The Impact of Service Quality and Service ... - Wiley Online Library

British Journal of Management, Vol. 7, 219-230 (1996)

The Impact of Service Quality and Service Characteristics on Customer Retention: Small Businesses and their Banks in the UK1 Christine T. Ennew and Martin R. Binks* School of Management and Finance and *Enterprise Centre, University of Nottingham, University Park, Nottingham NG7 2RD, UK The recent developments in relationship marketing have increasingly focused attention on the beneficial effects of customer retention. The notion of building relationships and delivering quality service in order to encourage loyalty is perhaps of particular importance in the service sector where it is often argued that customer attraction costs are significantly higher than retention costs. Central to the idea of investment in the development of service quality and customer relationships is the belief that such investments will enhance loyalty, retention and profitability. Empirical evidence on the extent to which such links exist is still partial. This paper explores the relationship between service qualitylcustomer relationships and customer loyalty and retention using evidence from the UK banking sector and its small business customers. Keyword's: customer retention, service quality, small business, banks, UK

Introduction At the centre of the marketing concept is the idea of improving organizational performance by attracting and retaining satisfied customers. Much of the teaching and research in marketing has tended to focus on the former - acquiring new customers by developing products to satisfy specific needs has been one of the main concerns of academics and practitioners. However, the relative costs of customer acquisition and customer retention have resulted in a growing interest in issues surrounding the building and maintenance of long-term customer relationships as a key to improved profitability. This notion of relationship I We thank Mike Wright and two anonymous reviewers for helpful comments on an earlier draft and the Forum of Private Business (FPB) for the provision of the database.

0 1996 British Academy of Management

marketing is thought to be of particular relevance in industrial and service markets, although many consumer goods suppliers are becoming increasingly interested in the concept of customer relationships and customer retention. Service quality is widely seen as a key antecedent to successful customer relationships. Arguably, this is particularly so in the service sector where quality can be difficult to imitate and as such can potentially provide the basis for a sustainable competitive edge. Offering a superior service which the competition cannot match provides consumers with a reason for selecting and remaining with a particular provider. Conversely, a service offer which is inferior or indistinct may lead to greater problems in attracting customers and an increased likelihood of defection. Thus service quality can, in principle, provide the basis for enhanced loyalty, retention and improved business performance. This paper examines the

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links between customer retention/defection and service quality in the context of the UK banking sector and its relationship with its small business customers. The next section of the paper discusses the issues surrounding service quality and customer retention in general while the third section presents a framework for examining the issues of satisfaction and retention in the context of UK banks and small businesses. The data and the measurement of constructs are discussed in the fourth section and the results of the empirical analysis are presented in the fifth. The final section provides a summary and conclusions.

Customer defection, retention and service quality Managing customer orientation and service quality is commonly identified as being one of the most effective - if difficult - means of building a competitive position in a service industry and improving organizational performance (Lewis, 1993). Indeed, a managerial perspective would suggest that investment in service quality and the building and maintenance of customer relationships can only be justified if it results in improved profitability2 (Rust and Zahorik, 1993). There is already an extensive literature dealing with the definition and measurement of service quality (Gronroos, 1984; Parasuraman, Zeithaml and Berry, 1985, 1988; Teas, 1993), but the linkages between service quality and organizational performance have been less thoroughly investigated (Thorpe, 1994). Evidence from the PIMS database indicates that high quality service offers result in more repeat purchases and market-share improvements (Buzzell and Gale, 1987) while Rust and Zahorik (1993) provide evidence of a link between customer retention and market share. However, there is still empirical debate about the nature of the causal relationships linking service quality, loyalty, retention and performance although there are strong conceptual arguments for their existence (Rust and Zahorik, 1993; Anderson and Fornell, 1994; Thorpe, 1994). The existence of a link between retention and profitability can be derived from a simple

* Or any other relevant measure of organizational performance.

