By Stephen Hall

In today’s hard-knock economy, experience has taught many of us that to be loyal to a particular brand or company, whether as a consumer or as an employee, is to potentially set yourself up to be taken for a ride. Examples are everywhere: A cellular phone service provider gives discounts only to new customers as an incentive to sign up, while longtime customers get charged full price. You talk to a friend overseas for 15 minutes during your stay at a hotel, and your phone bill ends up being more than your room bill. Need to change your flight home? That’ll be $100, says the airline. The moral seems pretty clear: Don’t stay with a company too long, or you’ll be labeled a sucker—and treated accordingly.

So if the marketplace is really full of jaded consumers who have learned to equate loyalty with stupidity, then as a company, what’s the use in trying to take your satisfied customers and make them loyal ones? According to Frederick Reichheld, director emeritus and Bain Fellow for Bain & Company, a global management consulting firm, it’s the only way to separate yourself from companies who abuse loyalty and to join the ranks of admired organizations like Chick-fil-A, The Vanguard Group, Enterprise Rent-A-Car, Harley-Davidson, Southwest Airlines, and State Farm Insurance. And, he added, it’s the only way to grow your business over the long-term. "These admired companies are industry leaders because they understand the value of loyalty, and they measure it just as carefully as profits," he said.

For LOMA’s 2003 Customer Service Conference in Tampa, Reichheld gave the keynote address, titled "Measuring Loyalty: Moving Beyond Customer Satisfaction." In his presentation, he explained how developing loyal customers translates into bigger profits and business growth; why many customer satisfaction surveys are not as effective as they could be (and therefore mean little to investors); and how streamlining customer service surveys and linking their results to compensation and advancement can make them tools for stimulating business growth that are used just as rigorously—and taken just as seriously—as a company’s tools for managing profits.

Reichheld began by explaining how he has personally wrestled with the concept of loyalty in his professional life. "I went to Harvard Business School, and they have reunions every once in a while," he said. "My 25th reunion is coming up, and I’ve found that they don’t want me to be the section party host, because I’m a little embarrassing to the section: I am the only graduate who’s still working with the same firm I joined out of school. They think, ‘Poor guy, he had no opportunities to really get ahead and do something, and maybe he just lacks ambition. It’s pathetic.’ And I thought about that and realized it’s true: Loyalty is stupid if you care about maximizing your career success."

As an example, he said that after his first book ("The Loyalty Effect: The Hidden Force Behind Growth, Profits, and Lasting Value") became an instant bestseller, conventional wisdom dictated that the smart thing to do, from a financial standpoint, would have been for him to leave Bain & Company and start his own firm. But there was just one problem. "It’s sort of hard to do that after writing a book about the importance of loyalty and still have any sort of credibility as an expert on the subject. So I was trapped," he said with a laugh.

Reichheld said he concluded that loyalty can be either smart or stupid, depending on the answer to one key question: Loyalty to what? After having much difficulty trying to answer this, Reichheld found that the most effective way to do so was to look at specific companies from a wide range of industries. The result was a list of companies whom he identifies as "loyalty leaders," or companies who have developed a loyal following of customers due to having implemented aggressive customer service measures and philosophies at every level of the organization.

"Chick-fil-A is a chain of 1,000 fast-food chicken franchises," he said. "I’ve heard that for Chick-fil-A store operators, the turnover rate is 5 percent a year, as opposed to the fast-food industry norm of 40 percent. Five percent turnover means an average career duration of 20 years—running a chicken sandwich shop. The people at Harvard would say, ‘Where’s the ambition? What kind of people are these?’ Well, I interviewed them, and you know why they stay 20 years? They say, ‘We’re proud of the way they treat people at Chick-fil-A, and we make three or four times as much money.’ I thought, ‘Oh, please. Fast food is the ultimate price-sensitive business. A nickel makes all the difference to volume per store.’ And each Chick-fil-A store costs around $1 million. But the average Chick-fil-A store operator made $180,000 last year. At McDonald’s, a comparable position would make $45,000. And get this: They close on Sunday, so I’m thinking, ‘This isn’t a business; this is a cult.’ Except they’re doing better per store than McDonald’s or Burger King or any of the other guys. Even today, they’re growing, and these other firms are headed into bankruptcy."

