Family Values

Posted on by Chief Marketer Staff

CRM expert Frederick Reichheld argues that loyalty starts with your employees

IT’S BEEN A LONG WAIT, but Frederick Reichheld has finally finished his second book. People who know his work have high expectations.

Countless executives learned the basic metrics of CRM from Reichheld’s first volume, “The Loyalty Effect” (Harvard Press, 1996). In that benchmark work — over 200,000 copies of which have been sold worldwide — he argued that a 5% improvement in retention rates could boost your profits from 25% to 100%.

Reichheld’s new book, “Loyalty Rules,” will tell just how successful companies do that. Their secret? They value their own employees.

Reichheld, who holds to Midwestern ideas of personal loyalty, rejects the notion that this is a “soft” subject. Virtue is its own reward, he says — the results are measurable.

A native of Parma, OH, Reichheld graduated from Harvard College in 1974, and took his MBA from Harvard in 1978. Five years ago, he gave up his status as a Bain & Co. partner — at great financial sacrifice — to become the first and, to date, only Bain Fellow. He now spends his time writing and lecturing on loyalty.

We observed that he is sticking with the same publisher (Harvard Press, which will publish the new book in September).

“When you make loyalty your thing,” Reichheld laughs, “it constrains your options.”

Schultz: Has the world changed much since 1996, when you wrote “The Loyalty Effect”?

Reichheld: The rules for earning loyalty haven’t changed much at all, but the economics of earning loyalty are even more vital in the new economy than they were in bricks and mortar, where they were already quite leveraged. But now it really is hard to make a business model work if you can’t earn repeat business from customers you invest in acquiring.

Levey: Are you talking about companies with mixed channels, or pure-play companies?

Reichheld: Truly both. But I find that when the Internet becomes a part of a business, whether it’s a separate channel or just a communication channel within the firm, there are a set of rules that they have to play by that require candor — open, honest, direct communication.

Schultz: And if you don’t?

Reichheld: The truth gets spread very quickly. It’s very hard to hold up the fiction that it’s good business to abuse your best customers, because your best customers can see exactly how you’re abusing them, and the reaction times are much shorter. The ability to e-mail a thousand of your closest friends with the truth accelerates the spread of your reputation going up or down.

Schultz: Are all companies getting it at this point? I have heard you say that a lot of companies are still not measuring customer retention rates.

Reichheld: It’s closer. I’m still disappointed with the number of companies that take this economic calculation seriously. It is true that most people still don’t measure retention rates very carefully. They certainly don’t give them the strategic import they deserve. Now the Internet improves the picture. It makes it easier to track customer purchase behavior, so I suspect that in truth we’re making a little progress. But it is extraordinary how few companies track carefully or set specific goals or budget based on those things.

Levey: What stumbling blocks do you see?

Reichheld: The paradigm most business people accept is based on accounting earnings, which don’t take into account life-cycle value of customers at all. Most of the tracking systems were set up in a way that makes the economics of customer loyalty very opaque. Is it that difficult to break through? No. Most good cost accounting systems are more complicated and more challenging than a good loyalty accounting system. But too many firms are finding they can push off the necessity of integrating their accounting with the realities of loyalty and cash flow.

Levey: What would you say to publicly traded companies that seem to live and die quarter by quarter?

Reichheld: There are a number of components in loyalty economics that pay off this quarter. More and more companies are seeing that they have to be thoughtful about who are the barnacles that will stay forever if you treat them right, and who are the butterflies that are going to flit off to the next deal and hot fashion. The easiest way to begin implementing a loyalty-based strategy is to be thoughtful about the upfront marketing customer acquisition.

Schultz: How important is it to be thoughtful after you’ve got them?

Reichheld: Enormously. Let’s say you run an average American business, and one-third of your customers are marginally profitable, and maybe one-third are actually earning more than the cost of capital. If you focus all of your energy on those customers in terms of product development, listening carefully to their problems and organizing your business to be simple for them to use, you become much more for them. If you try to do a little bit for everybody, you don’t go anywhere. And by defining some as good customers as long as they make some marginal contribution to my fixed costs this quarter — hey, I’ll pay a sales commission to get some of that — that’s a route to mediocrity. And, of course, that is American business today.

Customer Loyalty

Levey: Which industries are treating their customers well?

Reichheld: I would have to say the automobile industry is the weak end of the spectrum. It has terrible retention rates, and a business philosophy that’s inconsistent with earning loyalty. Not all the players, but many of the players. Cellular telephone companies are pretty awful. Cable television probably deserves that notoriety as well. Companies either put all of the economic value on the one-time transaction like the automobile, or they try to create a mini-monopoly and then milk it for all it’s worth. As a result, you get pretty disgruntled customers and, over time, disgruntled employees.

Schultz: Wouldn’t some of these companies perhaps argue that it pays for them to do business this way? As a restaurant owner said when told that the coffee was cold, “Do you see any empty seats?”

Reichheld: That is a short-term point of view. Real successful businesses have to succeed through boom times and difficult times. You can be pretty haughty in the good times, and you’re setting yourself up to fail in times like these. There are a lot of businesses where the seats are not filled any more.

Schultz: Any personal examples?

Reichheld: Well, how about my phone company? Instead of having their computers give you a fair price based on your usage rates, they try to make you guess about what package to buy. Or my cellular telephone company. If I want to upgrade to a high-technology handset, they charge me full retail, whereas I know if I went and switched to a competitor and said, “I’ll switch if you give me a free handset, no questions asked,” it would be done.

Schultz: You seem to not be in favor of quickie price promotions.

