Death by Butterfly

"Loyalty is dead, dead, dead!" (Wall Street Journal)

Stages of Loyalty

According to Frederick Reichheld, just about everything we're doing in business these days is wrong. In our haste to cut costs, we've created a generation of:

• disposable employees, unable to trust the organizations they work for,
• job surfing careerists, who view more than 3 years with the same company as the death-knell for their careers,
• fickle customers, who think only about price,
• fast-money speculators, intent on milking one company and then moving on to the next, and
• short-term managers, who care only about quarterly profits.

Poor Reichheld -- when he spoke up to suggest that there might be a place for loyalty in the modern corporation, he was unanimously shouted down:

Business loyalty, his critics sneer, is as much an oxymoron as jumbo shrimp or random order.

Sure, the New Age management types take his side. They long for an organization that is like a good friend: supportive, caring, and warm.

But that's not what Reichheld is getting at. He likes loyalty because it helps companies make money, and survive for the long term.

He's talking not just about loyal customers, who keep coming back to buy, but also loyal employees, whose skills and effort bring those customers back, and loyal employers, who keep the promises they make, and loyal investors, who stick with you through thick and thin -- even loyal vendors and dealers, who forge a partnership for long-term success all around.

He uses the analogy of a baseball player's batting average. The difference between the .325 average a superstar like Ken Griffey and the .275 average of a journeyman is only .05, or 5 percent. But that 5 percent is huge for the organization's margins.

Reichheld showed what that same 5 percent meant if it meant 5 percent greater customer retention, 5 percent less worker turnover, 5 percent less investor churn. It is the difference between average and excellent. A 5 percent increase in retention can improve customer net present value from 35 percent (software) to 95 percent (advertising) depending on the industry.

We continue to pursue a vision of business defined by "maximized shareholder value" despite the fact that investors have even less loyalty to companies than companies have to their workers.

To put it another way, if your organization routinely loses 20 percent of its customers annually, you are losing half of your customers every 5 years. All the investment you poured into acquiring and cultivating them is squandered. But as important as customer retention is, how many CEOs have an accurate handle on it at their organizations?

Loyalty is a powerful enough concept to Reichheld that he created a "loyalty practice" within Bain & Company, the consulting group he is a partner in. has enough It is his intention to spend the rest of his career spreading the gospel that loyalty boosts profits, using roundtables, talks, and master classes featuring CEOs who have pioneered loyalty at their companies:

The effect of loyalty in an organization is to ratchet up performance at every level. Employees who stay 5 percent longer than industry averages keep their knowledge within company walls, where it can be applied to meeting customer needs. And they do not take the skills you have taught them to competitors.

Customers who keep buying from a company 5 percent longer than average give the company a greater return on their investment in acquiring those customers. Since they are already acquired, the extra years of buying are like free money.

And investors, if they stay with your company just a little longer than the cup of coffee that is typical of most of today's investors, provide stability and predictability to soothe the anxious financial sector.

Using examples from the companies above, and a few others, Reichheld discussed seven "pillars" supporting the "High-Performance Partnerships" engendered by loyalty.

1. Strategy. MBNA states on its annual reports: "Our strategic plan is summarized in nine words: "Success is getting the right customers and keeping them." MBNA knows a new customer costs $51 to acquire, so it acquires them with care. The result is a 97% retention rate, unthinkable in the notoriously rate-sensitive credit card business.

Pricing is also part of loyalty strategy. How many companies attract new customers with low prices, only to gouge them when they become regular customers? The cellular company that gives new subscribers free phonesets, but charges existing customers an arm and a leg for one, has it exactly wrong. These aren’t customers, Reichheld says; they're hostages.

Companies like John Deere look at the very long view, seeing farm families as customers for more than one generation. Vanguard maintains the lowest in the mutual fund industry, where John Hancock has the most highest cposts -- and highest defection rate. Think of defections the way manufacturers think of scrap waste, Reiccheld says: you can’t afford to waste very many.

2. Selection. A company should select its partners they way an individual should select a spouse, Reichheld said. The better you select one, the more you will want to stay together.

Reichheld divides customers into "butterflies" and "barnacles." The butterflies alight on whatever is momentarily attractive. They're expensive to acquire and a waste of time. Barnacles, on the other hand, once acquired, will remain until you scrape them off your hull.

Avoid butterfly customers. Concentrate on prospective barnacles.