C. T. Ennew and M.R. Binks

cost-benefit equation. The costs of customer acquisition are generally higher than costs of retention (Reichheld and Kenny, 1990, Reichheld and Sasser, 1990) and this inequality is particularly in evidence in the service sector. Consequently, small reductions in customer defection rates can produce significant improvements in profitability. These improvements arise as a consequence of both cost savings and additional revenue generation. In principle, additional revenue is generated partly because established customers will tend to spend more in the course of their association with an organization and partly because such customers are thought to be less price sensitive and more willing to pay higher prices. Non-financial benefits arise because satisfied and loyal customers will tend to engage in positive word-ofmouth communication which may stimulate further customer acquisition. Cost savings may arise when the organization can meet customer needs more cost effectively as a consequence of being more knowledgeable about those customers. A variety of factors have been identified as potentially increasing or improving customer retention rates. These factors include senior management commitment, customer-focused cultures, a clearly targeted marketing campaign and the identification of switching barriers (Clark and Payne, 1993). The motivations and behaviour of customer contact staff may be of particular relevance to retention. In discussing the ‘hidden advantages’ of customer retention, Reichheld and Kenny (1990) stress the importance of employee satisfaction (see also Clark and Payne, 1993). Employees who are more satisfied with their job will typically deliver a better quality of service. These employees will tend to remain with the organization for longer periods of time and are then better placed to build long-term, personal relationships with customers. Customers will be more satisfied because they receive a better service, and enhanced customer satisfaction will tend to result in enhanced employee satisfaction thus creating a ‘virtuous circle’. Internal marketing plays an important role in developing this selfreinforcing relationship (Gronroos, 1990). An effective internal marketing strategy helps to create and maintain a customer-oriented service culture through enhancing employees’ perceptions of their role and importance within the organization. In the light of the arguments advanced

The Impact of Service Quality and Service Characteristics on Customer Retention

by Reichheld and Kenny (1990) and Clark and Payne (1993), targeting internal marketing activities at developing and retaining customerconscious staff must be a core component of any strategy to enhance customer retention. While these ‘supply side’ factors are of considerable significance, there are also important ‘demand side’ influences on customer retention. In particular, retention is seen as being preceded by loyalty, with service quality and/or customer satisfaction being widely acknowledged as antecedents of customer loyalty. The distinction between customer loyalty and customer retention is an important one - the former can be seen as an attitudinal construct, the latter as primarily a behavioural construct. While attitudes and behaviour are related, a positive attitude does not always result in continued patronage. In the context of a service relationship this suggests that not all retained customers have a positive attitude to their service provider and that not all customers with a positive attitude are retained. Generalizing this proposition using the concept of relative attitude suggests that the retained customer may be either genuinely loyal - having a positive relative attitude towards the organization - or spuriously loyal - having a negative relative attitude to the organization (Dick and Basu, 1994). To avoid the perjorative tone associated with the term ‘spurious loyalty’ we use the terms ‘wholly loyal’ - loyal in attitude and behaviour - and ‘partially loyal’ - loyal in behaviour only. In effect, ‘partial loyalty’ defines a situation in which loyalty exists as a consequence of situational factors which do not reflect the relative attitude of the consumer; these situational factors - such as switching costs, lack of perceived differentiation, locational constraints on choice, habit or inertia - may well represent valid and rational reasons for repeat patronage (retention) but they do not necessarily result in consumers being favourably disposed towards a particular supplier. In the short term the importance of such distinctions to organizations may be debatable. If high switching costs, insufficient difference between suppliers or customer inertia result in high retention rates, then real benefits may materialize from reduced customer acquisition costs. However in the longer term, the true value of the partially loyal customers is less certain because of their greater propensity to change should situational factors become more favourable to

