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Does ‘overcompensation’ foster customer loyalty?

Consumers expect a refund for malfunctioning products, but there’s a customer backlash if retailers seek to retain loyalty through ‘overcompensation’ that exceeds 150 per cent of the purchase price, says new study co-authored at Cambridge Judge Business School.

Person holding fifty pound notes

Suppose you buy a new vacuum cleaner or camera, and quickly discover it is defective. Most consumers expect a refund from the retailer, which is crucial to customer loyalty. But how effective is a refund that exceeds 100 per cent of the purchase price – meaning “overcompensation”?

There are clear costs to consumers in requesting a refund, in terms of time and money involved in returning to a store or posting something back to a retailer, and there’s also a psychological aspect of asserting oneself and risking an unpleasant situation. So one might expect that “more is better” when it comes to compensation designed to foster customer loyalty to the retailer – as measured by likelihood to return to a store, buy again from it, or recommend the establishment to friends.

But that’s true only up to a point, says a new study published in the journal Judgment and Decision Making, which paints a nuanced picture of overcompensation by retailers.

In a series of four tests involving nearly 600 people in the US, the study found that customer loyalty increases moderately until the overcompensation level reaches about 150 per cent of the purchase price, and then stagnates and even decreases at very high overcompensation levels – 250 per cent, 300 per cent and even 500 per cent.

The research shows, further, that customers don’t usually react uniformly to overcompensation: a large subgroup of customers react positively and a smaller segment of customers react negatively to limited levels of overcompensation – but what does seem universal is a negative reaction among all customer groups at the very highest levels of overcompensation.

David De Cremer

Professor David De Cremer

“The results show that, despite the strong customer instinct of economic self-interest, there are clearly limits to how retailers can regain loyalty through compensation,” says study co-author David De Cremer, KPMG Professor of Management Studies at Cambridge Judge Business School. “The results show that ‘more is better’ only up to a point, and then there’s a backlash. That’s probably because people grow suspicious when efforts of redress seem too far out of proportion to the underlying situation – even if someone really did buy a terribly malfunctioning vacuum cleaner or other product.”

The study results hold practical implications for retailers, who have long struggled with the issue of how to retain loyalty among generally satisfied customers who have an isolated bad experience.

“Overcompensation can help regain any lost loyalty, but this study shows that compensation that exceeds a 50 per cent premium is a waste of money and even cost-ineffective for companies given the incremental costs of overcompensation,” says Professor De Cremer. “It also raises the question of whether the limited customer loyalty gained from any overcompensation is worth the financial cost to a company – and that’s particularly true for big-ticket items, like automobiles, where the monetary value of an unsatisfactory product would be really high.”

The study concludes that the question of whether overcompensation is an effective repair strategy is “one that each company should answer for itself” – bearing in mind such factors as market competitiveness and whether the customer affected is a regular or an occasional client. Another factor to consider: if a company itself voluntarily recalls a product or acknowledges an issue, this sharply reduces the inconvenience and fault-finding expenses of the customer, implying that the client’s expectations of compensation would be lower.

The study – entitled “How much compensation is too much? An investigation of the effectiveness of financial overcompensation as a means to enhance customer loyalty” – was co-authored by Dr Tessa Haesevoets, Professor Alain Van Hiel and Dries H. Bostyn of Ghent University in Belgium, Dr Mario Pandelaere of Ghent University and Virginia Tech University, and Professor David De Cremer of Cambridge Judge Business School.