Consider Vanguard. Its ads stress "steady as she goes" -- dull but effective. Fidelity, by contrast, stresses top performance. You get what you advertise for. Fidelity has huge customer turnover, as its fickle investors search for this week's hot fund. Vanguard, meanwhile, is building a vast army of barnacles, attracted by longterm performance and low costs.

3. Incentives. Many companies use anti-loyalty incentives, Reichheld said. If a branch manager performs well, she's promoted to a bigger branch -- punishing her customers for her excellence. "It's a sick system."

Pizza Hut and Chick-fil-A use similar systems but in different amounts. Base pay for an operator of a Pizza Hut is $30,000, whereas Chick-fil-A pays $100,000. Managers desert Pizza Hut after two years, whereas at Chick-fil-A they go on and on. Because the money's good.

The founder of Chick-fil-A has a disconcerting saying: "I hope one of us dies before we stop doing business together." That is how strong the sense of mutual advantage there is.

The story is the same at Enterprise, which while being the low-cost renter of cars, is the highest paying employer ($25,000 starting salary vs. $18,000 at Hertz). A contradiction? Not at all -- the company is forming a profitable partnership with talented new hires, that will last a long, long time.

4. Values. Reichheld did not spend much time on values, but indicated that the values supporting high performance need to be real and measurable. Loyalty must mesh with a company's microeconomics to work. Values in this sense are hard as nails, not soft and squishy.

The best sign of loyalty-based values is when a company puts it partners' interests ahead of its own. Toyota's mantra, repeated in every annual report, is "Customer first. Dealer second. Company, third."

The new head of PR at Vanguard, asked to describe the difference between the company and his previous employer, mentioned a budget hearing where it was proposed that a single basis point -- a percent of a percent -- would provide 50 times as much money for advertising. "We could do it," he was told, "but it just wouldn’t be right."

Treating people like partners, making decisions partners would be proud of, a deep caring for people in the organization -- these are the signs of those values.

5. Communication. When Reichheld began his loyalty practice at Bain, his wife enccouraged him to obtain a vanity license plate bearing the word L0YALTY. Why, then, did the police in his home town of Wellesley, follow his car wherever he went? Evidently the word loyalty is meaningful within the Mafia.

Lexus establishes it loyalty using communications technology. Every service center has a satellite dish on the roof, beaming information back and forth to the parent company.

Lexus, before starting to do service business in North America, studied the successes of competing luxury car groups Cadillac and Mercedes. What they learned was that the #1 concern of drivers of these cars was repair delays due to part shortages. So Lexus dealers took upon themselves the logistical task of procuring parts in a timely fashion. Extraordinary and expensive, but as a result Lexus has the highest retention target, 80 percent, of any car company.

A commitment to holding onto people requires more than "satisfaction surveys," Reichheld said. Satisfaction surveys, he feels, are merely measures of who has the most spare time to fill out forms! He suggested that companies utilize the kind of failure analysis tools used in quality assurance, to track backward through processes to discover where customers (and employees) defect.

6. Opportunity. The soul of a successful partnership lies in the opportunities it creates for customers, employees, and vendors to grow to their full potential. Incentives help you do a better hob where you are. Opportunity helps you rise above your current level, without causing your customers to slip away.

Robert McDermott , retired head of USAA, says "Customers and employees are both precious resources."

Andy Taylor of Enterprise Rent A Car warns that no one can be promoted the company's system without receiving satisfaction survey scores in the top 50 percent (the sole example of Reichheld favoring satisfaction surveys).

Bob Harris of USAA states unequivocally that his job as CEO includes customer retention. "If you delegate it to marketing or human resources, it just doesn’t work."

What we are left with is a choice between two very different futures, Reichheld said.

The first choice is the choice most companies are moving to, Profit-Based Management.

The goals here are to:

On the other hand is Loyalty-Based Management, and its goals stand in stark contrast:

Is loyalty dying? Reichheld knows that it is, because the clear trend is toward Profit-Based Management, away from the cost and commitment associated with dealing with people as people.

At the same time, he knows that it isn't dying, not so long as a handful of shrewd companies can see through the trend toward cost containment at any cost -- to the undeniable truth that loyalty pays.

LOYALTY IS THE HALLMARK OF GREAT LEADERS AND GREAT COMPANIES.

AND MEASURING LOYALTY IS THE FIRST STEP TOWARD GREATNESS.