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switching. Indeed from an attitudinal perspective the partially loyal customer may have more in common with the non-loyal customer than with the wholly loyal customers. Furthermore, the absence of a positive relative attitude among the partially loyal customers may mean that potential benefits from positive word-of-mouth are not realized. However, from the perspective of the organization, the partially loyal customers are an interesting and important group. They can be thought of as the group most at risk - most likely to defect - but can be observed and contacted because they maintain a relationship with the organization, and through that relationship it may be possible to convert them from being partially loyal to being wholly loyal. Evidence concerning the role of service quality in relation to customer loyalty and retention takes a variety of forms. Customer satisfaction has been shown to influence both loyalty and repurchase intentions for a range of consumer products (LaBarbera and Mazursky, 1983) and in the case of a service, Bitner (1990) argues that satisfaction with a service encounter affects assessments of service quality and subsequent loyalty and switching behaviour. Empirical work in a variety of service settings provides some support for these propositions by identifying a link between service quality and satisfaction, and between satisfaction and purchase intentions (Cronin and Taylor, 1992). In a longitudinal study, Bolton and Drew (1991) highlight the importance of service features in relation to customers’ assessments of service quality. Certainly, the quality of the overall product offer must play a role in assessments of quality and satisfaction, although from a relationship marketing perspective, it is often argued that quality per se is not enough and more attention should be focused on the integration of quality, marketing and customer service (Christopher, Payne and Ballantyne, 1991). However, accepting as a general principle that relationship marketing requires the integration of marketing, quality and customer service, then relevant dimensions on which a product or service is assessed will typically consist not just of the core product features but also the full range of associated benefits offered to the target customer. This apparent distinction between the physical product and the overall product offer is widely used in the evaluation of quality in the service sector where it is usual to distinguish between the

222 outcome of the service (technical quality) and the process by which the service is delivered (functional quality) (Gronroos, 1984,1993; Bowen and Schneider, 1988; Lehtinen and Lehtinen, 1991). The need for a distinction of this nature partly reflects the issue of intangibility and the problems this creates in relation to customer evaluations of services (Zeithaml, 1981) but it is also a product of the importance of the ‘people’ component and the difficulties associated with maintaining consistent quality (Parasuraman, Zeithaml and Berry, 1985). Functional and technical quality are then presented as the two key dimensions of service quality, although corporate image is often incorporated as a mediating variable which influences perceived quality (Gronroos, 1984). Technical quality is typically more difficult for consumers to evaluate (Zeithaml, 1981);nevertheless, an acceptable level of technical quality is an important component of quality assessments. However, once an acceptable level of technical quality has been achieved, it is argued that performance in relation to functional quality becomes a much more important determinant of overall quality (Gronroos, 1993). In effect, technical quality may be viewed almost a s a hygiene factor. Certainly, there is a variety of evidence which emphasizes the importance of functional or process quality relative to technical quality. Thus, for example, Jain, Pinson and Malhotra (1987) note the importance of human aspects of banking for bankloyal personal customers while Turnbull and Gibbs (1987) identified staff quality as being of particular importance in corporate markets. Given the potential link between satisfaction and purchase intention (Cronin and Taylor, 1992), then the management of functional quality becomes increasingly important in addressing the issue of customer retention. If service quality - both functional and technical - and the development of customer relationships are to be of value in a service industry then success in these areas should be reflected in increased customer retention rates. Furthermore, from a longer-term perspective those improved retention rates should refer to wholly loyal rather than partially loyal customers. While there continues to be considerable debate about operationalizing and testing relationships between quality and retention and about the role of satisfaction, an examination of the impact of service quality on loyalty and retention can provide useful insights

C. I: Ennew and M.R. Binks

into the value to organizations of investing in these activities.

Modelling retention and defection in the banking sector The UK banking sector is dominated by a small number of large banks providing retail and corporate services both nationally and internationally. From the perspective of the banks, the small business segment is arguably of particular importance because of the profit and revenue opportunities it presents (Bannock and Doran, 1991). However this segment has not been an easy one for the main banks to target and a number of studies have highlighted gaps in service provision and problems regarding service quality (Smith, 1989; Ennew, Reed and Binks, 1993; Deakins and Hussain, 1994). The 1980s saw considerable development in the range and variety of products available to small businesses (Binks and Ennew, 1991) although, as is consistent with most services, the people component of the banking relationship continues to be of considerable importance to customers and difficult to manage for the banks. Indeed, evidence from Canada has highlighted the positive effects of the banking relationship on actual and potential bank switching among small businesses (Riding, Haines and Thomas, 1994). The nature of the overall banking relationship is arguably of particular importance in the context of small businesses because of the problems of asymmetric information (Binks, Ennew and Reed, 1992a) and the potential for credit constraints as a result of information asymmetries (Stiglitz and Weiss, 1981). A close relationship has the potential to provide the bank with a better understanding of the operating environment facing a particular business, a clearer picture of the managerial attributes of the owner and a more accurate overview of the prospects for the business. In short, from the perspective of the bank, the relationship provides the basis for understanding customer needs and resources and identifying the most appropriate ways of meeting those needs (Watson, 1986). This relationship is not simply a one-way process. An effective banking relationship requires a positive contribution from both parties. The ability of the bank to meet customer needs requires that the ownedmanager provides the bank with appropriate and timely information

