels. When improved service levels or other value-added elements are provided to select customers, this is often a result of increased customer requirements, rather than a deliberate decision by the manufacturer to differentiate service levels across its customer base. Key issues of CRM—including customer lifetime potential, requirements, and cost to serve—are rarely taken into account. That is, most products and services continue to be treated like commodities—everything from cars and computers to canned soup. Trying to satisfy all customers at all times will remain a losing battle for manufacturers."²

First and foremost, then, companies have to become much more discerning about their customers. They need to distinguish between customers that are valuable to them and those that are not. This necessarily means that for a given company there will be "good customers" and there will be (hold your breath) "bad customers." Customers are good or bad based on whether they help a company achieve its corporate goals. And yes, some customers (or many customers, in some instances) may actually be bad for business. Or, at a minimum, they may never prove profitable to serve if they continue to receive "premier" levels of service. And, no, all customers do not have to be treated alike!

Once the good are sorted from the bad—that is, the profitable/valuable from the unprofitable/unvalued—a response can be tailored according to the customers' needs. It is here that collaboration comes in handy. Leaders collaborate with stakeholders in their value network to deliver a tailored response to their customers that is commensurate with the value they bring to the company—in other words, the contribution they make to the attainment of the company's corporate objective.

What we are advocating then is discernment and differentiation. Companies need to discern the profitable customers from the unprofitable customers. Then, they need to create a differentiated response commensurate with the customer's profitability potential. We believe that the creation of a value network in accordance with the twin principles of discernment and differentiation requires a convergence of the demand chain and the supply chain.

This is exactly what Procter and Gamble (P&G) did when it restricted direct shipments of virtually all products to truckload volumes only. This policy led smaller customers (read less-profitable, in the P&G model) to use the alternative distributor channel and allowed P&G to offer differentiated service that was commensurate with the discerned profitability of a given relationship.

Building on our premise of discernment and differentiation, we believe that the Internet and other emerging technologies should not be used to provide optimal service to all customers. Rather, these tools should be leveraged to discern and differentiate. This differentiation can then be coupled with collaboration to produce powerful results. To quote again from our research:

"Leading companies will make a strategic decision to move toward creating 'digital loyalty networks.' These companies will combine excellence in supply chain management (SCM) with an integrated approach to customer relationship management (CRM). They will leverage new technologies and build supply chains that can differentiate in real time the response to individual customers and segments. This optimal fit from first supplier to end customer is the essence of the digital loyalty network."³

The study goes on to explain that digital loyalty networks, or DLNs, focus on customer loyalty by managing a portfolio of customers and matching them profitably with capabilities to serve and retain them over the long term. It then works as a network that collects, manages, and shares information seamlessly across organizational boundaries with customers and suppliers. All of this is digitally enabled by the Internet and new technology platforms for supply chain and customer relationship management.

The study concludes with this observation:

"Companies that can create these forms of networks will reap the real value of the emerging digital economy. Our study shows that manufacturers need to integrate supply chain management (SCM) and customer relationship management (CRM) capabilities to differentiate the way they treat each and every customer. Manufacturers can achieve this by leveraging Internet technologies to create ... 'digital loyalty networks' (DLNs), which provide real-time, differentiated responses to customers according to their loyalty, lifetime profit potential, requirements, and cost to serve. By maximizing the entire value creation process in DLNs, companies will begin to reap the real benefits of the new digital economy. ... Manufacturers that can do this—and they are a distinct minority today—are significantly more profitable than those that lag behind."

To assess the value of digital loyalty networks, the research solicited responses to a detailed survey from more than 850 executives in 35 countries around the globe. The respondents covered the gamut of industries and were in the top quartiles in their respective countries based on revenue. The study asked them to answer a series of questions that would determine how well their company performed in two main areas:

• Customer loyalty. How well they performed in terms of customer loyalty and retention.
• Supply chain collaboration. The degree of integration/collaboration with their key stakeholders: customers, suppliers, and distributors, as well as internally.

The responses were plotted along the two axes of customer loyalty and supply chain collaboration, and the respondents were then classified into the four quadrants shown in Exhibit 1: Market Takers, Collaborators, Loyalists, and Loyalty Networkers. The survey determined that nearly half (46 percent) of the companies fell into the Market Taker category, meaning that they did not perform well in collaborating with key stakeholders or in being close to their customers. Twenty-six percent were Collaborators, respondents who had a high degree of integration with their stakeholders but had not formed a strong bond with their customers. Another 15 percent of respondents were Loyalists, who had a strong degree of customer loyalty and retention but did not collaborate well with their partners. Finally, only 13 percent of the respondents were judged to be Loyalty Networkers, or companies that demonstrated a high degree of both customer loyalty and supply chain collaboration. For the purposes of this article, Loyalty Networkers and digital loyalty networks can be considered to be the same thing. But it is our sense that none of loyalty networkers are in the upper right-hand corner of their quadrant—even they have significant room for improvement.

