It's easy to see why Customer Relationship Management (CRM) has become the hottest management growth tool of the last decade. Bain & Company's Management Tools 2001 Survey of 451 senior executives found 72% of respondents expected to have CRM programs in place by the end of that year-more than twice that of the previous year. That's because few leaders have been able to resist a technology that promises to quickly identify your most profitable customers and target them with campaigns to increase both their purchases and their loyalty and do this at an ever-lower cost. With software companies promising to get a CRM system up and running within 90 days, for many managers the question has simply been "where do I sign?"

The catch is, the gap between promise and delivery could hardly be wider. More than half of all CRM programs fail to pay back their return on an investment that can be as high as $130 million. Senior executives in Bain's global survey ranked CRM one of the bottom four management tools in terms of satisfaction, and a fifth of CRM users had abandoned the tool altogether. When market research group IDC asked Western European business managers whether CRM implementation had delivered the expected benefits, only 14% said yes while nearly 60% said their CRM solutions were below expectations or replied "don't know."

Far from improving profits and cementing relationships, in the worst cases CRM wound up alienating long-term customers and employees.

Yet, the benefits of getting CRM right are well-documented. The objective is to increase customer loyalty. And Bain & Company research finds a 5% increase in customer retention boosts lifetime customer profits 50%, on average, across industries, and up to 90% in industries like insurance. (See sidebar: "In a Downturn, Loyalty Rules")

So what's gone wrong? By looking at case histories of the failures as well as the successes, we found at cause a mistaken view that CRM is a shortcut to acquiring, building, and retaining relationships with customers. It isn't. The first step in leading a successful CRM program is to develop a robust customer strategy based on good old-fashioned customer segmentation. Step two is to realign your organization to support this plan. Third, provide the right tools and technology to support your customer strategy and realigned organization. And at every step of the way ask yourself whether customer loyalty could be better promoted by a low- or no-tech solution.

Build a robust customer strategy

For a subject that garnered about 15,000 media mentions last year, CRM is a simple concept: a way of linking the tried and tested discipline of customer segmentation to determine which customers you want to "CR"-create relationships with-and which you want to "CM"-cost-manage. The only way you can do this is to develop a rigorous customer strategy that separates the profitable clients with whom you want deeper relationships from the ones you should service at low cost.

Managing costs of low-margin customers by automating sales, marketing, and customer service is straightforward. The logic that supports creating relationships is more complex, but boils down to this: loyal customers are more profitable over time. As well as buying more goods, it costs less to serve them. What's more, return customers refer others to your company. And they may also pay a premium to continue to do business with you rather than switch to a competitor they aren't familiar with.

The crux of any customer relationship strategy is customer segmentation, which is why some of world's pickiest companies have the most successful CRM programs. Take MBNA Europe, the international arm of the US credit card giant, which has enjoyed a 75% annual profit growth since 1995.

When its leaders set about expanding into Europe in 1993, they were as meticulous about selecting the "right" customers as they had been in the US. To this end, MBNA invests heavily in screening potential cardholders. A credit analyst manually reviews every application, and more than half are rejected. Around 65% of its customers hold affinity cards, reflecting MBNA's strategy of targeting members of clubs and organizations such as the World Wide Fund for Nature and the Manchester United football club. Attracted by the card's affiliation with their organization rather than a need for credit, these customers tend to have a better risk profile-one of the reasons MBNA's credit losses are one-third below the industry average.

Once it has identified and signed up the right kind of customer, MBNA holds on to them, retaining an impressive 97% of its profitable customers. MBNA is aggressive about getting the most from the customers who stay. It does this by continuous analysis of customer behavior and "re-underwrites" its customers on a quarterly basis via a dozen credit bureau data points, phone contacts, and customers' usage and payment patterns. As a result, MBNA customers' card usage is 52% above the industry norm, and their average expenditure is 30% more per transaction. By matching the right products with the right customers, an impressive 10% of account holders ask for further information on cross-sale products.

Another company choosy about who it does business with is Direct Line. The UK-based direct home and motor insurer was set up in the mid-1980s to provide customers with high-quality coverage and good service. Direct Line, a subsidiary of Royal Bank of Scotland, is now the leading UK direct insurer for both motor and household insurance and has successfully expanded into personal loans, mortgages, and tracker ISAs (Individual Savings Accounts).

Cutting out brokers' commissions, which typically account for 15-20% of premiums written, not only keeps prices competitive, but also enables Direct Line to vet customers itself. And it is persnickety about who it insures. It will not provide coverage to young drivers and exotic cars, for instance. Other riskier categories are offered insurance, but at prices that properly take the risks into account and often only under certain conditions. For example, Direct Line will only insure a property with contents valued at more than £50,000 after a staff member has visited the premises.

