the end of irrelevance: dunnhumby's loyal customer mailers

UVA-M-0790 Jun. 29, 2011

This case was prepared by Bank of America Research Associate Professor Rajkumar Venkatesan and Landmark

Communications Professor Paul W. Farris, with research assistance provided by Kelly Ateya. It was written as a

basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation.

Copyright 2011 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved.

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THE END OF IRRELEVANCE:

DUNNHUMBY’S BEST CUSTOMER COMMUNICATIONS

Introduction

Michael Lewis, chief of customer operations at dunnhumbyUSA, genially welcomed the

firm’s new director of analytics, Paul Fitch, then shifted crisply to the matter at hand. It was

2006, and Lewis had just received a call from John Smith, VP of customer marketing at Kroger,

a leading U.S. grocery retailer, with whom he was developing a loyal customer mailer (LCM)

program. The goal was to reduce exposure to price competition while providing returns that were

as good or better than traditional free-standing insert (FSIs), most familiar as coupons in

newspapers. The loyal customer mailer (LCM) would eventually be credited with part of

Kroger’s successful turnaround since 2000. But during these initial days getting LCM right was

a big challenge.

But the U.S. grocery market was quite different from the United Kingdom’s, so the

model for their approach—a successful customer insight program with Tesco, the UK’s largest

retailer—might have to be adapted to local conditions. Further, some managers thought any such

program should be about acquiring new customers and cross-selling new categories to current

customers, while others believed an LCM’s emphasis should be on reinforcing the loyalty of the

best customers—focusing on the product categories and brands that they bought most frequently.

Smith had called to confide that participating manufacturers of consumer packaged goods

(CPG), who had been providing targeted discounts and coupons to Kroger’s loyal customers, had

not yet noticed any benefits, and neither had Kroger—at least not yet—which appeared to

confirm that adaptation was in order. The good news was that Kroger, well aware of

dunnhumby’s success with Tesco, was fully prepared to stay the course. Fitch’s first mission for

Lewisquickly became clear: Figure out a way to improve an LCM program and demonstrate its

benefits to a major client. His first thought: It’s all about the data (Figure 1).

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Figure 1. dunnhumby insights.

Source: dunnhumby. Used with permission.

From Insight to Success

Edwina Dunn and Clive Humby, wife and husband, founded dunnhumby in 1989 on the

belief that intuition alone was unreliable at best—that the key to a successful business model was

tapping customer insight. Mutually beneficial relationships with customers and sustainable long-

term programs were built most viably on a foundation of loyalty data: Identify the most

profitable customers, listen to them, and leverage that essential core to build authentic value. On

this foundation they built a global brand: “essential customer genius.”

The dunnhumby approach attracted a clientele of more than 150 companies worldwide,

including Procter & Gamble, Kraft Foods, PepsiCo, General Mills, Kellogg, Dr Pepper Snapple

Group, and the Clorox Company. From a 30-employee outfit focused on direct mail in the

United Kingdom, dunnhumby would grow to a global enterprise with more than 1,500

employees worldwide and annual sales of more than $300 million.

A tipping point came in 1995 when, in partnership with Tesco, dunnhumby designed and

launched a loyalty rewards program that would change the industry. The Tesco Clubcard was the

first of its kind, in essence freeing retailers from chasing customers it did not yet have and

allowing them to reward existing customers for their loyalty. For every pound spent, Clubcard

holders earned a point equal to one penny. Points could accumulate for up to two years and be

converted into vouchers redeemable for a variety of merchandise, services, and other offerings

(Figure 2).

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Figure 2. Yearly growth in total sales for all the Tesco chain stores, 1995 to 2011.

Source: dunnhumby. Used with permission.

In this manner, Tesco could gather data on actual behavior, see what its customers

wanted, and respond to their needs. Of course, Tesco was not unique in its collection of data, but

the genius of the Tesco/dunnhumby collaboration was in the identification of consumer

preferences hidden not only in individual purchases but in seeing combinations of purchases as

mosaic portraits of preferences and values that could be served. Not surprisingly, growth from

Tesco’s existing customer spending outpaced the growth from new customers. Tesco therefore

believed that the Clubcard had been a profitable venture since 1995.1

An apt expression of the scope of this strategic shift can be found in a dunnhumby

publication by Martin Hayward, director of strategy and futures: “the end of irrelevance.” As

Hayward explains, customer data had the power to transform direct mail:

Cat owners are not sent promotions about dog food, vegetarians are not sent

coupons for steak, tee-totallers are not sent price reductions on wine. Tesco

customers don’t regard their Clubcard statement as junk mail, but something

they’ve signed up for and want to receive. It’s part of the contract between Tesco

and its customers. This is the difference between personalized communication and

irrelevant junk mail.2

1 Clive Humby, Terry Hunt Ed.D., and Tim Phillips, Scoring Points: How Tesco Continues to Win Customer

Loyalty (London: Kogan Page Ltd., 2007). 2 Martin Hayward, Any Colour You Like As Long As It’s Any Colour You Like (London: dunnhumby, 2009), 40.