The lmpact of Service Quality and Service Characteristics on Customer Retention

and is receptive to suggestions and advice provided by the bank. The development of close working relationships between banks and small businesses has often been identified as a weakness of traditional Anglo-Saxon banking systems (Yao-Su, 1984) and a comparative analysis of medium-sized enterprises in Germany, France and the UK lends some support to this hypothesis (Binks, Ennew and Reed, 1992b). Many of the recent developments in the provision of banking services to small businesses in the UK have attempted to deal with this weakness, particularly through the introduction of specialist small business account managers although it is by no means clear that these measures have had the desired outcome. Despite the evidence of dissatisfaction and concern about service quality, the banks typically have a high customer retention rate among small businesses. This low level of switching is generally attributed to the presence of a significant number of partially loyal customers as a consequence of an element of inertia, high switching costs and a belief that there may be little difference between banks. Indeed this situation is consistent with the view expressed by Zeithaml (1981) that higher degrees of brand loyalty were likely to be observed in services because of the difficulties in evaluating a new service ex ante and the costs of changing service providers ex post. The value of service quality can be evaluated by examining the relationship between quality and customer retention. Given the small number of actual defectors among UK small businesses this study focuses instead on wholly loyal customers - retained and had not considered changing bank - and partially loyal customers - retained but had considered changing bank. From the perspective of the banks, the ability to identify the factors which affect the potential to defect presents the opportunity to develop policies both to prevent increases in defection rates and improve retention rates. In addressing the factors which distinguish the retained from the potential defectors we draw on the distinction between functional and technical quality - product and process - as well as recognizing that the concept of integrating quality service and marketing across the relationship is important. Consequently we identify three broad types of variables which are of relevance. The first category consists of the specific features of the product provided

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and it would be anticipated that the wholly loyal customers generally receive a product that is more appropriate to their needs than is the case with the partially loyal customers. The second category concerns the overall service quality and includes both product and process dimensions. Traditionally service quality measurement has been based on a gap model which entails a comparison of expectations with performance. However, the relevance of expectations for a continuously produced service such as banking has been questioned as indeed has the general expectancy-disconfirmation framework (Spreng and Olshavsky, 1993). In addition, recent empirical work has questioned the usefulness of expectations in assessing perceived service quality and satisfaction3 (Anderson and Sullivan, 1993). In the specific case of a continuously produced/ supplied service, the incorporation of prepurchase expectations in modelling is problematic partly because of measurement difficulties and partly because with time these expectations play an increasingly passive role from the consumer’s perspective (Halstead, Hartman and Schmidt, 1994). Consequently a focus on perceived quality of delivery can provide a more parsimonious specification of service quality. Again, it would be expected that higher perceived quality of service - both technical and functional - will increase the chances of a customer being loyal and retained. The third category of variables focuses on the overall banking relationship with retainedfloyal customers expected to experience a much better relationship than the non-loyal or non-retained customers. A further issue relates to customer characteristics and the possibility that some banks are pursuing a focused strategy, which involves attempting to attract some types of business while being willing to lose other types of business which are perceived as less profitable. There is therefore a case for arguing that an analysis of this nature should attempt to control for customer characteristics to accommodate any specific targeting strategy. In practice the evidence for such Although as Gronroos (1993) has pointed out, in a dynamic context, there are inevitably difficulties associated with the fact that a high perceived quality in one time period may raise expectations and thus lead to a renewed gap between expectationsand performance in a subsequent time period.