Once it signs up a customer, Direct Line rigorously analyzes customer behavior in order to adjust premiums based on the level of overall actuarial risk. Its CRM system enables it to hold information on 18 million customers and it is updated with 60,000 transactions daily. Because this enables Direct Line to price risk accurately, there is a stringent "no-haggle" policy in which customers know they will be quoted on non-negotiable price.

Align your organization with your customer strategy

These companies made a success of their CRM programs by ensuring the organization was aligned with their customer strategy. One of the reasons more than half of all CRM programs fail is because a CRM software solution is parachuted into a company in the vain hope it will single-handedly resolve a business's customer relationship problems. This puts the cart before the proverbial horse.

UK supermarket group Safeway learned the hard way that installing CRM technology without devising the right customer strategy and without changing the organization accordingly is bound to fail. The company launched its ABC loyalty card at the end of 1995 in response to competitor Tesco's successful card program. In 2000, Safeway dropped the initiative altogether, failing to recover the £50m a year it spent running the program.

As is often the case with "me too" strategies, the initiative did nothing to tackle Safeway's key problem: stores underperforming their sales potential. To close this gap, Safeway needed to attract new customers altogether, not just persuade existing customers to spend more money by offering loyalty points.

Second, the loyalty card program was at odds with the company's existing strategy of competing with competitors on a store-by-store basis to win market share from the bottom up. In fact, the card scheme was run nationally so did little to help win new local customers. Third, Safeway did not align its technology with this strategy. Its software could not collect data for individual customers or even by store, so Safeway's managers could not adjust product lines to reflect local preferences. Safeway did not have the technology infrastructure to do anything with the card data on a centralized basis either: they could not analyze the information to help develop an e-commerce strategy or even simply cross-sell products.

When a new CEO, Carlos Criado-Perez, took the helm in 1999, he rethought Safeway's customer strategy and decided to get rid of the loyalty card program. The £50m a year it had cost to run was instead invested in the company's "Best Ever Deals" promotion. This strategy proved more effective at increasing customer traffic. Profits in the year after nixing the loyalty card rose by more than 30%.

Safeway's technology infrastructure was unable to usefully process the information gathered from loyalty card users. But the key problem was not the technology. It was a flawed strategy and a failure to marshal business processes behind a CRM program. Safeway's experience illustrates the results of a recent CRM Forum survey in which 87% of senior executives pinned the failure of CRM on leadership and change management issues. Only four percent cited software problems.

Contrast Safeway's experience with UK supermarket leader Tesco, whose CRM program was introduced only after the company restructured its processes around customer needs. Tesco's CRM program played a key role in the company's transformation from a buyer-led organization to a customer-focused group that has held its position as the UK's largest grocer since 1995. Tesco's profits now top £1 billion a year.

Throughout the 1980s, Tesco's image among consumers was poor. Tesco was perceived as having a mediocre product range housed in poorly maintained stores as well as competing entirely on price. At the end of the decade its leaders set about reinventing the brand. First, Tesco embarked on a major investment program to move the store upmarket, which involved building new, modern superstores and closing down unprofitable outlets. Second, it radically improved the quality and range of the products it sold, particularly developing its line of convenience foods and healthy food lines. Third, it upped its focus on "value for money" to the customer, introducing an initial 70 "value lines" and cutting the price of many other basic goods.

Tesco supported these initiatives with a host of organizational changes. The company formed a new senior management team to lead the new customer-focused group. Lord MacLaurin became chairman in 1986 and Terry Leahy was appointed deputy managing director in 1984. Tesco reorganized employees into teams centered on product categories and gave teams responsibility for the product range in each store. These employees selected products based on price, quality, service, innovation, and customers' changing expectations.

All this was in place before Tesco's leaders turned to technology, launching the company's highly successful loyalty card in 1995. The Club Card allowed Tesco to develop extensive knowledge of its customer base and to segment customers according to purchases, location, and life stage. Armed with this information, Tesco has carefully tailored its offerings to customers: vegetarians are never sent special offers on meat products and children's products are not sent to childfree shoppers. Moreover, Tesco's money-off coupon program encourages customers to try related, higher-priced products, not just receive discounts on goods they routinely purchase.

Tesco further adapted its business processes and added technology for a second innovation-online shopping. By thinking through the customer experience every step of the way, Tesco established the gold standard for UK online supermarket shopping with its repeat order functions and lists of favourites and previous purchases. A delivery time slot is selected before orders are made to limit the inconvenience of waiting around for orders, and customers can give Tesco staff discretion to replace list items with alternatives should their first choice be out of stock. Tesco is now the world's largest online grocer.

