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Did Harvard Miscalculate the Value of Customer Relationships?
[Spoiler alert: The short answer is no, Harvard didn’t, but a contributor to Harvard Business Review likely did. This post explains why.]
A recent essay published on HBR.org takes a negative stance on the future of branding: because customers can easily access the information they need to make purchasing decisions, brands themselves will become less relevant. This ultimately leads the authors to conclude that, “The value of ‘brand’ or ‘brand image’ as an entity distinct from the offering itself, we think, will diminish.” Instead, the article argues, what matters is customer relationships.
The core case for the rise of customer relationships over branding in the article comes from a set of M&A data from 6,000 mergers and acquisitions between 2003 and 2013. With it, the authors show acquirers are paying more for “customer relationships” (something that’s not well defined in the article but is assumed to represent known receivables, recurring revenue and average customer lifetime value), and lower valuation multiples for brand value (intangible or goodwill assets like individual brands, trademarks and product names).
The problem with the author extending that data to argue branding is in decline overall is that stronger brands capture higher customer value. The most recognized brands also receive higher customer loyalty rates. That’s not a hypothesis, it’s been proven by researchers over decades of time and hundreds of businesses. Customer relationships and ‘brand value’ aren’t two independent variables — they’re both interconnected byproducts of a brand’s strength and market share.
To show this more clearly, let’s walk through some research. First, studies show that almost all consumer purchases are at least partially memory-based, which can be broken into two steps: (1) evocation and (2) evaluation. These two steps together are also commonly referred to as mental availability. When a person has a need (“I’m thirsty.”) and they start to consider getting a drink, the first stage in their potential purchase is evocation: what drink brands, products and options does that person know and remember? Some of this process is unconscious, and may happen without the person even realizing it — those times when they really just crave a can of Coca-Cola. Then, based on physical availability (“What is the closest store, and what drinks does it sell?”), the purchaser moves to stage two, and performs a conscious evaluation (“What drink would I like the most right now, given the ones available on this shelf and how much each one costs?”). In this case — and nearly every case — the winning, chosen beverage has the most memory connections to what the customer wants at that moment. If the purchaser has the strongest memories of Vita Cocoa being sweet and refreshing, that’s the drink they buy. Strong brands build and reinforce memories, which leads to customer loyalty and purchases. Brand can’t be viewed as “an entity distinct from the offering itself,” as the author in HBR contends, because our brains don’t separate the two.
To support how this translates to sales, data from Nielsen and TNS — analyzed by the Ehrenberg-Bass Institute for Marketing Science — shows that brands with higher market share have both (1) more buyers in a time period and (2) more customer loyalty. This pattern, known as the double jeopardy law of marketing, shows that purchase loyalty, something customer relationships are intended to increase, is a direct result of market share. What’s one of the most important factors for a company increasing its market share? A strong, distinct brand.
Double Jeopardy Law for U.K. shampoo brands, 2005
|Brands||Market share (%)||Purchase frequency (avg.)|
|Head & Shoulders||11||2.3|
As the data shows, leading shampoo brands in the U.K. show a direct relationship between market share and purchase frequency. Interestingly, Nielsen data shows the U.S. shampoo market follows the exact same pattern, despite different brands, consumers and retail locations. But this isn’t just a phenomenon for hair products; the Ehrenberg-Bass Institute finds the exact same relationship across consumer banking services, financial products, soft drinks, alcohol and autos.
Defection rates for U.S. car brands, 1989-1991
|Brands||Market share (%)||Customer defection rate (%)|
|Average defection rate||67|
Within this second data set, major car brands in the U.S. suffered a defection rate of around 60-70%, and brands with higher market shares had lower average customer defection rates than competitors with lower market shares.
Now, the findings above aren’t being presented to say customer relationships don’t matter. People buy from people, and relationships are an important part of business, particularly for brands in niche markets and smaller companies looking to win and retain early customers. Instead, the goal is to highlight a three part relationship: (1) distinct brands build stronger memory links with customers, (2) memory links increase the likelihood people think of that brand, (3) the more of this mental availability a brand wins, the more likely people will purchase their product or service once, and continue to buy it in the future. The strength of a brand directly influences its customer relationships at scale in consumer markets, so if the enterprise value of relationships is rising, it’s in part because of — not at the expense of — brand. The larger and more mature an industry is, the more this relationship holds true*.
Even if, as Peter Drucker says, the sole purpose of a business is to create a customer, it’s the brand that bridges a customer’s needs with their decision to purchase. People buy from brands they remember and believe in, and customer relationships can only be built after you’ve won a person’s business in the first place.
*Note: As discussed above, the studies cited in this essay are based on data from large, efficient consumer markets. Data on other types of markets, like software as a service (SaaS), a recurring revenue segment where churn is an important factor in brand growth (and may be reduced with a thoughtful, systematic approaches to customer service), is limited. B2B markets with large, complex sales cycles, few vendors and buyers and low transaction volume may also deviate from these patterns, although, to date, there has been little research done with these types of market segments.