This book’s title also gives a sense of paradigm shift by playing off a classic example of a monolithic marketing

approach, the statement often attributed to Henry Ford that his Model T was available to a customer “in any color

that he wants so long as it’s black.”

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The idea is put even more succinctly by Edwina Dunn herself: “The more relevant your

offer, the fewer gimmicks you will need to sell it. It will sell itself because it is what people

want.”3

As a testament to the success of their relationship, dunnhumby took on even greater

responsibility within the Tesco organization in 2007, when it agreed to partner in international

markets and assume responsibility for the sales, planning, and evaluation of retail media for the

overall organization. Building on that success, dunnhumby continued to expand and develop a

reputation as a retailer’s “secret weapon” and customer data insight provider.

In 2001, dunnhumby began selling Clubcard insights to Procter & Gamble and Nestlé,

the first of many major CPG manufacturers to utilize its services. Soon after, in 2003,

dunnhumby formed a key joint venture with Kroger, marking a major expansion into the U.S.

marketplace.

The dunnhumby Method

At the heart of dunnhumby’s success was its ability to extrapolate insights from its data.

Loyalty card data, using minimal personal information obtained unobtrusively, solved the

discrepancy between what customers said they did versus what they actually did. Every product

was scored along 50 dimensions, and these scores were fed into a clustering model, organizing

the products into one or more emergent segments, such as price-sensitive, health-focused,

traditional, convenience, mainstream, or upmarket. Then, as each shopper’s buying data

accumulated, patterns emerged, culminating in a unique profile of that shopper, a profile that

would be fine-tuned with each subsequent trip to the store (Figure 3).

Using an algorithm dunnhumby dubbed the “rolling ball” method, the 65,000-plus items

a large supermarket typically carries were narrowed into a focused group of several thousand

“seed” products—code-breaking variables—that could be used to draw links and form common

shopping patterns. For example, a consumer purchasing both organic apples and whey protein

powder might indicate a member of a Green and Healthy or High Price segment, whereas one

purchasing organic apples and instant cocoa mix might indicate a Snacking Kids or No Time

segment. In this manner, as a pianist can play any tune through selected chords across 88 keys,

dunnhumby could discern the needs of any business partner’s customers through selected

segments across a range of dimensions, so that strategic decisions could be based on real

customer and product data and business transformed into a dance of fruition.

3 Hayward, 44.

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Figure 3. Sample dimensional profile of customer purchasing.

Source: Adapted from Feeder’s Digest, CITI Investment Report and dunnhumby. Used with permission.

The model was constructed to process billions of product attribute associations, the

resulting data clustering continuously, growing deeper and more complex, updating in real time

to accommodate both new products and changes to relevant variables of existing products; if a

once-niche product became more mainstream, the assigned “mainstream” score associated with

that item would increase proportionately.

In Kroger’s case, management determined that Kroger’s more than 42 million loyalty-

card-carrying shoppers could be classified into seven different shopper segments. Kroger created

customized mailings to target each shopper segment; extending personalized coupons and

marketing messages to its customer base and avoiding the redundancy and inefficiency of the

typical scattershot approach.

Coupons

Coupons had long been a staple of grocery marketing. CMS, Inc., reported that over $300

billion in potential consumer savings was distributed through coupons in 2006. Figure 4

provides the five-year trend in the number of coupons distributed in the United States.

Note: As indicated, a pattern of high scores in particular dimensions may be used to organize customers into segments by behavior and priorities. A list of sample dimensions:

Ethnic Baby Diet Gourmet Frozen Kids Meat Pet Home Baking Organic

Dimension

Score

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Figure 4. Five-year trend in U.S. CPG coupon distribution volume (in billions).

Data source: 2008 Coupon Facts, NCH Marketing Services report, 2007.

CPG manufacturers typically spent approximately 50% of their total advertising and

promotion budget on trade promotions, 26% on advertising, and 24% on consumer promotions,

including coupons. Despite the growth of many other retail channels, grocery stores or

supermarkets still accounted for the highest coupon redemption rates (Figure 5).

The cost of circulating an FSI nationally—the most popular mode of distributing

coupons—is provided in Table 1. Some of the major determinants of a coupon’s redemption rate

include the face value of the coupon, the expiration data, the coupon and page size, the

competitive activity, the brand’s market share, trade support and display activity inside the store,

and the effectiveness of the copy.

Figure 5. Percentage of redemption volume by channel, 2002 to 2004.

Data source: Food Industry Review, Food Institute report, 2007.