C. T Ennew and M.R. Binks

224 targeting among the main banks is limited but the inclusion of these variables does provide a basis for controlling for customer specific characteristics.

Model specification, data collection and measurement Data used for the empirical analysis were obtained from a survey conducted among its members by the Forum of Private Business in springhummer 1992. Approximately 16 000 questionnaires were distributed to the entire membership, along with a follow-up reminder after three weeks. This resulted in 6101 usable responses which represents a response rate of 37.5%. A comparison of the sample with the national population of small businesses reveals some biases. Specifically, the sample has a higher than expected proportion of manufacturing firms and a lower than expected proportion of agricultural firms and there is some bias within the sample towards firms located in the south-east of England and away from firms located in the south-west of England. Neither of these problems were considered particularly significant. The presence of a relatively small number of agricultural firms may actually be desirable given the unique nature of the problems facing farming businesses. Similarly, in the context of the UK market, the uneven distribution of respondents between south-east and south-west is unlikely to cause problems because there are few grounds for believing that the experiences of these two regions would differ significantly. Respondents to the survey ranged from very small businesses through to those which would be considered as medium rather than small. 30% of firms had a turnover of less than 2150000 per year and the majority of these (22%) had a turnover between 250 000 and 2150 000, with only 8% reporting a turnover of less than 250 000. Around 17% reported turnovers between 2150 000 and 2250 000 and a further 20% between 2250 000 and 2500 000. It is noticeable that 17% of respondents had turnover in excess of the 21 000 000 threshold which is sometimes used to define the margin between small- and medium-sized business. Around 47% of firms in the sample reported a profit level of between 0% and 10% as a percentage of turnover. The average profit figure for respondents

in the sample as a percentage of turnover was 16.7%. A high proportion of respondents were experiencing low or negative growth rates, as might be expected given the prevailing economic climate. Firms which were declining or growing slowly typically expected to follow similar patterns in the immediate future, and it was only among the firms which were expanding rapidly that there was a substantial expectation of future fast growth. Thus, the basic characteristics of the sample are indicative of a small firms sector which was suffering significantly from the effects of the recession but within which there was evidence of a significant number of firms which were prospering and growing in spite of prevailing economic conditions. The survey contained a variety of questions which related to the constraints faced by business and the nature of the relationship between businesses and their banks. These data, along with basic demographic characteristics and details on financing were used empirically to test the hypotheses outlined in the previous section. The variables were operationalized as follows. Loyaltyhetention

The wholly loyal customers were identified as those who had not considered changing their bank in the course of the previous year. Conversely, the partially loyal customers (potential defectors) were defined as those who had considered changing bank. Approximately 52% of respondents indicated that they had considered changing bank in the previous year. On the basis of the discussion in the previous section it was hypothesized that the potential to defect (partial loyalty) would be negatively related to the quality of the service and the quality of the overall banking relationship. Product characteristics

Although banks provide a range of products to small businesses, the core product is the provision of finance and most commonly this is in the form of overdrafts. A number of variables relating to overdraft funding were used as indicators of the characteristicsof the core product. Rate of interest was measured as percentage points above base, and collateral ratios were measured in relation to


overdraft limits, with adjustments for outstanding mortgages when the ownerlmanager’s house represented the collateral. In addition, because of its potential impact on attitudes and its implications for limited liability status a dummy variable was included to indicate whether or not a respondent had been required to give personal collateral. Finally, to obtain some indication of the extent to which the finance provided was adequate, the level of overdraft use calculated as the ratio of amount overdrawn to size of overdraft limit was employed as a crude indicator, although it is acknowledged that this may also be an indicator of the extent to which any given firm is experiencing financial difficulties. The quality of service provision

Quality of service provision was measured using the scale shown in Appendix 1. Respondents were required to provide (on a 1-5 scale) their assessment of the quality with which a range of aspects of bank services were provided. Factor analysis of the perceptions of quality of provision identified the three underlying dimensions based on knowledge and the advice offered, personalization in the service delivery process and general product characteristics. The first two factors were viewed as measures of process quality while the latter was viewed as a measure of technical quality. These three factors accounted for 74% of the variance in the original data set. The reliability of these scales was acceptable with Cronbach’s alphas of 0.90, 0.75 and 0.86 respectively. To reduce statistical problems with multicollinearitf in the subsequent analysis, factor scores were computed from a varimax rotation. For each variable a higher factor score was indicative of a higher level of perceived quality. The nature of the banking relationship

