True story: A few days ago one of my employees was telling me about a local diner she had been going to at least once or twice a month for several years. The last time she was there, the cashier informed her that there would be an extra 50-cent charge for using her debit card. My employee called for the manager who confirmed the restaurants’s new policy. No exceptions for long-term customers. My employee paid the extra 50 cents and has no plans to return. Ever.
My employee passed on this story to me and to her co-workers. I’m sure she told others as well. What are the chances any of us will be visiting that establishment soon?
Analyzing this transaction from a strictly financial viewpoint, you have a restaurant that risked a long-term loss of possibly hundreds of dollars in exchange for a short-term profit of 50 cents. Does anybody think that sounds like a good investment?
The proper course of action for the example described above seems obvious to most people.
But take a similar set of circumstances with only slightly different details and the obviously correct action actually becomes counter-intuitive.
Here is another true story, this one from us at Simplicity Sofas, a manufacturer and e-commerce company that relies on word of mouth as our predominant marketing strategy:
A customer purchased a sofa with a one-year warranty on the cushions. Three years later, she contacted the company to ask about the cost of replacing the worn-out seat cushions.
The company’s cost for replacing the cushions was approximately $100 and the customer was willing to pay $200. The obvious short-term response is to simply sell the customer a new set of seat cushions and pocket the $100 profit.
Simplicity Sofas, however, considers the word of mouth “value” of its customer interactions. As a result, our immediate response was to offer the customer a new set of upgraded cushions (with a lifetime warranty) free of charge.
Although this is not as intuitively obvious, the mathematics behind our strategy is just as simple as in the example of the restaurant above.
By sacrificing the $100 short-term profit, we get the strong possibility of gaining a customer who will purchase in the future and who will also recommend the company to others. With a downside risk of $100, Simplicity Sofas can generate profits of $500 — $2,000 per new customer. If the customer with the new cushions buys one new piece of furniture over the next 10 years, the company has already made a good profit on its investment. If the customer induces 5 friends or relatives to also buy, the ROI could increase by an additional $2,500 — $10,000. That’s a pretty good return on a $100 investment.
When Simplicity Sofas informed the customer of their proposed offer, here is the response we received:
Thank you so much for getting back to me so quickly. The [upgraded] cushions would be great! I am hoping, down the line, to purchase another sofa from your company in about a year’s time. I tell everyone about Simplicity Sofas when asked if I know of any quality, hard to fit sofas. Again, thank you I am a customer for life!
How does the $100 word of mouth investment look now?