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Table 1. Cost breakdown of an FSI with a 40-million circulation (in U.S. dollars).

Artwork $ 30,000

Insertion (full page) $ 240,000

Redemption ($0.50)4 $ 400,000

Handling ($0.10) $ 100,000

Total $ 770,000


After 2000, trends towards shopper marketing led to a greater reliance on in-store coupons than

on coupons distributed outside the store.

Loyal Customer Mailers

Dunnhumby launched its pilot LCM program with Kroger in spring 2006 (Figure 6).

Inspired by the “statement-like” program dunnhumby had developed for Tesco, the LCM was

intended to reward Kroger’s loyal customers for their business. The intention was to thank

Kroger’s loyal customers and provide them with discounts on products they regularly buy. They

were mailed once every quarter and contained coupons from several CPG manufacturers. Other

programs dunnhumby developed for Kroger included themed events for specific occasions, such

as the Super Bowl, and single manufacturer solo coupon mailers.

Figure 6. Typical Cover Letter in a Kroger LCM.

Source: Kroger. Used with permission.

4 Assumes a 2% national redemption rate.

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About 200 CPG manufacturers provided coupons in one or more LCMs, with a maximum

of three national brands per manufacturer per campaign. Each LCM provided about 10 to 12

coupons from both the manufacturers and for Kroger private labels. About 7% of the coupons in

each LCM were for private labels. Kroger customers who spent more per trip and visited Kroger

more often were prioritized for the LCMs. Customers could redeem both the FSI coupons and

the LCM coupons if they are both available for the same product at the same time. As per legal

requirement, the manufacturer coupons in the LCM campaigns were mostly redeemable at other

retailers as well. The cover page in the LCMs, however, carried a Kroger logo, and the cover

letter contained a message from a senior executive at Kroger thanking the customer and

explaining that the coupons were picked to match customer preferences and that the discounts

were available only for the retailer’s best customers. The message within the mailer emphasized

the benefits the brands provided rather than the savings the coupons provided. For example, a

coupon for sliced cheese coupon provided recipes for making cheese dips and also highlighted

different uses of the couponed product. The coupons themselves were clustered within three

pages in the center of the booklet (Figure 7).

For each LCM, manufacturers nominated a set of brands to participate and the maximum

number of coupons that were allowed to be dropped. Then, after participants were determined,

manufacturers would decide, in consultation with dunnhumby, on the type of offer (such as “buy

one, get one free”). Funding was sourced largely from trade dollars or, sometimes, from the

manufacturers’ brand groups. It was up to dunnhumby to determine which offer is most

appropriate for each customer.

Figure 7. Cluster of coupons at center of LCM booklet (standard booklet page on left).

Source: Kroger. Used with permission.

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The number of coupons mailed to Kroger customers could end up being lower than that

proposed by the manufacturer; likewise, because of variation in the coupons nominated, the

number of customers receiving an LCM could change each quarter. With this in mind, multiband

manufacturers could provide a “pooled” nomination for which they specified a total number of

coupons and brands. dunnhumby then determined the allocation of brands with the pool based

on customer purchase history. Coupon customization was based on the data sourced from its

customer loyalty cards with the intent of matching customer preferences with coupon offers.

Kroger treated its private-label products as a separate CPG, vetted through the same process as

were other manufacturers.

Initial Results

The initial LCM results were not encouraging. The manufacturers reported back to

Kroger that the costs of the LCMs were about ten to twelve times as much but the redemption

rates were only 2 to 3 times higher than the non-targeted FSIs. With these metrics, the LCM was

not proving to be profitable. Something had to change for the LCM to survive.

Redemption rates were commonly accepted within the industry, and Fitch knew that

dunnhumby had to provide the value of LCM on this metric before a broader evaluation of LCM

would be entertained. So the option of pushing for other metrics, such as incremental sales lift

from mailed customers, was moot.

As Fitch scanned reports to diagnose the weak response, one analysis stood out. It

evaluated redemption rates based on whether the coupons supported products consumers had

purchased in the past and matched it to purchase behavior for each consumer group. (Exhibit 2

and Exhibit 3 provide a summary of this analysis for the yogurt and cereal categories). The

report, in other words, tracked the relationship between brand loyalty and redemption rates.

Based on pre-LCM purchase histories, customers were split into three groups: “brand-loyal,”

“category loyal but no brand purchase,” and “variety-seeking.5” In the case of the dairy

category, brand 1 accounted for more than 60% of category purchases among the “brand-loyal”

customer group but less than 40% among the “category loyal but no brand purchase” group, with

purchases among the “variety-seeking” group across the 40%–60% range.

During the previous year, of the 13 “brand-loyal” households that received a customized

coupon for brand 1 in the dairy category, 11 of those households made 86 purchases of brand 1.

