The radically simple loyalty question

Citation

Rader, D. (2006), "The radically simple loyalty question", Strategy & Leadership, Vol. 34 No. 6. https://doi.org/10.1108/sl.2006.26134fae.002

The radically simple loyalty question

The radically simple loyalty question

David RaderManagement Consultant based in Redwood City, helps executive teams make strategic choices in the face of changing markets, technologies and industries (david.rader@scc.cc).

The Ultimate Question: Driving Good Profits and True Growth

Fred ReichheldHarvard Business School Press, 2006

The Ultimate Question by Fred Reichheld, Director Emeritus and Fellow at Bain & Company, raises the issue, “How can customer satisfaction be measured?” In answer, Reichheld introduces the metric Net Promoter Score, advances the theory of the value gaining steadfast customers and elaborates on the best practices described in his previous two books, The Loyalty Effect (1996) and Loyalty Rules (2001). There’s a unifying thesis to his decade of work on customer loyalty: “… the purpose of companies and other organizations is to provide outstanding value and great relationships for their customers or members – and … an organization’s best chances for long life and prosperity require measuring performance on this dimension just as carefully as profits.”

The Ultimate Question begins with an examination of the difference between a transaction and a relationship. Management practices that foster relationships also promote loyalty and produce “good profits.” In contrast, “bad profits” result from manipulating markets and consumers to maximize the immediate number of transactions and revenue per transaction at the expense of longer-term customer loyalty. For example, maximizing transactions may generate a flood of new customers, thus overwhelming the company’s service capability and causing a wave of defections. The cost of acquiring the new customers is unlikely to be recovered because typically they do not stay long enough.

Why does such dysfunctional behavior frequently occur even though CEO surveys often show customer loyalty to be management’s top priority? Reichheld believes that the problem is that the incentives provided by stock options, quarterly financial reports and business plan objectives emphasize revenue, profits, market share, asset turns, share price increases – everything except customer satisfaction.

Though the science of measuring profits had progressed steadily since the advent of double-entry bookkeeping in the fifteenth century, measuring the quality of relationships remained stuck in the dark ages, trapped by the pseudoscience of satisfaction surveys. Companies lacked a practical, operational system for gauging the percentage of their customer relationships that were growing stronger and the percentage that were growing weaker … What we needed was a foolproof test – a practical metric for relationship loyalty that would illuminate the difference between good profits and bad (p. 17).

So, here is Reichheld’s radically simple ultimate question that every manager should pose to customers: “How likely is it that you would recommend this company to a friend or colleague?”

The “how likely” phrase implies a scale – 1 to 10 or 0 percent to 100 percent. The “you” implies the personal commitment inherent in a relationship versus a transaction (note the difference between the apparent softness of “recommend” versus the hard quantification of a “perfect order” – on time, right quantity, right location, right cost, and complete). The “to a friend” phrase implies ability to extend the target customer relationships (grow the business by serving customers similar to those who are happy with the value proposition).

The granularity of a specific relationship measure means this can be easily tracked by team, location, line of business (not necessarily product; product issues or gaps can become relationship irritants to be remedied). This can also be tracked by age, type and source of relationship (new customers versus existing, customer demographics and channel partner or lead generation source.

Reichheld’s idea of using a continuum to measure this relationship is important. He recommends a ten-point scale where “5” is a neutral position and zero means “not at all.” On his ten-point scale, relationships rated at “9” or “10” are classified as “promoters.” “Promoters are loyal enthusiasts who keep buying from a company and urge their friends to do the same.” They drive profitable growth.

Relationships with scores of “7” or “8” are classified as “passively satisfied.” “Passives … are motivated more by inertia than by loyalty or enthusiasm, these customers may not defect – until somebody offers them a better deal.”

Relationships with scores of “6” and below are classified as “detractors.” According to Reichheld, “This group accounts for more than 80 percent of negative word-of-mouth comments. Some of these customers may appear profitable from an accounting standpoint, but their criticisms and attitudes diminish a company’s reputation, discourage new customers, and demotivate employees. They suck the life out of a firm.”

Reichheld recommends calculating a “net promoter score” (NPS) which is simple: (number of promoters – number of detractors)/number of relationships.

“Many firms – and some entire industries – have negative net promoter scores, which means they are creating more detractors than promoters day in and day out.”

Reichheld states that “… the average US company has an NPS of less than10 percent … ” (p. 32). Exhibit 2-3 shows the mean and range of NPS scores for a set of industries (mostly service industries and segments of the financial services industry). The entire range for the utility industry is negative (every company surveyed has a negative NPS). In contrast, the entire range for the online brokerage industry is positive. Three industries have negative mean NPS: utilities, cable TV and health insurance (lowest mean of any industry shown in the chart and the lowest range endpoint). The highest mean scores are for package delivery (mean NPS of 39.8 percent) and auto sales (mean NPS of 37.1 percent).

