WHY DOES LOYALTY MATTER?

Y CHAPTER ONE WHY DOES LOYALTY MATTER? Does loyalty really matter? As long as we can keep recruiting new donors, does it matter how many of them will offer a second and subsequent gift? After all, if we are always able to find new supporters, we will still be hitting our income targets, won t we? Loyalty does matter, however, because organizations have to spend a lot of time and effort to find new major donors, and even in the realm of direct marketing, where expenses (per donor) are lower than in major donor development work, it still costs up to ten times more to reach a new donor than to successfully communicate with an existing one. So although new donors can certainly be attracted, the costs of fundraising in an organization with poor donorretention rates can quickly begin to climb dramatically. Low levels of donor retention can also have an effect in other, more subtle, ways. In this chapter we explore the impact that even a small increase in donorretention rates can have on your fundraising performance. We look both at the immediate impact and at the longer-term results, introducing the concept of donor lifetime value. As we shall see, lifetime value is a critical concept to grasp because it can turn the traditional economics of fundraising on its head and open up a whole new way of looking at the value inherent in your fundraising database. COPYRIGHTED MATERIAL 1

2 Building Donor Loyalty The Scale of the Retention Problem Nonprofits typically lose a high proportion of their supporter base each year, particularly if they use direct-marketing fundraising. Figure 1.1 illustrates the pattern of retention achieved by most nonprofits involved in annual campaigns or the solicitation of single gifts, the type of fundraising where an organization solicits a number of separate gifts over time. Most organizations find that they lose a high proportion of their donors between the first and second gift. Typically as many as 50 percent of those recruited never give a second gift. After that, organizations tend to lose 30 percent of the remaining donors each year. In recognition of these figures many nonprofits are now moving to regular giving or (in U.K. fundraising terms) committed giving. Here donors are asked to offer a regular and often low-value gift. The gift is typically collected each month (or quarterly) from the donor s bank account or, as is more prevalent in the United States, from the donor s credit card. Regular giving changes the economics of the exchange as a much lower percentage of individuals who agree to give in this way FIGURE 1.1. DONOR-RETENTION CHART. 100 90 80 Percentage of Donors Remaining Loyal 70 60 50 40 30 20 10 0 1 2 3 4 5 Year

Why Does Loyalty Matter? 3 will choose to terminate their support, and the attrition rate will be closer to 20 percent per year. Although this pattern of performance is a dramatic improvement, it is still far from ideal. Imagine losing 20 percent of your friends each year! The Real Cost of Attrition Our experience with benchmarking fundraising costs tells us that donor acquisition is expensive. Bringing new major donors into the organization can take months, if not years, of research and cultivation. At the lower end of the spectrum most direct-marketing fundraisers lose money on their donor-acquisition activity. Although donor performance varies by media (see Table 1.1), it can typically be up to eighteen months before newly acquired donors have given enough to an organization to justify the costs of their recruitment. Comparing these returns with those from donor-development activity (that is, taking care of a donor following acquisition) shows us that it can cost up to ten times as much to reach a new donor as it does to communicate with an existing one. Donor acquisition is indeed an expensive activity. Thus, it makes sense to focus on donor retention to ensure that the number of donors who stop giving is held to a minimum and to reduce the need for the organization to continually seek new donors. There will always be a need to make up for natural attrition (for example, when someone dies or moves away), and some organizations do look to expand their base of support in line with their need for resources, but the key here is that unnecessary recruitment activity should be avoided. TABLE 1.1. INITIAL DOLLARS GENERATED BY ONE DOLLAR OF INVESTMENT. Mean Standard Deviation Median Recruitment media Direct mail cold recruitment $0.39 $0.21 $0.47 Direct-response television 2.27 0.56 2.77 Direct-response press advertising 0.61 0.58 0.58 Press/magazine inserts 0.87 1.01 0.26 Unaddressed mail 0.56 0.46 0.35 Face-to-face solicitation 0.66 0.33 0.71 on-street recruitment Development media Direct mail 2.88 1.45 3.00 Source: Sargeant and Lee, 2003.

