How much compensation is too much? An investigation of the effectiveness of financial overcompensation as a means to enhance customer loyalty

Abstract

AbstractThe present paper examines the effectiveness of financial overcompensation as a means to enhance customer loyalty after a product failure. Overcompensation implies that customers are entitled to a refund that is larger than the purchase price. It is, however, still unclear whether large overcompensations entail saturation effects, or alternatively, result in an actual drop in customer loyalty. We predicted that the overcompensation-loyalty relationship is generally characterized by an inverted U-shaped function. In line with this prediction, the results of four studies showed that mild overcompensations had, on average, a positive effect on customer loyalty beyond equal compensation, but only up to compensation levels of approximately 150% of the purchase price of faulty products. Beyond this level, the effectiveness of overcompensation diminished, eventually leading to a general drop in customer loyalty. Despite this overall pattern, two studies revealed robust individual differences in how customers react to increasing overcompensation. A majority of customers increased their loyalty when the overcompensation enlarged, but the curve flattened out in the high range. However, there was also a smaller portion of customers who reacted negatively to every form of overcompensation. A practical implication of these findings, therefore, is that companies should not offer compensations that are greater than 150% of the initial price, as these do not contribute to greater loyalty in any category of customers.