W o broad aspects of the banking relationship were measured. The first of these focused on the extent to which respondents felt that the policies of the bank constrained the performance of their business. Respondents were required to score seven aspects of bank practice which might It should be noted that some degree of collinearity between these explanatory variables would be expected in a coherent marketing strategy.

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constrain their business, namely collateral requirements, interest rates, availability of credit, bank charges, competence of manager, speed of service and term of loan. These items were combined to form a scale which measured at an aggregate level, the degree to which respondents believed that their business was constrained by banking practice. Cronbach’s alpha of 0.86 indicated that this scale was reliable. At a more general level, aspects of the relationship between the business and the bank manager were also measured. Respondents were asked to rate 11 aspects of the relationship with their bank manager (see Appendix 1).Factor analysis suggested three underlying factors which accounted for 60% of the variance in the original data set. The first was concerned with the absence of trust and confidence in the relationship with higher scores being indicative of a lack of trust and confidence. The second factor reflected a perceived lack of approachability and equality in the relationship with higher scores indicating that managers were less approachable. The final factor concerned information flows with higher scores on this factor indicating a reluctance to provide information on the part of respondents. Cronbach’s alphas for these scales were 0.82, 0.71 and 0.43 respectively suggesting that the first two scales were reliable. Although the reliability of the third scale was questionable, it was retained in subsequent analysis for completeness. Again, to address potential multi-collinearity problems, factor scores from a varimax rotation were computed for use in subsequent analysis. Customer characteristics

Finally, five firm-specific characteristics, namely age, size, profitability, financial difficulties and current bank were identified as potentially providing a basis for distinguishing between wholly and partially loyal customers. Age of firm entered the model directly as a continuous variable as did profitability and size, measured by number of fulltime employee^.^ W o dummy variables were included to measure first whether the firm had Number of full-time employees is a crude measure of size but was preferred to turnover in this instance because employment was measured as a continuous variable while turnover was only available as an ordinal variable.

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C. I: Ennew and M.R. Binks

Table I . Descriptive statistics for variables used in the analysis Mean values

Constraints Trustb Approachabilityb Information flowsb Knowledgeb Productb Personalizationb Rate of interest (YOover base) Overdraft use (YO) Collateral ratio Full-time employees Growth (mode) Profit Age (years) Giving personal collateral Experienced financial difficulties Using Scottish bank

Considered changing bank

Not considered changing bank

T-ratio n = 5878

20.09 0.35 0.16 0.01 -0.26 -0.24 -0.15

15.72 -0.37 -0.17 -0.01 0.29 0.25 0.16

-24.76 -27.81" -12.28" 0.58 20.59 11.50a 18.248

1.9 0.44 2.4 11.2 Declined more than 5% 16.7 16.9

2.2 0.47 2.9 12.2 Declined more than 5% 16.8 19.8

-5.12" -1.73 -2.17" 1.51 Declined more than 5% 0.43 4.77a

59% 10%

24%

25 %

43 % 16%

52% 13%

Notes: a Based on unequal variance Means derived from factor scores

experienced financial difficulties and second whether the firm's bank was based in England or Scotland. The justification for the latter was the potential for different policies between the two banking systems. A summary of the descriptive statistics for the variables described above is presented in Table 1. This highlights a number of apparent differences between those who had considered changing bank (the potential defectors) and those who had not. The relative importance of these variables is explained in more detail in the analysis in the next section.