Reichheld then named The Vanguard Group and Enterprise Rent-A-Car as two other examples of loyalty leaders. "Vanguard is a mutual company that has grown faster than any of its competitors to become the No. 2 mutual fund manager in America," he said. "Vanguard’s founder, Jack Bogle, explained to me that their customer retention rate was five to seven points higher than their competitors. And he kept track of this to two significant decimal places. He explained that their high retention rate is the reason for them being a low-cost enterprise.

"Then we go to Enterprise Rent-A-Car, which is the largest car-rental company in America, and they shot by Hertz and Avis like they were standing still," Reichheld continued. "Enterprise is also the largest hirer of college graduates in America. They pay 50 percent more than the competition for a starting position, and if you’re good, then after 10 years, you’ll be making over $200,000 a year. And conventional wisdom says, ‘You’ll never retain people that way. They must be really sticking it to their customers.’ But they have the lowest prices available of any major car rental company. And you go, ‘Wait a minute: You’re charging less, and your costs are above the industry average? You must be losing money.’ Well, the founders are worth $10 billion. This pattern that you see is not specific to any industry, but it does make you think very differently about what drives the success and the growth of an organization."

He then cited Harley-Davidson, who caught Reichheld’s eye after he read a passage in one of their annual reports that declared, "We have the world’s most loyal customers." "I asked them to show me their customer retention rates and to give me proof about the loyalty of their customers. They said, ‘Fred, retention rates are for sissies. We determine the percentage of loyal customers by how many of them have our brand tattooed on their body.’"

For his final example of a loyalty leader, he discussed Northwestern Mutual, who, like Vanguard and Harley-Davidson, has a customer retention rate that is marching up to the top of its industry, he said. "They have a 5 percentage point persistency advantage," he explained. "While speaking with Edward Zore, Northwestern’s president and CEO, I said, ‘That helps you grow, right?’ He said, ‘Yes, but the thing I’m most impressed by is that it saves us over $200 million a year in operating expenses.’ I asked him how, and he went through every one of the major cost and accounting departments and explained how that persistency advantage gave him superior economics. Some of this stuff is simple: For example, you don’t have to re-underwrite someone for their second policy as carefully as you did for the first. You don’t have to have as big a computer if you’re not churning through different people every few years and you have the same policies on the book. Accountants don’t capture this in most companies, because it’s invisible. But the economics of loyalty are very powerful, especially in your industry."

Having pointed out that these loyalty leaders are growing at more than twice the rate of their competition, and that they have a 15 to 20 percent cost advantage, Reichheld abruptly shifted gears. "I’m going to change the presentation so that we’re no longer talking about loyalty," he said. "This is a lecture on growth. Because your bosses and certainly your investors in your public company don’t care much about loyalty. They care about growing the business."

When it comes to the question of how you go about growing your business, Reichheld said there is no shortcut. "It turns out that customer loyalty is the only way to stay profitable," he said. "Sure, you could acquire a company and merge, or you can add new branches, but it’s not going to work out unless you’ve got an underlying foundation of a loyal customer base that comes back for more and tells their friends. You don’t build customers through frequent-flyer miles and marketing gimmicks; you get them because employees treat customers right. And how do you get employees to put the interests of customers first? By leaders doing the same thing. Most companies and individuals think loyalty is stupid; I’m saying loyalty is smart, but only as loyalty to the right things."

Drawing from the tenets put forth in his latest book, titled "Loyalty Rules! How Today’s Leaders Build Lasting Relationships," Reichheld laid out his six "loyalty rules" upon which business leaders can go about fortifying their business so that it can endure and grow. The first rule, "Play to win/win," emphasizes the importance of finding solutions and processes that benefit both the company and its business partners or employees, and he used Dell Computer as an example of how this can be done.