I recommend his case study of Intuit, which clearly illustrates the value of focusing on a relationship measure and evaluating product, pricing, sales channel and other business elements as contributing factors (root causes) of customer satisfaction. As Scott Cook, a senior Intuit executive explained:

We have every customer metric under the sun … and yet we couldn’t make those numbers focus the organization on our core value of doing right by the customer. The more metrics you track, the less relevant each one becomes. Each manager will choose to focus on the number that makes his decision look good. The concept of one single metric has produced a huge benefit for us – customers, employees, and investors alike.

Chapter 3 makes the argument that “NPS can drive growth.” Bain consulting teams have found a correlation between industry leading NPS and industry leading (segment leading) growth (see Exhibit 3-1). Reichheld’s caveat: “Let’s be clear: NPS does not explain relative growth in every industry situation. Factors other than customer loyalty can play a role … technological breakthroughs can create growth surges.” Furthermore, “… a high NPS by itself is not the engine of growth. … High-quality relationships are a necessary but not a sufficient condition for growth” (pp. 45-6).

The end of Chapter 3 reprises Reichheld’s prior book, The Loyalty Effect, which demonstrates the economic value of loyal customers. Reichheld’s summary of the many factors is: long life-time to accumulate profitable stream of transactions, higher margins since they are less price sensitive, higher spending from more frequent purchases and purchase of a broader array of the company’s product and service offering, cost efficiencies from alignment with the company’s business model and generation of new profitable customers from word-of-mouth promotion (highly effective new lead generation within the target customer segment).

Chapters 4, 5 and 6 deal with the theory, problems and practice of measurement. Chapter 4 establishes the value of measurement. The key point of Chapter 4 is to make the measurement a tool for daily operations. This means personal accountability, timeliness, high customer participation and operational relevance. This chapter is anchored by a case study of Enterprise Rent-a-Car which used a five-point “homegrown” satisfaction scale (very close analog to NPS) to drive individual performance and a three-fold growth in the decade from1994 to 2004 ($2 billion to $7 billion). Bain conducted its own survey of auto rental customers in the UK in 2004 and found Enterprise to be the only company with a positive NPS in the UK (25 percent) with the major firm competitors having NPS ranging from -3 percent to -35 percent (Exhibit 4-1).

Chapter 5 describes the top ten problems with existing customer satisfaction measures. This chapter is useful for preparing to overcome objections from the marketing department, which in most companies is responsible for managing the existing customer satisfaction process. Reichheld points to a variety of problems in execution and in structure of surveys, including a major conceptual problem– mixing up transactions (and products) with relationships.

Chapter 6 provides coaching on how to administer the Ultimate Question. These seven principles echo the themes of the Enterprise Rent-a-Car case study in Chapter 4. The first principle is to ask the question and very little else. Reichheld coaches to separate the operational NPS measure from in-depth customer feedback, dialog and focus groups. Scott Cook at Intuit summarized: “What we really need is more managers talking directly with their customers, listening carefully, and then responding to their feedback” (p. 99).

Reichheld also recommends an audit to ensure accuracy and freedom from bias. In Reichheld’s experience “Ironically, the more progress you make toward granular accountability, the more difficult it becomes to gather honest and candid feedback from your customers. … Net promoter measurements are vulnerable to three types of bias: fear of retribution, bribery (or mutual back-scratching), and grade inflation.” Timeliness, independence and confidentiality (anonymity) can mitigate these issues but an audit of effectiveness is still needed.

The third section of the book – Chapters 7, 8 and 9 – contains practical advice on satisfying customers – the fundamental driver of a high, positive NPS. Of course, “… the purpose of companies and other organizations is to provide outstanding value and great relationships for their customers or members.”

Simply stated, this is accomplished by “… design value propositions that focus on the right customers” (Chapter 7), “… deliver those propositions end-to-end … ” (Chapter 8), and “… develop your company’s capability to do all this over and over again … ” (Chapter 9). The main technique in Chapter 7, design, is customer segmentation and needs analysis. The main idea in Chapter 8, deliver, is breaking silos – cross-functional focus on doing the work required by the value proposition promise to the customer. Chapter 9 calls for listening and customer-driven innovation in products and processes. Chapter 9 also includes ideas on building communities of promoters to amplify the economic benefits described earlier.

The book concludes with a call to “ethical” business practices in Chapter 10. The essence of a positive relationship is the “Golden Rule”: do to others as you would have done to you:

So why is this simplicity so radical? When you put all of these simple ideas together, you come to the inescapable conclusion that the best way for an organization to grow profitably is to build … relationships worthy of loyalty because they are governed by the basic set of ethical standards defined by the Golden Rule. It is truly radical to think that the more ethical a company becomes, the faster it can grow and prosper. Yet the data is hard to ignore. Companies that have earned the highest loyalty are winning the battle for market share in most industries.