Estimation In order to examine the factors affecting customer retention and defection and the extent to which these outcomes are influenced by service quality, we specify a simple logit model in which the likelihood of considering a change of bank is a function of perceived quality, product and business characteristics and the overall banking relationship. The parameters of the model were

estimated using the maximum likelihood routine provided in SPSSx (Norusis, 1993). To reduce potential multi-collinearity problems, orthogonal factor scores were used for the relationship and quality variables. An examination of the correlations between the various explanatory variables (see Appendix 2) suggests some collinearity as might be expected given the nature of the variables being analysed. However, none of the correlations were deemed to be so large as to justify the exclusion of specific variables from the analysis. Missing values in the data set initially reduced the number of available observations to 3418. Given the sensitivity of maximum likelihood estimators to both outlying observations on the dependent variable and to extreme values of the independent variables (Pregibon, 1981), a range of diagnostic checks was performed following the initial estimation. An examination of the residuals is useful in the identification of potential outliers and the initial estimation produced 116 cases with studentized residuals greater than two. However, an inspection of the residuals reveals little about the degree to which a particular case

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The Impact of Service Quality and Service Characteristics on Customer Retention Table 2. Logit analysis results (whole sample n = 3291)

Variable

Coefficient

Wald statistic

R

Constraints Trust Approachability Information flows Knowledge Product Personalization Rate of interest Overdraft use Collateral ratio Financial difficulties Full-time employees Growth Profit Age Personal collateral Scottish bank % Correctly classified Model Chi-square

0.066 0.737 -0.188 -0.040 -0.444 -0.543 -0.213 0.025 -0.196 0.020 0.346 0.008 0.025 -0.002 -0.002 -0.257 -0.453 73.4% 12.08,p = 0.000

64.98 134.8# 13.2" 0.8 59.9a 103.1" 17.1" 0.7 5.4b 5.0b 13.58" 12.3a 0.9 0.21 0.7 6.24b 10.42a

0.12 0.17 0.05 -

-0.11 -0.15 -0.06 -

-0.03 0.03 0.05 0.05 -

-0.03 -0.04

Notes: a Significant at p < 0.01 Significant at p c 0.05

influences the fit of the model. Accordingly, based on leverage measures and Cook's distance (Norusis, 1993) a total of 11 influential observations were identified. This produced a total of 127 observations which were then excluded and the model re-estimated. The second estimation improved the performance of the model from a 70.5% correct classification to a 73.5% correct classification but did not substantially change the pattern of the parameter estimates. To test the robustness of the results, the model was reestimated using a random sample of 50% of the available observations; fitted values and predicted group membership were calculated for the holdout sample resulting in a 72.8% correct classification. Performance on the holdout sample combined with the apparent stability of the parameter estimates suggests that the model is robust. While it is recognized that the holdout sample is a relatively weak test of the generality of the results, the realized classification rate does offer a 50% improvement on that which would be obtained by chance. The results of the analysis for the full sample are presented in Table 2. Of the relationship variables, the degree to which managers believe their business to be

constrained, the lack of trust in the banking relationship and lack of approachability all have a positive impact on the potential for defection. The trust variable has the largest impact of the three as indicated by the partial correlation (R). All three quality variables were also significant and correctly signed, with higher perceived quality reducing the potential for defection. Interestingly, the technical quality measure (product) has the largest impact on potential defection, closely followed by one of the functional quality measures (knowledge). The remaining measure of functional quality measure (personalization) has a significant but weaker impact although given the correlation between personalization and trust (-0.28), it may be that part of the personalization effect is picked up by the measure of trust. Accompanying the significant effect due to general assessments of the quality of the product there are also a number of significant effects relating to specific product features. In particular a high level of overdraft use and pledging personal collateral both tend to reduce the potential for defection. Given concerns about credit constraints and collateral taking, these two results may initially seem surprising although it is possible that they reflect the fact that firms with high

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levels of overdraft use and firms pledging personal collateral feel more ‘locked in’ to their bank and thus do not consider switchinge6Collateral ratios are also significant and have a positive impact on potential defection, but interest rates proved to be insignificant. Of the firm-specific factors, size has a positive effect on potential defection but profit and growth rate are insignificant. Firms which have experienced financial difficulties appear more likely to be potential defectors while customers of Scottish banks are less likely to consider defection. This latter result is consistent with anecdotal evidence of differing degrees of quality and customer satisfaction between the English and Scottish banking systems. The overall model provides some support for the hypothesis that genuine loyaltylretention is influenced by service quality and customer relationships. Trust in the banking relationship has the largest impact on potential defection, followed by general product features, knowledge and the degree to which bank policies constrain a business. These results suggest that both technical and functional aspects of quality are of relevance in the specific form of general product features and knowledge. In addition, the trust variable which is also highly influential may, at least in part, be measuring aspects of functional quality. In general then, the evidence suggests that

If this is the case then the extent to which such customers may be viewed as genuine loyal in terms of the earlier conceptualization may be debatable.