The survey reveals that investing in loyalty networks pays off. Big time. Loyalty Networkers—companies that coupled their customer loyalty focus with their prowess in supply chain collaboration—significantly outperformed their peers on dimensions ranging from supply chain performance to shareholder returns.

Here are some insights gleaned from the research:

1. Collaboration is not sufficient. Our study revealed that, in every case, Loyalty Networkers performed better than all other companies in every traditional measurement of success—profitability, growth, return on investment, and so on. Second best were the Loyalists, those companies that are close to their customers. They were followed by Collaborators and then Market Takers. These results show that, to enhance success, collaboration needs to be merged with a strong focus on customer loyalty.
2. Loyalty is not sufficient. Loyalty pays; however, without strong, integrated links to their stakeholders, the competitiveness of companies will be severely compromised. The research reveals that companies with a customer-centric focus (called "Loyalists") produce a 25-percent lower shareholder return than Loyalty Networkers. (See Exhibit 2.)
   
   
3. Size doesn't matter. Digital loyalty networks are size-independent. Companies of any size can benefit from the loyalty network strategies.
4. Non-alignment hurts. Market Takers, the non-aligned amongst companies, get squeezed from both directions: They are forced to accept current market conditions from both the buy side and the sell side because of weaker relationships with customers as well as suppliers.
5. DLN is a journey. Although those 13 percent classified as Loyalty Networkers have taken a step in the right direction, they still have a ways to go. Companies will attain sustainable competitive advantage only by continuing to hone their ability to build loyalty among customers that are valuable to them and by collaborating and integrating with an ever-changing cast of stakeholders. The unrelenting demands of customers and the fierce pressure of competition will continuously raise the bar of what constitutes a "world class" DLN.

Our report suggests that digital loyalty networks will be central to a company's competitive future. But are any companies doing anything like it at present? What does the concept mean for your company in particular? How do you go about creating a DLN? It is to these questions that we now turn our attention.

A number of leading companies in a variety of industries are following the twin tenets of DLNs: discernment and differentiation. For instance, Dell Computer has internalized these principles into every fiber of its corporate being. A recent Fortune article says:

"Dell is right with its customers as they design their new systems. The goal ... is to be 'so tightly coupled' that a customer won't ever want to shop around. Not all customers at Dell are created equal, nor are they treated equally. Dell's data enable it to know the ultimate fact about its largest customers—exactly how profitable they are. The more money a customer brings in, the better treatment it gets; for instance, someone who buys servers and storage from Dell is more likely to get a special package that includes PCs and portables. Other industries—such as airlines, advertising, and banks—have also begun to offer better service and prices to large accounts, but they don't like to say so. Dell is willing not only to admit it but also to say that some accounts may not be worth its time. Dell has told customers that it may not bid again for their business. They look at them like they are crazy."⁴

The Fortune article mentions the airline industry, which provides another example of the tenets of a good loyalty network. The airline industry is composed of multiple value networks. The airline value network produces/delivers passenger transportation. The value network can be thought of as having different constructs based on the channel through which a passenger purchases a ticket, travels to the airport, passes through the airport (in a frequent-flyer club lounge or in the regular passenger seating areas), and then the class in which a passenger flies. (Virgin Atlantic, for example, has chosen to manage the entire value network, down to arranging for a limousine to pick up passengers, pampering them upon arrival at the airport, and providing stellar in-flight service.) The airlines build customer loyalty through frequent-flyer programs and then discern and differentiate the service provided to a passenger based on the value of that customer to the organization.

To cite another example, a global supplier of components to manufacturers of electrical appliances and heating systems found that it was actually losing money when servicing certain customers that it had always considered to be profitable. In fact, one of the more prestigious of these customers was using the company as a backup supplier to handle small special orders of low-priced components that the customer's main supplier could not deliver. The company's customer focus, without any regard to the manner in which it was fulfilling the need of these customers, actually resulted in a severe drain on corporate resources. Once it realized this, the supplier changed its policy to classify its customers based on the demands they made on its supply chain and customized the supply chain accordingly. The supplier installed direct online order entry at these "large, prestigious" customers, and directed a customer that had placed several small orders for many of its products to a distributor. The company thus created a differentiated supply chain to serve the varying needs of its customers. The efforts resulted in a 45-percent increase in profits and an overall return on capital of 25 percent.⁵ Discernment and differentiation resulted in significant improvements to the company's bottom line.