4 Building Donor Loyalty Although the figures in Table 1.1 remind us of the different economics of acquisition and development activity, the impact of minimizing donor attrition can be more profound. Reducing the number of donors that terminate their support reduces the need for an organization to find replacement givers. It also, however, heightens the lifetime value of the organization s supporter base. As individuals stay longer, the amounts that they give over the duration of their relationship with the organization grow. Although this correlation seems intuitive and is perhaps no great revelation, many fundraisers fail to realize that the impact of enhancing retention compounds with the passage of time. In other words, even a comparatively small annual increase in loyalty can result in a major increase in lifetime value and in the efficiency of an organization s fundraising activity. Figure 1.2 illustrates how compounding works. In this example we have mapped out the direct-marketing performance of two nonprofits. To keep the math simple we have chosen one with an annual attrition rate of 10 percent (that FIGURE 1.2. IMPACT ON TOTAL ANNUAL REVENUE OF REDUCING THE ATTRITION RATE. 6 5 4 Millions of Dollars 3 2 10% attrition 1 20% attrition 0 1 2 3 4 5 6 7 8 9 10 Years

Why Does Loyalty Matter? 5 is, it loses 10 percent of its donors each year) and one with an annual attrition rate of 20 percent. In all other respects these two organizations are identical. They each start with one hundred thousand donors in their database, and they each attract average annual gifts of $50. Figure 1.2 illustrates the total revenue each organization generates each year for ten years, including the year of recruitment. At the end of year 1 both organizations have achieved revenue of $5 million. Thereafter, with every year that passes, the attrition rate has an increasing impact on the total revenue generated. When we add up the revenue generated in each case, the organization with a 10 percent attrition rate will have generated a sum of $33 million in ten years; the organization with a 20 percent attrition rate, a mere $22 million. In other words, the impact of cutting the attrition rate from 20 percent to 10 percent will have equated to an improvement in profitability of 50 percent. The graph shows the additional revenue that would accrue from a decrease in donor attrition. But this decrease is only part of the equation; few organizations would not engage in donor acquisition over the period in order to make up the balance of support. If both organizations wish to maintain the size of their donor base over the period, or even expand it, the organization with a 20 percent attrition rate will have to work twice as hard as the organization with a 10 percent attrition rate to attract new donors to fill the gap. As we noted earlier, this activity is undertaken at significant cost, and so, if we were to factor this into the equation, for a typical nonprofit we would find that decreasing the attrition rate from 20 percent to 10 percent would increase the lifetime value of donors by over 100 percent. In a nutshell, this is why loyalty matters. Impressive though the effect on revenue is, it does not indicate the full impact of enhancing donor loyalty. Donors who remain loyal are also much more likely to engage with the organization in other ways. Long-term donors are significantly more likely than single-gift donors to offer additional gifts in response to emergency appeals, to volunteer, to upgrade their gift levels, to lobby for the organization, to actively seek out other donors on the organization s behalf, to buy from a gift catalogue, and to promote the organization to friends and acquaintances. The value of these activities will differ from one cause to another, but, in our experience, adding the impact of these variables to our example can bring a total uplift in donor value of between 150 and 200 percent. What Is Loyalty? What exactly do we mean by loyalty? Are donors who continue to give necessarily loyal? The short answer is no. Some may feel trapped into giving, perhaps because of pressure from their family, peer group, or employer. Although these

6 Building Donor Loyalty individuals will appear perfectly loyal, as soon as the pressure disappears, so too will their giving. Loyalty also can be either passive or active. Passive loyalty is the easiest for competitors to attack and therefore is the easiest to lose. Indeed, passive loyalty isn t really loyalty at all. It occurs when donors feel comfortable giving to an organization, respond to occasional solicitations, but give relatively little money. These individuals feel no real sense of commitment to the organization; perhaps they simply have not yet found the most appropriate outlet for their philanthropy. In the case of regular, monthly givers, inertia may creep into the relationship; although these donors may not feel themselves to be loyal, they are equally not especially motivated to take the time to cancel the regular payment arrangement. Clearly, if these individuals are presented with an opportunity to give that is more inspiring or more in line with their interests, they may terminate their support. They can also lapse because giving of this passive nature suffers first when pressures increase on their budgets. Active loyalty, by contrast, occurs when donors believe passionately in the cause, identify with the values and ethos of the organization, and regard their support as an essential component of their personal or household budgets. Active loyalty is not a function of inertia, it is a function of the genuine enthusiasm and commitment an individual has for a nonprofit s mission. Try as they might, competitor nonprofits will find it difficult to break the bond that this sort of donor feels with your organization. We need to foster active loyalty because it is the key to the development of lifetime value. Is Loyalty Always Good? We have so far examined the merits of developing a focus on retention and explained how even a small increase in retention can have a dramatic effect on your organization s fundraising performance. Implicitly we have therefore assumed that generating loyalty is always good. This need not be the case, however, as the following discussion of donor value illustrates. For most nonprofits the simplest way to look at value is simply to ascertain how much money each donor in the database has given to the organization. This assessment is easily accomplished by most modern fundraising software, and the total number of all gifts at various levels can then be calculated. A pyramid is the best way of presenting this information graphically (Figure 1.3 is an example) because a typical fundraising database has a large number of individuals who give comparatively small sums (the base of the pyramid) and then progressively smaller numbers of individuals who give larger sums as one works up the pyramid. At the