"Dell has what they call a Customer Experience Council that reports to the CEO," he said. "The council sits down and thinks about how they are going to make their customers have a better lifetime experience buying, using, taking care of, and replacing Dell computers. Their job is to come up with ways to conceptualize this, manage it, assign it to the departments, and come up with a set of metrics that is tied into compensation. So they search for ways to grow. They don’t just say, ‘Oh, we’re going to Africa or Asia’; those are logical steps. They also say, ‘What can we do for our customers that would make using a Dell computer that much easier?’ So they came up with a way to configure all the software and have it shipped to your desk, and they put together a service called Premier Pages that allows all corporate accounts and employees of those corporate customers to go online and find out exactly where they are in the queue or how long it takes to get what they want. Dell doesn’t get rich from doing this, but this makes it easier for customers to want to do business with them, and it has made them grow. They’re not just a cost leader; they’re a loyalty leader. Cost leaders don’t grow; loyalty leaders do."

The second rule, "Be picky," refers to catering only to the kind of customer your business is ideally positioned to serve. Acknowledging the apparent contradiction between being loyal to your customers and being finicky about who they are, Reichheld explained: "Loyalty leaders are very picky about who they do business with, because they know it is extremely difficult to give the world’s best value to just anyone."

Returning to the example of Enterprise Rent-A-Car, he pointed out how The Wall Street Journal recently conducted a survey on what it costs to rent a car at various airports. "It was $32.65 at Enterprise; at Hertz and Avis, it was almost exactly double that," Reichheld said. "Now, isn’t that weird that they can charge half as much as their competition, overpay their people, and still grow in business with the largest fleet of cars? Well, it has to do with being picky; they don’t just rent cars on every street corner to everybody. Enterprise has a 60 percent market share. So if you have a car accident, and your insurance is with State Farm, and your car is not available, they’ll put you in an Enterprise car. Enterprise figured out that when they did that well, they had customers who got to know them and appreciated the value of how they were treated, and so they started expanding to these other markets. They are now in all the airports, and they’re very popular there because they’re not spending an arm and a leg to acquire new customers through advertising and sales promotions. They’ve already built a loyal franchise of customers who, when those customers discover Enterprise is available at the airport, will give them a try because of their prior experience. So growth is really based on being picky and building a crew of loyal customers that way."

Reichheld’s third rule of loyalty has to do with reducing the complexity of your business to promote speed and flexibility for customer transactions. "There are a lot of ways to keep things simple, but maybe more important than any other is the size of the teams that your company is organized into," he said. "Enterprise Rent-A-Car has eight people per branch. The competition, many of whom are bankrupt, have four times that team size. Vanguard is cleaning up in mutual funds and still growing while its competitors are laying people off and are desperately trying to stay alive. Vanguard has nine people per home team; the typical phone center has 20."

Then there’s eBay, whom Reichheld cited as another low-cost loyalty leader. It’s easy to assume that as a major Internet destination, eBay can keep its costs low because of its virtual teams of infinite size. Not so, said Reichheld: "eBay’s customer service center has eight people per team. There’s a very consistent pattern among these companies. Seven to 10 people is the sweet spot of a team that is capable of building loyal relationships. If you have military experience, that’s probably not a shock. If you get bigger than that, it doesn’t make that much difference whether you come to work or not, and accountability disappears. Go back and measure the average team size that you’ve got in your call center. If it’s bigger than eight or nine, there’s a chance that you’ve started a negative chain reaction that’s going to destroy the loyalty of your people and your customers."

Once your company is organized into the appropriate unit sizes, according to Reichheld, the next challenge is to determine how to properly reward customers and employees—and he began with a few textbook examples of how not to do this.

