The Loyalty Effect: The Hidden Force Behind Growth, Profits & Lasting Value
A Leadership Alliance summary of Frederick Reichheld’s book,published by Harvard Business School Press
According to Dr. W. Edwards Deming, the Einstein of quality and business success, the true role of enlightened management is Prediction. The Loyalty Effect is about a new management method – and new measurement tools – that allows you to predict with superior accuracy the future growth and profits of any company. Mr. Reichheld calls this breakthrough method Loyalty-Based Management (LBM). LBM is not some vague, futuristic theory about the increasing importance of intellectual capital. It is a well established, working method for growing profits, delivering outstanding results in today’s fast-moving, highly competitive world. Applicable to individuals and organizations alike, LBM offers a breakthrough system for profit growth.
If you care about long-term growth and profits, using short-term/quarterly earnings as your primary measure of performance will never predict future performance as well as “Loyalty Metrics” (measurements) can. Profit is indispensable, of course; nevertheless, profit is always a consequence of value creation. Creating value for the customer is the foundation of every successful business system: It builds loyalty, loyalty in turn builds growth, profit, and still more value – in a continuous & predictable upward spiral.
There are three types of Loyalty: Customer, Employee and Investor. All three are inextricably linked. Once a company understands the ways in which customer, employee, and investor loyalties are linked, its management team can then use loyalty metrics to understand its company’s “present condition,” predict future growth and profit – and enjoy growing, sustainable success. A key point: Customer Loyalty is very different from Customer Satisfaction: Studies show that four out of five “satisfied” customers will defect, given the right opportunity. Contrary to what many have been taught, improving satisfaction levels does not keep customers loyal or improve profits. This is a vital point to remember.
Loyalty leaders engineer all of their business systems to keep their employees permanent, by valuing them as true assets. Loyalty leaders thus lower their employee losses as low as possible. By continuously decreasing defection rates in all three groups –customers, employees, and investors – they achieve consistent, remarkable growth in profits and cash generation. Once these long-term economic consequences of loyalty growth are understood, this new awareness requires business leaders to focus on the strategic target of “zero defections.” If they don’t focus on this key objective, they simply will not be leaders going forward, and may risk their very future.
Surprise – the loyalty leader is also the profitability leader. On average, improving retention (loyalty) by just five percentage points doubles a company’s profit margins. Example: Lexus leads all car brands by a wide margin in customer loyalty, and accounts for only 2% of parent company Toyota’s total unit sales – yet Lexus delivers fully one thirdof Toyota’s total operating profits. Toyota’s success is no accident.
State Farm Insurance is another organization with a superbly designed Loyalty-Based Management System. It measures incentives, agent selection, training, career paths, customer acquisition, product line, advertising, pricing, service levels, and all other company functions in the service of loyalty and value (the primary mission of any company is to create superior value for customers and employees so investors/owners can prosper). As a direct result, agents stay with State Farm more than twice as long as they stay with its competitors – and they achieve productivity levels 40% higher than the industry norm. Customers of State Farm receive such a potent mix of service and price (value) that retention (loyalty) rates exceed 95% – the best performance of any national insurer that sells through agents. And, despite (or because of) this generous helping of value it allocates to its customers and agents, State Farm’s capital has mushroomed to more than $20 billion – all of it internally generated surplus. This is more capital than either AT&T or General Motors commands. Fortune magazine calls State Farm the US financial services industry’s most successful corporation – “Indeed, one of the nation’s great businesses.”
To manage customers as assets, one must be able to value them as assets. This means you must be able toquantify and predict customer duration and “lifecycle cash flow.” The secret rests in making the loyalty picture in your business visible, as it’s nearly impossible to manage or improve what you can’t see. Loyalty management metrics makes these analytical processes easy – and compatible with the financial systems that are currently used to allocate resources and run businesses. These new, simple metrics are designed to make the invisible loyalty factors visible. Once made, these metrics greatly aid decision making: A company will now clearly know which investments need to be made and which do not. The Customer-Base Net Present Value and the Customer Value Flow Statement are the two basic measures utilized.
Another major key:Each loyalty-leading company has a very clear set of high-level values, values which are the foundation for a code of behavior that is close to the Golden Rule. These companies demonstrate that loyalty to principles is the critical element of success, both short and especially long-term. They rigorously seek out customers, employees, and investors who demonstrate the highest character and integrity. They will then often settle for a “reasonable” level of raw talent to build on. This is a vital difference from the all-too common practice of attempting to maximize raw talent – while setting just a “reasonable” threshold for character, integrity, and principles.
The Key Secret to Business Success
The practice of carefully selecting customers, employees, and investors and then continuously adding value to all of them so that the company retains them long-term creates, over time, record growth and profits. Until now, this integrated approach and its measurement methods have been totally lacking in our short-term, profit-centered world. This is why the growth and future earnings of businesses has been so hard to predict. The “Loyalty Factor” in all three areas is the one crucial key to producing long-term growth and success – in all businesses.
Loyalty management is clearly a paradigm whose time has come. Its application can transform individual, team and organization-wide performance. Leadership Alliance provides customized loyalty systems development and guidance for organizations of all sizes. We offer focused support for your journey to greater loyalty, profits and success.