Why Does Loyalty Matter? 7 FIGURE 1.3. DONOR-VALUE PYRAMID. $5,000 and over $1,000 4,999 $750 999 Lifetime Value $500 749 $400 499 $300 399 $200 299 $101 199 $51 100 $50 and under top are just a few individuals who give large sums of money. This pyramid is a representation of the Pareto principle, which (in the language of fundraising) postulates that 80 percent of an organization s funding tends to come from 20 percent of its donors. This seems to hold true even if one creams off the truly major givers for separate consideration. Even in a standard direct-marketing database a small number of individuals will always be donating most of the income. Why is this pyramid of interest? Our simple example totals only the revenue from each donor, but if we include the costs of servicing the relationship with each of these donors and of making the solicitations themselves, a rather different picture emerges (see Figure 1.4). In this example, it is costing the organization more to look after those who give under $50 than it is receiving from them. This pyramid is fictitious, but it is typical of the pyramids many nonprofits produce when they undertake such a cost-benefit analysis. These results present an ethical problem: the individuals giving low sums may be well intentioned, but they are in reality diverting money from the mission of the nonprofit. Deciding what to do about this group is not easy. Some would

8 Building Donor Loyalty FIGURE 1.4. DONOR-VALUE PYRAMID FACTORING IN COSTS OF FUNDRAISING. $1,000 and over $750 999 $500 749 Lifetime Value $400 499 $300 399 $200 299 $101 199 $51 100 $1 50 $0 and under advise that you simply stop communicating with them and save your organization money. However, some of these individuals might be good bequest prospects; equally, some may have developed a personal association with the cause, and it would be harsh to deprive them of a source of pleasure. They may also help in other ways, such as through volunteering, lobbying, or advocacy. The best course is probably to develop a strategy of benign neglect and to minimize contact with these individuals, perhaps writing to them occasionally to remind them of the work undertaken and to afford them the opportunity of offering a higher-value gift or bequest. Targeting the Top of the Pyramid Our pyramids suggest a further strategy that may be appropriate: spending more on the retention of those individuals toward the top of the pyramid than on those toward the bottom. Losing a few donors at the bottom of your pyramid may be

Why Does Loyalty Matter? 9 sad, but it will not have a dramatic effect on income. Losing donors toward the top end of your pyramid will, in contrast, have a dramatic negative effect on the money you are able to generate. The lesson here is that organizations should move away from studying their overall attrition rates and begin to look separately at the attrition rates at different levels of the pyramid and to concentrate development resources on retaining the most profitable donors. By way of illustration, consider for a moment the case of a commercial organization whose pioneering work on lifetime value has now become part of marketing folklore. One of the first divisions of this large, diversified company to investigate the lifetime value of its customers was the division that dealt with cruise holidays on a fleet of ocean liners. To ascertain whether some customers were worth more than others, the company looked back at its records for the previous five, ten, and fifteen years. This analysis revealed that a lady by the name of Elsie Naylor took pride of place at the top of the pyramid. In fifteen years Elsie had spent 4,100 days on board the company s vessels, but not once in this time had the organization acknowledged her loyalty because she had never previously come to the company s attention! Given the money she had spent on this organization s services, the organization should not have been marketing to her the same way it did to customers who may have taken a cruise only once every five years particularly when one considers the revenue that the Elsie Naylors of this world would take with them were they ever to become disenchanted and defect to another supplier. Higher-value customers, or in our case donors, are critical to an organization s success, and they should be identified and treated with a differentiated standard of care to reward their loyalty and value appropriately. In our experience, some faith-based organizations have difficulty with this approach, preferring to regard all donors as being of equal worth. They object on moral grounds to selecting individuals for special treatment because a low-value gift from one individual might be more significant for that person than a major gift is for someone else. Treating these two donors differently would therefore be wrong. We have no quarrel with this perspective, but we believe that most organizations will find it worthwhile to consider treating higher-value donors differently. Although we are concerned primarily in this book with the issue of retention, it is appropriate to consider in passing a further use to which our pyramid might be put. In attempting to acquire new donors, many nonprofits profile their databases to ascertain the types of individuals who donate. The organization can then go out and find other individuals who match this particular profile and who therefore are statistically more likely to give. A glance at the pyramid, however, should remind us that such global profiles will be heavily dominated by individuals who give low amounts and who may even be costing the organization money. The smart approach is thus to profile particular value segments of the database and

