Idea 31 - Loyalty (50 Management ideas you really need to know)

Idea 31 -  Loyalty

Management consultants devote many long hours, days and months hunting the snark - hoping for a better management idea, an undiscovered causal link between how businesses do what they do and the size of the bottom line. Frederick F. Reichheld and his colleagues at Bain &: Company came up with a winner when they identified close connections between customer retention, growth and profits. They called it 'loyalty' and discovered that, in the best-performing companies, it was intertwined with employee and investor loyalty. Each one reinforced the others.
All those loyalty and rewards cards you don't know where to keep, from shops you can't remember visiting? Blame Reichheld. Loyalty programmes are nothing new, but his 1996 book, The Loyalty Effect, made them a competitive must-have as companies scrambled to put his ideas to work and retain their best customers. For those who thought that loyalty had died along with chastity and good manners, Reichheld insisted that it was not only alive and bright-eyed, but was a sure measure of value creation. Those of a certain age will remember Green Stamps, effectively introduced to the US in 1896 and, much later, as Green Shield stamps, to the UK.

Depending on how much they spent, shoppers were given stamps to paste into a book and redeem for toasters and glasses. They had faded away by the 1980s, though their inventor, Sperry and Hutchinson, lives on with its Internet-based Greenpoints programme.

American Airlines created the check-in's answer to Green Stamps, and the modem loyalty marketing programme as we know it, when it launched its AAdvantage air miles scheme in 1981. Since then, such schemes have multiplied in number and grown more ambitious in the scope of their 'prizes'.

So companies have been thinking up more or less inventive ways of hanging onto their customers for generations, and it was no great revelation to hear that customer retention was a good thing. It was known that long-term customers should be valued, partly because the longer they stay, the lower the amortized cost of acquiring them and the less likely they are to leave. They are more inclined to spread the good word about the company and to buy ancillary products. And because they know the ropes, long-term customers are quicker and cheaper to
deal with.

What Reichheld and his team did, however, was to put the loyalty of customers, employees and investors at the heart of superior performance and to shine a light on the most desirable ones to have. Though they don't appear on the balance sheet, Reichheld argued that these three groups are a firm's most valuable assets. He pointed to the prevailing extent of disloyalty, with typically 10-30% of customers defecting every year, employee turnover of 15-25% and an investor chum rate of over 50%. He asked: 'How can any manager be expected to grow a profitable business when 20-50% of the company's most valuable inventory vanishes without
a trace each year?'
Value indicator The fundamental mission of a business was not profit but value creation, with profit as a vital consequence, said Reichheld. Profits alone can be manipulated by firing people. Pay cuts and price increases can boost earnings but have a negative effect on employee and customer loyalty (and the assets they represent). 'Since the only way a business can retain customer and employee loyalty is by delivering superior value, high loyalty is a certain sign of solid value creation.' The effects of Reichheld's loyalty cascade through the business. Revenues and market share grow as the best customers are kept and acquired, so the firm can afford to be more selective in choosing new customers. Sustainable growth means it can attract the best employees. They get satisfaction from delivering superior value and, as they get to know their long-term customers, can deliver still more value, reinforcing loyalty on both sides.
These loyal employees learn on the job how to reduce costs and improve quality, enriching value and raising productivity. The productivity surplus funds better pay, tools and training more productivity and pay rises, more loyalty. Spiralling productivity and increased efficiency of dealing with loyal customers mean a cost advantage that is hard for competitors to match. Sustainable cost advantage and steady customer growth generate the kind of profits that attract and retain the right kind of investors - the loyal kind.
Loyal investors behave like partners, Reichheld maintains, which doesn't mean they are not
demanding. 'They stabilize the system, lower the cost of capital, and ensure that appropriate cash is put back into the business to fund investments that will increase the company's value-creation potential.'
Destructive profit Profit does not hold centre stage in this system, though it is crucial as fuel for improved value creation and an incentive for sustained loyalty all round. The kind of profit generated by this model Reichheld calls 'virtuous'. The be-all-and-end-all profit that has its eye fixed on the quarterly results is 'destructive'. It comes not from value creation and value sharing but from exploiting assets and selling off a business's true balance sheet.
As he says, it's not always easy to tell them apart. The accounts won't tell you, because they look the same in the profit and loss statement. But one way is to measure the three loyalties. If defections are low and getting lower, the profits are virtuous. If not, then the company is probably liquidating its balance sheet and destroying long-term value.

Not everyone agrees. There is a school of thought that insists that, all else being equal, a growing number of customers will go for the lowest price time and again. Reichheld would, no doubt, call them destructive prophets.

Reference: 50 Management Ideas You Really Need to Know

Book by Edward Russell-Walling

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