Provide the right tools

Once a robust customer strategy has been agreed and the organization tailored to support that plan, it is time to shop for the tools that best support that strategy. These waters can be treacherous. Some managers are so beguiled by the latest software system they fail to select the package that most precisely fits their customer strategy. Instead of tracking down the solutions most likely to promote customer loyalty, they retrofit customer strategies to suit the most dazzling software package.

The second pitfall is to assume that, if some technology is a good thing, more must be better. Some managers look to companies like Amazon.com and put its success down to its ability to marshal a vast array of software to customize its product.

In fact, though few companies have embraced cutting-edge technology with such gusto as the online retailer's leader, Jeff Bezos, the key to Amazon's success is not technology, but the clarity of its customer proposition. The starting point for Amazon.com was Bezos' vision of using the information Amazon gathers about its customers to offer each one their own virtual store.

This involves more than the personal greeting that repeat customers receive when they log on to a website. Amazon.com uses collaborative filtering, which links customers with similar tastes and purchasing histories as electronic "soul mates"-identifying and recommending products that one soul mate has purchased but the other has not.

Amazon also harnesses technology to provide personalized and detailed feedback to employees. The online retailer provides feedback to customer service representatives four times a month via phone or e-mail based on monitoring their contact with customers. Representatives are given URLs on the corporate intranet to which they can link for training in areas of weakness.

Initiatives like this have helped Amazon.com almost double its customer base every year since 1998. And once consumers have purchased goods from Amazon.com they tend to return; 80% of its customers are repeat.

The third pitfall is to assume CRM must be technology intensive at all. Companies with well-functioning CRM programs may use low-tech, high-tech, or even no-tech methods. Often a good starting point for examining the benefits of a CRM software program is to search for a no-tech solution. Try asking managers the following question: "If I gave this amount of money and time to my customers and asked them how they would have me spend it, what would they say? Would they rather have a sales representative know their name or would they prefer four more checkout registers open?"

The New York Times provides a good example of the way in which many CRM programs don't start out looking like CRM at all.

When its circulation reached a plateau of about 10% of the city's newspaper market in the 1990s, the Times invested a good deal of time and money discovering what it would take to gain more share. What the company eventually discovered was that, to win the business of loyal readers, it had to provide better availability and earlier paper deliveries. So management invested millions of dollars to address these shortcomings. Satellite feeds now link the seven additional printing facilities that were brought online between 1997 and 2000. The paper upgraded distribution capabilities and customized local weather and TV listings.

The upshot is the New York Times is growing in a relatively flat industry and it has an enviable 94% retention rate of mature subscribers-way above the industry average of 60%. And all this was achieved long before its managers took a look at CRM technology, which has only recently been implemented to automate some processes.

While there are examples of CRM winners at each point in the technology spectrum-no, low, and high-many companies take a hybrid approach, selecting a combination of tools to support their customer strategy. We've seen how valuable CRM technology has been to Tesco. But its short queues, wide aisles, large parking lots and-most importantly-wide selection of quality products are what customers care about most. While Tesco prizes its online technology, in the stores Tesco managers emphasize low-tech customer enhancements-like making sure there are plenty of seats for elderly customers. And Tesco does not handle complaints by computer; every Tesco store has a dedicated customer service representative who swiftly resolves customer problems. Putting its customer strategy first enabled Tesco to make wise decisions about where software technology could help and where low-tech solutions made more sense.

Even Direct Line-which has no face-to-face contact with its customers-has welded some low-tech initiatives onto its technology-intense business as it tries to take the hassle out of insurance. On the high-tech side, Direct Line gives motor and home insurance quotes over the telephone within three minutes (two minutes for online quotes). On the low-tech side, Direct Line accredits and affiliates mechanics and builders to tend to customers' car and home repairs. And it deals with claims swiftly, handling many over the telephone without onerous form-filling and lengthy waits. The company has eliminated complicated forms and jargon to keep applications simple.

Asked to explain the company's success, Direct Line's group information technology director, Richard Beal, doesn't point to software or technology, but to building relationships. "The better you relate to your customers, the more likely they are to stay loyal," he says.

The result? Direct Line's insurance profits grew 65% every year between 1996 and 2000 and group profits before tax grew nearly 350% annually between 1998 and 2000.

If you want CRM to deliver results rather than disappointment, make sure you have a clear customer strategy, make sure your business processes are aligned with that strategy, and then introduce the right technological and other tools to support it. And test your program at every stage by asking whether you could do it without any technology at all.

Crawford Gillies is Bain & Company's managing director for Europe. Darrell Rigby is a director in Boston and founder of Bain's Management Tools survey. Fred Reichheld is a Bain Fellow and author of The Loyalty Effect: The Hidden Force Behind Growth, Profits, & Lasting Value; and Loyalty Rules! How Today's Leaders Build Lasting Relationships, both published by Harvard Business School Press.