10 Building Donor Loyalty to determine whether and how the higher-value givers differ from lower-value givers. Perhaps they are older, are male, have a certain level of income, live in certain types of housing, or have certain lifestyle characteristics. This information can be used to select potential new donors for contact. To use our earlier example, the profile of Elsie and others like her would be the most fruitful tool for the cruise-ship company to use in future customer acquisition. Most organizations would prefer to recruit individuals who are likely to remain loyal over time and to donate (in aggregate) large sums. Ascertaining Projective Value We have been concerning ourselves here only with historic value: we have been asking how much a donor has been worth to us in the past. Many organizations determine the standard of care an individual will receive based on this form of analysis. Nevertheless it is not the ideal approach. To understand why, it is necessary to consider newly acquired donors. These individuals are likely to have given a low amount because they have as yet given only one gift. If we manage the database as we have suggested above, they may well be assigned to a lower-value segment, and their names may even be swapped with other organizations. If, however, their potential value to the organization is recognized from the outset, they may be subject to a better standard of care. This is an estimate of likely donor lifetime value, and it is distinct from historic value. This perspective can also help drive donor acquisition. Previously we argued for using the profile of the highest-value givers for donor acquisition. Using the example of Elsie Naylor, we would be most interested in the profile of her and those like her. When thinking about value projectively, however, we need to look back through our database and determine Elsie s profile when she first became a donor. In other words, we want to know what high-value givers looked like when they first began their support. This is the best possible profile to use for donor acquisition because the organization can then deliberately recruit individuals who are most likely to exhibit considerable loyalty and to be extremely valuable over time. A final complication at this stage is the fact that few organizations have the time or capability to calculate the lifetime value of each donor individually or to act on this information if it is produced. Organizations are often more concerned with how certain segments or groups of donors will behave in the future and how each segment should be managed. Combining these various approaches to the management of donor value yields the matrix in Figure 1.5. Here we can see clearly the choices open to fundraisers. They can choose to look at the value of donors historically or projectively (that is, into the future). They can also choose to look either at segments

Why Does Loyalty Matter? 11 FIGURE 1.5. APPROACHES TO MANAGING DONOR VALUE. Individual Segment Historic Projective (future) of donors or at specific individuals. It is impossible to predict in advance which approach will suit an organization best. As we shall see later, particular costs and benefits are associated with each approach. Summary In this chapter we have explained how even small increases in donor loyalty can have a marked impact on fundraising performance. We have also explained that in seeking to maximize this performance it is not enough for organizations to try to improve loyalty across the board. Nonprofits involved in direct marketing will always have some donors who are costing the organization money. In designing the best retention strategy for your organization, you should therefore conduct a value analysis of the individuals in the fundraising database and use this information to focus retention efforts. There are two ways of looking at donor value. First, you can simply calculate how much individuals have given in the past and use this as the basis for the standard of care they will receive in the future. Second, you can take a more sophisticated approach that uses knowledge of how others have behaved in the past to predict how much similar donors may be worth in the future. This lifetime value can then be used to determine an appropriate retention strategy. So far we have provided few clues as to the form a retention strategy might take and the factors that can persuade individuals to continue their support. We develop both these themes in the chapters to come.