"Magazines often give the highest subscription price to an old customer and a cheap price to a new one," he said. "In fact, if you’re stupid enough to renew three times, they not only triple the price at most magazines, but they try to collect your money six months in advance. And they’ve sort of guaranteed your loyalty, but they’ve got your money, so you’re trapped. And people who are small group health buyers know it’s crazy to stick with the same insurer for three or four years, because then you get the lousy pricing. That’s why customers think loyalty is stupid: because companies abuse loyalty more often than not."

Opting to heed these examples as cautionary tales, Vanguard decided to go in the opposite direction, according to Reichheld. "Jack Bogle said, ‘I know that our competitors are willing to take a little bit out of the pockets of their long-term customers to subsidize investment in marketing for getting new customers. But that’s wrong. It’s unethical to not give loyal customers the best value.’ So if you’ve been a customer at Vanguard for more than 10 years, and you have $50,000 or more with them, they cut their pricing by one-third. You don’t have to call and ask for this. They spent millions of dollars to create a whole new class of shares, and the SEC made this hard for them. But they wanted to be able to offer a better deal to long-term, loyal customers than to short-term customers."

Honest, two-way communication and learning is also important for a company culture that’s conducive to building customer loyalty, Reichheld said. "When you go to eBay, you can log on to one of the message boards they’ve created for each of their customers in each of the little categories," he said. "If you post a complaint on one of them, it is available to everyone in the world: journalists, competitors, and other customers. Cisco Systems has done the same thing: They put their error rates out there for the world to see and let customers complain to each other about the problem."

If this sounds crazy, Reichheld said, then there’s a method to the madness. "They found out that when customers are talking with each other, they can help each other solve their problem. That kind of open, honest, direct communication takes enormous courage, but think about how much money Firestone and Ford lost as a result of not taking that approach."

Reichheld’s final rule of loyalty is about a company stating very clearly who they are, what they’re in business for, and their core values, as well as using those values to measure their performance. "If you want to earn loyalty, you need to be particularly outspoken and let people know what you’re loyal to," he said. "Most people who read the newspapers today think leaders of American business are only loyal to the notion of making as much money as they can without going to jail. You must determine what it is you stand for that is worthy of loyalty."

Back in 1985, after a narrow escape from almost-certain bankruptcy, Harley-Davidson did exactly that, Reichheld said. "They sat down and said, ‘Why would anyone with any options want to stay here and work with us?’ And they came up with a simple answer: ‘We’re going to be a place where we can live up to a set of values that are the basis of mutual, beneficial relationships. We’re going to talk about what they are and write them down, and we’re going to run our business according to those values. And that’s how we’ll evaluate our process. We certainly value profits; we don’t want investors doing business with us where it’s not a mutually beneficial relationship. But we owe that same level of rigorous duty to our customers and our employees.’ When you have a set of principles to guide a relationship by and live up to, it opens up a whole new set of possibilities for customers and employees. And that is the basis of a high-loyalty organization."

It’s difficult to find a CEO who, when asked about customer service, doesn’t snap to attention and proudly declare customer satisfaction to be a top priority within their organization. But at the end of the day, when it comes down to which holds more sway in the boardroom—profit margins or customer survey results—it’s not much of a contest. And according to Reichheld, this has as much to do with the way the surveys are conducted as it does with the survey itself.

"Satisfaction surveys are ridiculously wimpy and unprofessional," he said. "Audits are a $10 billion industry, whereas the total satisfaction survey business is $500 million. The Wall Street Journal has an American Customer Satisfaction Index (ACSI) for all companies, but nobody cares, because no one in the investor community is convinced that satisfaction scores link up to growth and cash flow. We looked at The Wall Street Journal’s survey, which is based on cutting-edge technology, and they ask all the smart-sounding questions. So you would think that as your customer satisfaction score goes higher, your growth would increase. But we don’t see that much growth."