Creating Digital Loyalty Networks

As these examples suggest, some leading companies already are well under way in creating digital loyalty networks. Others embarking on this same journey should understand that the process incorporates four key activities: understanding customer value, requirements, and network costs; designing loyalty networks; managing and executing network strategy; and measuring loyalty network performance. (Exhibit 3 on the preceding page depicts these activities.)

Understanding Customer Value, Requirements, and Network Costs By knowing their customers better, Loyalty Networkers can design the most appropriate capability chain to satisfy each customer—starting with the most valuable. This is the critical first step in creating a DLN. As Exhibit 4 (on the preceding page) indicates, Loyalty Networkers have taken a lead in using customer-centric technologies. These efforts, as Exhibit 5 suggests, have helped Loyalty Networkers make greater strides than Collaborators in getting to know their customers. But weaknesses remain. Despite the globalization of the manufacturing sector, most companies continue to struggle when it comes to understanding customers in foreign markets.

Designing a Loyalty NetworkTo define what matters and design an optimal customer value proposition, companies need to identify and understand their customers' lifetime value, supply chain and customer- service requirements, and total cost to serve. Once they have that information, they can then dynamically commit plant capacity, logistics, labor, and inventory to customers according to their value and requirements. The sheer task of doing this in collaboration with network partners is enormous. But emerging technologies can provide an overview of opportunities and constraints, as well as decision-making support. It should not be surprising that Loyalty Networkers are ahead in using technologies such as real-time data systems, customer data integration, data warehousing, e-commerce, and enterprise resource planning (ERP) systems.

Managing and Executing Network StrategyExecuting the strategy and managing the loyalty network present the real test of capabilities. Without deep, online links to relevant network partners and customers, companies are likely to find that managing such a network is a daunting task. Again, Exhibit 4 shows that Loyalty Networkers are ahead on investing in the necessary technologies. Leading companies such as Hewlett-Packard (HP) are rapidly realizing that customer relationship management, supply chain management, and e-business platforms are on the edge of being able to deliver the capabilities needed to create meaningful and effective digital loyalty networks. Although it focuses its main efforts on key customers and segments, Hewlett-Packard uses online spot markets and auctions for components and other hardware products. This helps alleviate problems of excess demand for HP's products while providing outlets for excess supplies of components and returned goods. As companies continue their switch from product-centric to customer-centric strategies, the most profitable part of their business will likely continue to focus on strategic suppliers and loyal customers.

Measuring Loyalty Network PerformanceMost importantly, companies must design and implement new performance systems and metrics spanning their network of business partners. Companies need to be continuously evaluating the digital loyalty network's performance in areas such as customer satisfaction, inventory and manufacturing management, cycle times, and delivery efficiency. To accomplish this, measurement systems must live online, be updated in real time, and be shared with key supply chain partners. The "soft" side of those metrics is likely to become the most important one. Aligning employees and the organization often will prove a huge obstacle to becoming a digital loyalty network. Bringing down silos of information, metrics, and ways of doing business will be a key challenge.

New ways of measuring and sharing performance information will be crucial to changing mindsets and goalposts throughout the network. As Exhibit 6 indicates, Loyalty Networkers are taking on the challenge. They lead in tracking customer satisfaction, vendor quality, employee loyalty and satisfaction, and other key metrics. The results illustrate that measuring performance is important. For example, building employee loyalty is crucial for any company trying to build strong relationships with customers as well as with suppliers. It is not surprising that Loyalty Networkers are far ahead of other companies in retaining their employees. (See Exhibit 7.)

For companies that are starting out, the journey to becoming a digital loyalty network will prove to be very rewarding. As emphasized earlier, it does not matter how big a company is or whether the company is currently discerning and differentiating among its customers. Nor does it matter whether the company currently has a loyalty or a collaboration focus.

Because only a few companies have even begun thinking about the concept, there is a huge opportunity for any company to gain considerable ground. Having the resolve to take this path will distinguish winners from the competition. The experience gained in moving down this road will only widen the gulf between leaders and the laggards. Carpe diem.

Footnotes

¹"The Future of Manufacturing and Distribution in the Internet Age," Gartner Group Presentation, 2000.

²"Digital Loyalty Networks: e-Differentiated Supply Chain and Customer Management," Deloitte Research, October 2000.

³See the sidebar "Survey Methodology and Respondent Profile" on page 68 for information on our methodology.

⁴Morris, Betsy. "Can Michael Dell Escape the Box?" Fortune, Oct. 16, 2000.

⁵Kaplan, Robert S. "Kanthal (A)," Harvard Business School Case, Aug. 25, 1993.

Robert E. Sabath is a director and Himanshu Kumar is a senior manager in Deloitte Consulting's Buy-Side practice.