Reichheld: Most companies give the best bargains to the lousiest customers, and then they sort of abuse their loyal customers, which of course leads to fewer and fewer customers thinking they should be loyal.

Levey: You wouldn’t be talking about the magazine business, would you?

Reichheld: Well, the magazine industry is a good one. If you look at the overall margin of that business, it’s not a great business. The philosophy of abusing your customers whenever you can get away with it almost never leads to good growth, or a good profit margin business. If your timeframes are very short, abusing your best customers does look profitable. But when you keep doing it through the years, you end up with an industry — or at least a business — where you have no loyal customers.

Schultz: How badly can you treat a customer in the lower tier, without having the PR impact harm the business?

Reichheld: I don’t think you can treat anybody badly and not have it hurt you, because when you treat people badly, it steals energy from your employees. And it makes your organization less worthy of their commitment and trust.

Schultz: Can you think of any new-economy businesses that are doing it well?

Reichheld: You know, it’s speculative with new-economy businesses. EBay is a company that’s doing things right, and that understands the importance of loyalty. It knows that its basis is not gimmicks and tricks but a way of dealing with people that earns their trust and commitment. When you send an e-mail, it really tries hard to get back to you within 24 hours.

Schultz: What about Amazon.com?

Reichheld: I think Amazon did so many things right and is doing a few things wrong. Amazon has outstanding customer service, it creates value for its customers in that “you might be interested in these books” technology. That’s a real service. But some of the pricing strategies I’ve read about, where it doesn’t give best prices to its best customers — I think that’s wrong. It spread itself way too thin across too many product lines where it couldn’t offer the best value, which isn’t a very loyal thing to do to your customers. It’s done some really good things, and I think it has fixed a number of the bad things, so there’s hope there.

Levey: What about classic direct marketing companies?

‘The idea that you can track your customers and use dynamic pricing to abuse them really bugs me,’ Reichheld says.

Reichheld: I don’t have the measurements for anybody in that pure sector. I suspect L.L. Bean is a good candidate, having met some of the people who work for it. It really does want to earn the loyalty of its people. It’s not trying to nick its customers for everything it can get away with; it wants to earn a reasonable margin and serve its customers so well that they keep coming back for more. And it treats its people well. It wants to create successes for its people — not just sort of suck them dry and spit ’em out when it’s done because there are plenty more people it can hire.

Employee Loyalty

Schultz: How would you describe your new book, “Loyalty Rules,” as being different from “The Loyalty Effect”?

Reichheld: “The Loyalty Effect” was primarily about economics that made focusing on loyalty a rational thing to do. It explained why a 5% change in retention rates of customers could turbo-charge growth and profits in a counter-intuitively large way. This book is about what the leadership practices have been for companies that have been able to build astonishing loyalty.

Levey: What’s the new revelation?

Reichheld: The revelation of the work I’ve done over the past five years is how vital it is to have loyal employees if you want to build customer loyalty. I think where companies are making the most mistakes are on the employee side. If they want to start fixing something, that’s a good place for most of them to concentrate their improvement.

Schultz: In which areas — compensation, building morale, HR issues?

Reichheld: It all fits together. If you try and build a business that doesn’t earn customer loyalty, you’re not going to have much excess cash flow to share with your employees or invest in your employees. You’ve got to have a way of sharing the improvements in performance with those employees who helped create them. You have to have a way of treating them that they find is fair, and leaders have to behave in a way that their people considered principled.

Schultz: Who’s doing it right?

Reichheld: MBNA, the credit card company, is a good example. It understands employee loyalty brilliantly. It hires carefully, trains people, thinks about career progression in a way that is really based on a long-term career with the company. And it has matched those results in terms of retaining customer loyalty. The things go hand in hand.

Schultz: With all these mass layoffs going on, doesn’t that make it tougher to achieve the kind of loyalty you’re talking about?

Reichheld: Loyalty is most valuable when times are tough. And today, if you don’t have loyal employees, there’s no way you can go through the necessary layoffs and end up with a remaining group that is going to do the things it takes to earn the loyalty of your customers. I find it amazing that a lot of executives seem to think they can earn customer loyalty through an employee workforce that’s disloyal or ambivalent about whether this organization is deserving of loyalty. Investments in technology are just good money flushed down the drain unless they’re being put in the hands of loyal employees.

Schultz: How to you sell that to upper management?

Reichheld: The thing I’m most proud of is breaking it down into a micro-economics that’s understandable and logical so you can make decisions and learn.

Levey: When you’ve gone to conferences, have you taken the time to wander through the vendor exhibit halls?

Reichheld: I don’t do that much, probably because early on I got a little jaded. I got a little frustrated with an underemphasis on really treating people right. The idea that you can track all your customers and use dynamic pricing to abuse them in a scientific way — that really bugs me. My point of view is that there are increasing opportunities to use technology wisely, but few people are using those tools wisely.

Levey: Why do you feel that is?

Reichheld: There’s this enormous confusion that the way to treat people in business is to do whatever is legal and you can get away and that makes a profit this quarter — as opposed to this higher standard.

Schultz: So it’s not a technological issue but a management issue?

Reichheld: Exactly. I would take it even one more step. It’s a leadership issue. [People] have just sort of given up on it because they don’t see the leaders of their organization living by those rules.

Start at the Top

Levey: What message would you want to give someone who is trying to reconcile your work with what he or she is seeing every day in The Wall Street Journal?

Reichheld: Loyalty starts with leaders. Either find the people to work with where this philosophy is at the core of what they’re going to live by, or do it yourself and make it your own. The good news is that there are outstanding financial results for those who do it well. And although there are other ways to make a lot of money, most of them are actually harder to maintain over the long haul, and they’re definitely not going to be as much fun.

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