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THE
LOYALTY EFFECT:
The
Hidden Force Behind Growth, Profits, & Lasting Value
A summary of Frederick Reichheld’s masterpiece book,
published by Harvard Business School Press
According
to Dr. W. Edwards Deming, the Einstein of Quality Management,
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.
Loyalty-Based
Management is not some vague, futuristic theory about the increasing
importance of intellectual capital. It is an established, working
method for growth and profit that delivers outstanding results
in today’s fast-moving, super-competitive world.
If you care
about long-term growth and profits, using short-term earnings
as your primary performance measure 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 sustainable success.
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, they simply will not be leaders in the 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 third of Toyota’s total operating
profits.
State Farm
Insurance has 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 to quantify and predict customer duration
and “lifecycle cash flow.” 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
metrics are designed to make the invisible loyalty factors
visible. Once made, these metrics 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
point: 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. They seek out customers, employees, and investors
who demonstrate the highest character and integrity - they
then settle for a “reasonable” level of raw talent to
build on. This is very different from the more common practice
of maximizing raw talent - and setting just a “reasonable”
threshold for character, integrity, and principles.
The Essence
of Loyalty 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 crucial
key to producing long-term growth and success - in all businesses.
Loyalty management
is clearly a paradigm whose time has come. Leadership Alliance
provides custom loyalty strategies and true quality management
solutions for organizations of all types and sizes. We offer focused
guidance and support for your journey to greater loyalty and success.
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