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Microeconomics of Customer Relationships Essay (Article)


Introduction

With the increase in competition and various challenges in business, these days, managers are looking for new, and more appropriate ways of managing the businesses of the organizations. One of the ways to manage business that some managers make use of is called value chain analysis. Fred Reichheld is considered to be a champion in value addition while using customer relations. He has published articles supporting the use of customer relations to enhance the growth of the firm. Some of his articles are “The one Number You Need to Grow” and “The Microeconomics of Customer Relationships” that discuss this issue in-depth.

According to the author, customers play an important role in the growth of the organization. The fact that customers are important for the successful development of the organization is not in contention. The contentious issue of the articles is measuring the contributions that customers provide to the development of the company. Some theoretical models try to quantify the contributions of customers to the value of an organization. This paper seeks to check and critique the theoretical perspective on the microeconomics of customer relationships which was put forth by Fred Reichheld in his article titled “The Microeconomics of customer relationships” (Reichheld, 2006).

In the provided article, the author explores the Net Promoter Score model of quantifying customer’s contributions to the growth of the organization. He seeks to explain why there is a high correlation between change in NPS and growth in revenue. He also explores how a customer affects the value of the organization, and whether the microeconomics of NPS is effectively quantified. In the article, Reichheld also seeks to check ways through which an organization can raise its NPS, and the class of customers an organization should focus on.

The NPS Model works on a 0-10 scale, where customers rate the organization based on whether they would recommend the organization to a friend. Judging from the recent ratings, there are three categories of customers, which are also promoters, passive and detractors can be formed. The NPS metric thus presents the difference between promoters and detractors. Generally, the NPS model proposes that a 12% increase in NPS corresponds to doubling of the revenue of an organization (Reichheld, 2006).

Critique of the Article

The first critique provides the discussion of the model itself. The NPS model ranks customers according to whether they can recommend or refer another person to the organization. This single aspect is not enough to measure customer quality. There are other aspects such as cognitive dissonance, for example. The model overlooks different industrial factors. The model also assumes a cause and effect relationship between growth in revenue and customer relations.

There is a weak relationship. Growth in revenue is also caused by other factors, such as effective management, reduction in costs, and other factors. Calculating the NPS is quite complex and involving task. It takes much effort, which could be directed to other important areas that contribute to the improvement of the organization’s performance (McConnell, Brue, & Flynn, 2011).

According to Reichheld, measuring the value of customers is the basis of the NPS model (Reichheld, 2006). The method he proposes to measure customer value is almost impossible due to lack of data. The majority of organizations do not keep information about their customers, on retention rates, annual spending by the customers and others. This would call for estimates, which would produce subjective results.

Classification of customers, either promoters or detractors, could be wrong due to the inaccurate gathering of data and information. The NPS model is also based on the “mouth-to-mouth” referrals. Under normal circumstances, it is difficult to differentiate between referred customers and those who have learned about the organization through other means, such as television and newspaper adverts. An organization can differentiate between referred customers and others through interviews, which are inconveniencing and unnecessary.

The NPS model overlooks some other factors that make customer loyal to a product other than satisfaction. There are other factors that prevent customers from moving from one brand to another. These include exit barriers where switching costs are high and lack of other alternatives can be observed. An organization, while using the NPS model, should understand that customers might stay loyal due to other factors other than satisfaction.

The service quality model of customer microeconomics proposes that profitability, associated with customer retention, occurs because of lower amortized costs of acquisition of new customers, low account maintenance costs of customers, low price sensitivity of long-term customers, less service costs to the customers and other factors. The claim by Reichheld and other proponents of the NPS model estimates that mouth-to-mouth referrals increase revenues, and therefore is mistaken (McConnell, Brue, & Flynn, 2011).

Reichheld proposes that in drawing a line between high profitability customers and low profitability customers, one could use the cost of capital (Reichheld, 2006). This is not a good measure of comparing profitability of various customer segments. This is due to the fact that if an organization is profitable, all customers’ profitability will fall above the cost of capital. On the other hand, if an organization is running at losses, customer profitability is likely to fall under the cost of capital.

The point here is that classification of customers according to high profit and low profit is highly subjective in this model. In addition, in his article, Reichheld suggests that organizations should focus their strategies on promoters and not on the ways of acquiring new customers. This proposition is not correct since, for an organization to grow, it should increase its customer base. An organization should do more in terms of advertising, sales and marketing, instead of depending on referrals from promoters only (McConnell, Brue, & Flynn, 2011).

Conclusion

In conclusion, it should be mentioned that the main aim of Reichheld’s article “The Microeconomics of customer relationships” was to look at the reason for existence of a strong correlation between growth in revenue of an organization and increase in NPS, on the effects that customer quality has on the economics of an organization, as well as on the ways in which an organization can quantify and manage its NPS. The article advances a complicated method of measuring customer quality and a subjective method of classifying customers. The article also overlooks other factors that affect revenue of the organization such as economic factors and, cost of operation and others. Generally, the propositions suggested by Fred Reichheld are not applicable to all organizations due to different industries and different types of customers. The propositions could, however, be useful if it would be tailored to suit various industries (McConnell, Brue, & Flynn, 2011).

Reference List

McConnell, C. R., Brue, S. L., & Flynn, S. M. (2011). Economics (19th Ed.). New York, NY: McGraw-Hill.

Reichheld, F. (2006).The Microeconomics of Customer Relationships. MIT Slogan Management Review, 47(2).

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IvyPanda. (2020, July 12). Microeconomics of Customer Relationships. Retrieved from https://ivypanda.com/essays/microeconomics-of-customer-relationships/

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"Microeconomics of Customer Relationships." IvyPanda, 12 July 2020, ivypanda.com/essays/microeconomics-of-customer-relationships/.

1. IvyPanda. "Microeconomics of Customer Relationships." July 12, 2020. https://ivypanda.com/essays/microeconomics-of-customer-relationships/.


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IvyPanda. "Microeconomics of Customer Relationships." July 12, 2020. https://ivypanda.com/essays/microeconomics-of-customer-relationships/.

References

IvyPanda. 2020. "Microeconomics of Customer Relationships." July 12, 2020. https://ivypanda.com/essays/microeconomics-of-customer-relationships/.

References

IvyPanda. (2020) 'Microeconomics of Customer Relationships'. 12 July.

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