The important distinction to make here, Reichheld said, is that a satisfied customer does not a loyal customer make. "Loyal relationships are affairs of the analytical and emotional sides of your brain," he explained. "The analytical side of a customer is interested in the best value, features, quality, price—functionality, in other words. Those are the things you can get pretty well from today’s survey. On the other hand, what surveys do terribly is the emotional connection in a relationship—the feeling that a company knows you, values you, listens to you, and shares your values. When you do those surveys, it usually screams out that you know nothing about that customer or their purchase history, and you’re giving them a mixed message on whether you listen to them. Although you’re asking them to take time to fill out the survey, they never hear back from you about what you’re going to do in response to the results. So in and of itself, the survey almost destroys half of the relationship you’re trying to build."

Three months ago, Reichheld conducted a survey of six different industries (including the insurance industry) to determine which survey questions (and customer responses to those questions) were accurate predictors of future customer behavior. "We took all of the key satisfaction survey questions, and then we found out ways to check at the individual customer level in six different industries and see which ones actually predicted and linked up to referral rates and repurchases," he said. "One simple question—‘Would you recommend us to a friend?’—dominated the others as the No. 1 question nine times and the No. 2 question once. And in 80 to 90 percent of the industries surveyed, that one question gets you everything you need to know about whether you are building a loyal relationship."

The reason some companies have such great difficulty building loyal relationships, according to Reichheld, is that they don’t have a scoring system that makes much sense. "They don’t know how good is good," he said.

An effective scoring system, he continued, should take into account the fact that there are three categories of customers: promoters, undecideds and passives, and detractors. "Promoters are the ones who come back to do more business with you and tell their friends about you. The undecideds and passives are in the middle, and the detractors are the people who go around making hell for your front line, because they’re unhappy and resentful, and they’re telling all their friends not to do business with you.

"It turns out that if you look at real customer behaviors in the industries we’ve analyzed, nine-tenths of your customers are promoters. On a zero-to-ten-scale, promoters are your nines and tens. But the one metric that captures everything is a company’s ‘net promoters,’ which you get by taking your promoters and subtracting out the detractors. This metric actually explains the level of customer loyalty for everybody in a given industry, unlike anything I have ever seen in my analytical history. The bottom line is, you can’t grow your business unless you have more promoters than your competitors. If I were a CFO, I’d say, ‘Hey, I want control of this metric. This is not for my customer service department; this is information that is vital to the success of my business that will determine whether it’s going to grow.’ The CEO and the board of directors ought to see this data regularly, and that is what’s happening at places like eBay and Enterprise."

But just as important as designing a practical survey is what you do with the data. And Reichheld said a major step toward getting a strong customer satisfaction survey the respect it deserves is linking it to employees’ compensation and job advancement. "eBay President Meg Whitman is one of my former partners at Bain & Company," he said. "At eBay, she pays her service reps in this brilliantly simple way. She pays them every week based on two things: their customer feedback score and their productivity. They use software that automatically samples customers and keeps track of which rep they talked to, and then the feedback is collected electronically. And then in real time, you can keep track of which reps are getting the best customer feedback. Also, 60 percent of their bonus is determined by customer feedback, with the rest determined by productivity. Meg said, ‘People who are productive and have the highest customer feedback scores are the people who are promoted to management. That way, we’re sure we’re getting people who understand the value of treating customers right.’"

In summary, Reichheld reminded the audience that it’s crucial to make the distinction between measuring customer satisfaction and measuring loyalty—especially when it comes to conducting customer surveys. "The difference between the two is, loyalty links up to growth and cash flow; satisfaction doesn’t," he said. "If you go to all the people who are promoters and ask them the satisfaction question, they give higher scores than they do on the question that asks if they would recommend your company to a friend. So satisfaction is a lower threshold of success. It tends to focus on a transaction, a one-time moment of truth, whereas loyalty gets at the relationship issue. Most loyal relationships go through a number of unsatisfactory events. But they stay on track because people think it’s worth it to complain and get it fixed."