C.i? Ennew and M.R. Binks functional quality is at least as important as technical quality in influencing potential defection. Certain product and firm specific characteristics also provide significant effects although their impact was relatively small.

Conclusions Customer retention is an issue which is of increasing importance for all businesses but is arguably of particular relevance to services such as banking in which the building and maintenance of a longterm customer relationship is seen as central to improved business performance. Service quality has been identified as an important factor which should contribute to an organization’s ability to retain loyal customers and thus contribute to improved organizational performance. Using data relating to banks and small businesses in the UK, this paper has provided preliminary evidence concerning the positive impact of aspects of functional and technical quality on loyalty and retention. Furthermore, it is apparent that functional quality is at least as important as technical quality in influencing the decision to consider a change of bank. The results also highlight the importance of the overall banking relationship and suggest that investment in quality and in the management of customer relationships may assist organizations in improving the degree of loyalty among customers, thus increasing the likelihood that customers who are retained in the short run are also retained in the long run.

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Appendix 1:Scales used in measuring service quality and the banking relationship Lack of trust My bank manager is always available to help in a crisis. My bank manager often comes forward with positive suggestions to help my business. I am confident in the advice I get from my bank manager. I am confident that my bank understands small businesses. I can rely on my bank manager to find ways of meeting my business’s changing financial needs.

Quality of service provision

How well do you think your bank supplies these particular requirements? (Ranked on a scale from 1 = very poor to 5 = very good.) Knowledge Knows your business Understands your industry Understands your market Offers helpful business advice

Approachability (scales reversed in subsequent analysis to ensure consistency with other scale items) I prefer to avoid contact with my bank manager. My bank manager is not really interested in my business. I feel intimidated when dealing with my bank. My bank manager is only prepared to offer standard financial small business products.

Product Offers wide range of banking services Competitive interest rates Competitivelpredictablecharges Personalization Speed of decision Tailors finance to needs of business One person deals with all credit needs Easy access to loan officer

Information flows It is important to provide my bank manager with timely and regular management information. It is important to discuss in advance potential excesses over agreed borrowing limits.

Relationship with bank manager

The following statements about the banklsmall business relationship were scored on a scale from 1 = strongly agree to 5 = strongly disagree.

Appendix 2:Correlation Matrix for Explanatory Variables

Constraints

-

Trust

0.39

-

Approachability

0.26

0.00

Information flows

-0.12

0.00

0.00

-

Knowledge

-0.26 -0.49

-0.27

-0.06

-

Product

-0.33 -0.28 -0.15

-0.01

0.00

Personalization

-0.19 -0.28

-0.13

0.00

0.00

-

-0.23

-

-

-0.04

-0.03

-

0.03 -0.01 -0.02

0.00

0.03

-

0.00 -0.26

-0.06

0.08

0.02

Overdraft use

0.10

0.04

0.02 -0.02 -0.17

Collateral ratio

0.01

0.02

0.01

Rate of interest

0.29

0.18

0.18 -0.03

Employment

-0.04 -0.05 -0.11 -0.05

Profit

-0.08

0.00

0.06

Age

-0.16

-0.07

-0.08

0.05

0.09

Growth

-0.04 -0.02 -0.07

-0.01

0.01

0.05

-

-

0.08

0.06

0.00

0.10 -0.01

-0.02

-0.04

0.01

0.04

0.04 -0.02

-0.03

0.04

-0.18

0.17 -0.11

0.05 -0.03 -0.04

-0.01

0.02

0.01 -0.02

-0.21

0.08 -0.19

-

-

0.04 -0.12

-

230

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