Fitch found this report contrary to years of conventional wisdom in the industry. Among

other things, coupons had often been employed as a mechanism for acquiring competitor’s

customers, but the yogurt and cereal analyses seemed to suggest that redemption rates and

incremental sales were higher when consumers received coupons for products they had bought

5 A fourth group, “Did not buy in the category” was also considered, but is not reported here.

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before, a kind of “preaching to the converted” effect. As a consumer himself, Fitch thought this

made sense. So why weren’t coupons as a reward for brand loyalty not yet common practice?

Decisions

The yogurt and cereal results reminded Fitch that the LCM was meant to reward

customers for their patronage of Kroger. Did the objective of LCMs get lost in the operations of

the campaigns? Smith and Lewiswere expecting a new strategy that would make the LCM a

more attractive option for manufacturers than FSIs. He wondered whether LCMs ought to target

brands already purchased by the consumers and whether this would restrict the entry of smaller

and newer brands to the LCM. Would that help or hurt Kroger’s relationship with its customers?

Should a customer always receive a coupon from the same brand on multiple LCMs—would this

make the consumers more price-sensitive? Also, would manufacturers always prefer higher

coupon redemption rates? Or could the LCMs be used by Kroger to work with specific

manufacturers to develop their brand loyalty? And what would be the appropriate metrics for

evaluating the long-term value of LCMs? Fitch turned once again to the Tesco experience and

wondered whether repeating its success in the United States required transposition.

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Exhibit 1


DUNNHUMBY’S LOYAL CUSTOMER MAILERS

Grocery Coupon Redemption Rate by Media Type, 2006 (in percent)

Sunday FSI 0.8

Newspaper 0.6

Magazine 0.8

Direct mail 1.1

Regular in-pack 4.2

Regular on-pack 4.6

In-pack cross-ruff 1.7

On-pack cross-ruff 2.6

Instant on-pack 18.3

Instant in-pack cross-ruff 5.2

On-shelf distributed 6.4

Handout electronically dispensed 6.3

All other handouts in-store 2.0

All other handouts away from store 1.9

Internet 6.1


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Exhibit 2



Dairy Category Analysis

Brand Loyalty*

Targeted

Coupon

Available

for Brand

Number of Purchases Number of Purchasing Households Number of

Households

in the

Segment Brand 1 Brand 2 Brand 3 Brand 1 Brand 2 Brand 3

1 Brand-Loyal No 413 32 36 73 11 13 15

8

1 Brand-Loyal Yes 86 2 11 11 1 4 13

1 Category Loyal No 99 945 320 26 105 56 32

3

1 Category Loyal Yes 42 107 49 3 14 8 33

1 Variety-Seeking No 46 34 39 9 5 6 34

1 Variety-Seeking Yes 3 2 0 1 1 0 3

2 Brand-Loyal No 28 39 294 7 9 41 92

2 Brand-Loyal Yes 0 0 0 0 0 0 1

2 Category Loyal No 679 1145 148 113 129 43

42

9

2 Category Loyal Yes 24 15 8 5 5 1 8

2 Variety-Seeking No 61 8 71 6 2 10 33

2 Variety-Seeking Yes 0 0 0 0 0 0 1

* Brand-Loyal = Brand has more than 60% share of the customer’s category purchases. Category Loyal = Brand has less than 40% share of the customer’s

category purchases. Variety-Seeking = Brand has between 40% and 60% share of the customer’s category purchases.

Data source: dunnhumby.

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Exhibit 3



Breakfast Category Analysis

Brand Loyalty1

Targeted

Coupon

Available

for Brand

Number of Purchases Number of Purchasing Households Number of

Households

in Segment Brand

1 Brand 2

Brand

3

Brand

4

Brand

1 Brand 2

Brand

3

Brand

4

1 Brand-Loyal No 17 77 36 10 11 38 14 9 85

1 Brand-Loyal Yes 1 10 5 1 1 3 4 1 11

1 Category Loyal No 460 306 423 164 237 202 238 125 1585

1 Category Loyal Yes 38 47 57 23 21 31 36 17 135

1 Variety-Seeking No 27 45 35 10 17 21 25 8 98

1 Variety-Seeking Yes 3 11 12 1 3 7 7 1 18

2 Brand-Loyal No 50 73 191 37 30 40 68 25 85

2 Brand-Loyal Yes 6 15 43 7 4 9 20 6 32





3 Brand-Loyal No 30 29 30 67 14 17 17 21 29

3 Brand-Loyal Yes 1 6 6 13 1 1 2 6 9





Data source: dunnhumby.

1 Brand Loyal = Brand has more than 60% share of customers’ category purchases. Category Loyal = Brand has less than 40% share of customers’ category

purchases. Variety-Seeking = Brand has between 40% and 60% share of customers’ category purchases.

the end of irrelevance: dunnhumby's loyal customer mailers

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