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The Loyalty Effect - The Hidden Force Behind Growth, Profits, and Lasting Value. by: Frederick F. Reichheld The following book review was prepared by: Bradley E. Hosmer. It appeared in the November 1998 issue of the "Journal of Management Consulting." Because of corporate re-engineering, business-to-business selling no longer means simply delivering the goods. Increasingly, today's products must be sold along with value-added services that replace functions previously handled by the customer. As a result, vendors worldwide are changing their sales and marketing model by adding customized services. This new business model cuts overall costs to create stronger links with existing customers and it sets the stage for winning new business. Loyalty binds family, community, and friendships; and it's nice to work where we can give and receive loyalty. But hasn't loyalty been killed by layoffs and downsizing? Hasn't it been elbowed aside? Isn't l Frederick Reichheld says no. He makes a powerful case from his own consulting experience at Bain & Company that loyalty should be nurtured and pursued as a fundamental business strategy because high loyalty produces superior bottom-line results. He says the average company loses half its customers in five years, half its employees in four years, and half its investors in less than a year. Those departing take with them some knowledge that is irreplaceable. Thus, the typical company loses most of its core assets every five to ten years. It takes a massive effort just to replace the losses caused by that churn, and all that must come before growth can be sought and achieved. Consider customer loyalty. Suppose two companies add 10 percent new customers a year; company A has a 95 percent customer retention, while company B retains only 90 percent. In fourteen years company A will double in size while company B will not grow at all. Moreover, because of superior loyalty, company A's customers are more profitable. It costs less to keep customers than to get them; money is saved as companies and customers learn to work together; satisfied customers generate more referrals; and it's much easier to get better prices from loyal customers than from those who are not. The net result is that company A outperforms company B on most measure. Generally, retaining 5 percent more customers increases he value of the average customer by 20 to 100 percent; in advertising companies it's 100 percent; in credit card companies it's 75 percent, and in software makers it's 35 percent. Accordingly, Reichheld advises executives to seek customers who are likely to become loyal and avoid customers who are not. This requires studying their loyal and disloyal customers to understand where they come from and how they were attracted to the company, and then purposefully doing more of what produces loyal customers and less of what does not. To illustrate, "one auto insurer found that its worst new risks, as well as its least loyal customers, very often found the company's agents through advertisements in the Yellow Pages. Needless to say, the company now discourages its agents from placing such ads." Consider employee loyalty. Profitability improves dramatically when a company cuts turnover. Reichheld cites a trucking company that boosted profits 50 percent by cutting driver turnover in half. Similarly, a stock brokerage increased the economic value of its brokers 155 percent by reducing turnover from 20 to 10 percent. Chick-Fil-A, a restaurant chain, inspires loyalty in its store managers by aligning their objectives with those of headquarters: it shares store profits fifty-fifty. Small wonder that Chick-Fil-A outperforms other restaurant chains seven to one on employee retention. Another example is State Farm Insurance which takes extreme care in hiring new agents. Their training includes two or three years as employees before they're eligible to become agents. As agents they are responsible for all aspects of running their agency and do so with little interference from headquarters. Their loyalty is 80 percent far above the 20 to 40 percent typical in the industry. It's no coincidence that, relative to peer companies, State Farm sets the standard for profit. Consider investor loyalty. Reichheld notes that since 1960 investor turnover in the United States increased from about once in seven years to once in two years. Corporate owners are even more transient than employees and customers. The major reason is investors who pressure managers to boost earnings in the short term. These are mostly institutional investors, most of whom are not loyal to any company, only to the economics of buying and selling for immediate gains. This destructive practice makes companies hard to manage, and systematically erodes the effort to create lasting value. Reichheld recommends four ways to counter that and improve the loyalty of investors: Educate current investors, shift toward institutional buyers who avoid churning, attract more loyal core owners, and if those methods fail, go private. As more investors buy and hold (that is, become more loyal), management gets the time to focus on creating lasting value. Not incidentally, it is the idea of value - and especially the idea of a company as a system that creates value - that ties Reichheld's work together. As companies provide more value to their constituencies, those constituencies become more loyal, and that loyalty enables the companies to provide even more value. That's the cycle to seek. Loyalty, then, becomes the early warning indicator of the health of the business. That is very different from monitoring and evaluating progress by watching profits. Executives who put profit before the value they deliver see problems only when profits decline. Corrections are made to symptoms, and that fails to recognize of fix the breakdown of the fundamental value-creation system. Reichheld discusses measurement systems, including how to analyze failure and present value, to consider these further, and to put numbers on the Loyalty Effect. Overall, this book makes a compelling case for loyalty based management in ways that are applicable to most any organization and useful to most any management consultant. I heartily recommend it to you. Bradley E. Hosmer, CMC, heads The Beta Consulting Group, Inc. in Concord, NH (USA). His specialty is improving performance with better business-to-business sales and marketing. For further information please contact Mr. Hosmer at Beta Consulting. |
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