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The Loyalty Effect: Excerpts

Grow by Fixing the Leak in your Bucket…
“Say you steadily add new customers to the top of your inventory, but old customers are steadily vanishing from the bottom. If you could slow the defection rate, the new customers you gained would increase the total at a much faster rate. It’s like a leaky bucket. The bigger the leak in your bucket of customers, the harder you have to work to fill it up and keep it full.”

Getting the Right Customers through Selective Filtering…
“The principle of buyer beware has been with us since Roman times. For most businesses today, however, the more relevant principle might be seller beware. Businesses … can be very sloppy about deciding which customers to seek out and acquire. It is simply not possible to build or maintain a healthy business without learning how to get the right customers. In many businesses, the customers most likely to sign on are precisely the worst customers you could possibly find. One auto insurer found that its worst new risks, as well as its least loyal customers, very often found the company’s agents through advertisements in the Yellow Pages. Needless to say, the company now discourages its agents from placing such ads.”

Growth can be a Poor Bargain…
“The need for growth can cause companies that have captured the best of their natural customer base to recruit more and more of the less desirable customers who remain. But it’s a poor bargain. As customer quality declines, so does the firm’s ability to deliver value; which in turn discourages good customers, stifles growth, demotivates employees, weakens the process of value creation, and encourages the salesforce to chase customers who are even less likely to be profitable and steady. In short, the entire spiral turns upside down and drills the company into a hole.”

Getting the Right Employees…
“The best employees, like the best customers, are those who get swept up in a kind of value-and-loyalty spiral. Specifically, the best employees are those with the talent and motivation to raise their own productivity (and consequently their own incomes) swiftly enough to fuel their motivation further still - producing even greater improvements in service and productivity and therefore a growing surplus of value for company and customers.”

The Real Result of Workforce Reductions…
“The unsettling volume of recent CEO firings has forced top executives into making virile gestures in hopes of demonstrating their mettle and resolve. While most CEOs hate the idea of layoffs - they know perfectly well that no business leader ever achieved greatness by firing people - they feel trapped. The institutional investors who drive the stock market are showing less and less patience with mediocre earnings, and executives have to please those investors if they want to keep their jobs. Xerox’s stock surged 7% on the day its layoffs were announced. This kind of news exhilarates short-term investors. But in its next Sunday Business section, the Times asked Xerox the important question: ‘In a company that prides itself on worker harmony, will those remaining stay loyal?

The True Cost of Turnover…
“The key to quantifying the cash-flow consequences of employee turnover in all these industries is essentially the same: to recognize that employee retention is not only critical for cost efficiency but an important factor in revenue growth as well, because of its direct link to customer acquisition and retention.”

The Economic Benefits of Loyalty Leadership…
“In an industry where annual turnover in store managers runs between 30 and 40%, Chick-fil-A loses only 4 to 6% of its operations every year, almost none of them from the top two-thirds in performance. The economic benefits of this superior loyalty have allowed the company to open six hundred stores over forty-nine years without using any outside capital. Chick-fil-A’s loyalty-based system has funded not only impressive growth but superior compensation for the store managers themselves. Fast-food managers in general make $30,000 to $35,000 per year. The average Chick-fil-A manager makes about $45,000, and the top 10% make better than $100,000 - a salary almost unheard of in their industry.”

The Enemy of Productivity Improvements…
“The idea of paying people for the importance of their jobs - instead of for the productivity of their teams - means that the only way to get ahead and earn more money is to get promoted. The terminal position in a bureaucratic organization is the chief executive, and most career paths point in that direction. It’s an absurd system. Only one person at a time can hold the job, so 99.99% of the rest will necessarily fail to achieve their ambition. The counterproductive behavior this creates in the form of politics and personal disappointment is enormous.”

Crazy Career Paths…
“Another productivity monster is the career path that encourages employees to skip the position that drives value creation for the business. In a bank, this position is branch manager; in insurance, it’s the local agent; in restaurants, it’s the operator. If the primary route to prestige and higher compensation is to move past the terminal line position to a staff job whose impact on value and profit cannot be precisely defined, then customer loyalty, productivity, profit, and overall business longevity must all suffer.”

What Value Do Investors Really Provide?
“To calculate this flow of value to the company, a manager must be able to estimate the benefits received, net of the costs incurred, from various types of investors. Benefits include the stability of the cash investors provide as well as the value of their advice, their expertise, and even their constructive questions and demands, which help managers to build a more successful company. Costs include the unconstructive demands, asset exploitation, managerial distractions, and systems instability that certain kinds of investors generate. By failing to recognize these costs and benefits, managers undervalue the worth and loyalty of the right investors. Of course, most managers prefer to have loyal investors, just as they would prefer to have loyal customers and loyal employees. But few have put the necessary effort into building a loyal investor base. We’ll see how catering to the needs of high-cost investors eventually impairs a firm’s capacity to deliver value to the investors who cost the lease and give the most benefit.”

Smart Money
“All schemes to reduce the pressure on quarterly returns are open to the suspicion that managers just don’t want their feet held so close to the fire. But if you believe that getting rid of short-term investors is a way of reducing the pressure to perform, then you haven’t understood the message of this chapter. Loyal capital is more committed to your business, knows more about it, and therefore tends to demand more than the transient investors you never meet of hear form. Investors like Warren Buffett, Alfred Lerner, Paul Desmarais, Bain Capital, and State Farm insist on altogether exceptional performance. The difference is that they know what kind of performance is possible and understand the time-frame in which they can reasonably demand it.

“It’s not patient money you want but smart money. Smart investors know that the only way to maximize shareholder value is to earn the loyalty of customers and employees. That is increasingly true as businesses become more knowledge-based and service-intensive. As a manager, you must take steps to find smart investors, educate the investors you already have, and avoid the high cost of disloyal capital.”

Forget Profits, Focus on Value…
“The true mission of a business is to create value. Any business muddled enough to believe that its real purpose is producing profit is probably not long for this world. Profit is absolutely essential, to be sure, but it is a downstream outcome of creating value, and so it functions very poorly as an objective in itself. One of the reasons so many businesses fail is that all their analysis and learning revolves around profit, so they become aware of problems only when their profits begin to decline. In struggling to fix their profits, they concentrate on a symptom and miss the underlying breakdown in their value-creation system.”

Ethical Profits…
“State Farm’s essentially moral approach to business earns high customer and employee loyalty and gives new meaning to the phrase Golden Rule. Agents see their jobs as gold mines - and with more than $20 billion in retained earnings, the company has been dubbed [by Fortune Magazine] ‘the Fort Knox of the insurance business.’”

Harvard Business School Press 1996
Bain & Company  (c) Bain & Company, Inc.