Table Of Contenttitle:
The Loyalty Effect : The Hidden Force
Behind Growth, Profits, and Lasting Value
author:
Reichheld, Frederick F.; Teal, Thomas
publisher:
Harvard Business School Press
isbn10 | asin:
0875844480
print isbn13:
9780875844480
ebook isbn13:
9780585056425
language:
English
subject
Customer relations, Consumer satisfaction,
Job satisfaction, Labor productivity,
Loyalty.
publication date:
1996
lcc:
HF5415.5.R438 1996eb
ddc:
658.4
subject:
Customer relations, Consumer satisfaction,
Job satisfaction, Labor productivity,
Loyalty.
Page i
The Loyalty Effect
The Hidden Force
Behind Growth, Profits
and Lasting Value
Frederick F. Reichheld
with Thomas Teal
Bain & Company, Inc.
Harvard Business School Press
Boston, Massachusetts
Copyright © 1996 by Bain & Company, Inc.
All rights reserved
Loyalty-Based ManagementSM is a registered servicemark of Bain & Company, Inc.
Printed in the United States of America
00 99 98
15
Library of Congress Cataloging-in-Publication Data
Reichheld, Frederick F.
The loyalty effect: the hidden force behind growth, profits,
and lasting value / Frederick F. Reichheld with Thomas Teal.
p. cm.
Includes bibliographical references and index.
ISBN 0-87584-448-0
1. Customer relations. 2. Consumer satisfaction. 3. Job
satisfaction. 4. Labor productivity. 5. Loyalty. I. Teal, Thomas
A. II. Title.
HF5415.5.R438 1996
658.4dc20
95-39972
CIP
The paper used in this publication meets the requirements of the American National Standard for Permanence
of Paper for Printed Library Materials Z39.49-1984.
Page iii
This book is dedicated to my family,
who taught me the value and the virtue of loyalty.
Page v
Contents
Preface
vii
1. Loyalty and Value
1
2. The Economics of Customer Loyalty
33
3. The Right Customers
63
4. The Right Employees
91
5. Productivity
117
6. The Right Investors
153
7. In Search of Failure
185
8. The Right Measures
217
9. Transforming the Value Proposition
255
10. Partnerships for Change
279
11. Getting Started: The Path Toward Zero Defections
301
Notes
311
Index
315
About the Author
323
Page vii
Preface
The ideas in this book began to come together in the mid-1980s when
I and a group of my colleagues, all of us consultants at Bain &
Company, were struggling with a series of growth-and-profit riddles.
Traditional models of competitive strategy did not fit the marketplace
realities we observed in industries where knowledge and intellectual
capital comprised the critical assets. Initially, we were trying to make
sense of some striking disparities in performance among various
companies in the insurance brokering industry, and the usual strategic
factorsmarket share, scale, unit cost, and the likehad failed to explain
the wide range of results. Eventually, however, we noticed one
previously unexamined factor that did seem to make sense of the
situation and the numbers. Firms that earned superior levels of
customer loyalty and retention also earned consistently higher
profitsand they grew faster as well. Closer study enabled us to
quantify this loyalty-based advantage and nail down its connection to
superior profit and growth, at least in insurance brokering.
A short time later, another consulting team I worked with extended
this new economic framework to the credit card industry. We
constructed the lifecycle economics for credit card customers and
measured retention performance among competitors. Once again,
retention explained relative growth and profits with remarkable
accuracy. We then turned our loyalty laser on a third business in which
intellectual capital comprised the key strategic assetour own
consulting businesswith much the
Page viii
same result. Bain's profit margins over time were closely linked to
variations in customer loyalty.
Over the past decade, Bain's loyalty practice has studied dozens of
industries and developed practical toolsdescribed in this bookto help
our clients find and keep the right customers. In the process, we
learned that customer loyalty is inextricably linked to employee and
investor loyalty and that major improvements in the one often require
improvements in the other two. We will discuss this subject at length,
because once a company understands the ways in which customer,
employee, and investor loyalty are linked, its management team can
use loyalty to shine a new light on its value creation process and
reexamine and improve the fundamentals of its core strategy.
As intellectual capital assumes greater and greater competitive weight
in more and more industries, we expect the loyalty-based business
paradigm to grow steadily more compelling. Over the next decade,
thousands of businesses will come to realize that their most important
assets are their human assetstheir customers, employees, and
investorsand that to build winning strategies, they have to find ways to
attract and develop the right human assets and earn their loyalty. A
number of companies recognized the precious nature of their human
assets long ago and built their business systems accordingly. We call
these companies loyalty leaders, and we use many of them as practical
case studies of how a business can be managed to earn superior
loyalty. And as you will see, their impressive track records argue
persuasively that Loyalty-Based ManagementSM is not some futuristic
theory about the increasing importance of intellectual capital but
rather an established formula for growth and profit that has worked
reliably in the past and continues to deliver outstanding results even in
today's supercompetitive world.
Given the increasing importance of the knowledge that resides in
human assetsand by extension, in their loyaltyit is reasonable to
wonder why ours is the only major consulting firm to include loyalty
among its core practice areas. The answer can be found in several of
Bain & Company's unique characteristics and operating principles. To
begin with, Bain's consulting approach includes a passionate focus on
concrete, sustainable, and measurable client results. We have found
that using short-term earnings as the only rigorous measure of
performance leads many companies to place too much emphasis on
reducing costs and too little on investing in the assets (usually human)
that generate growth. Loyalty is a practical way of measuring the
efficacy of those investments and, of course, of predicting the duration
and value of the
Page ix
human assets themselves. Chapter 8 shows that for businesses where
intellectual capital is critical, profits and loyalty together provide a
clearer and more balanced scorecard than short-term earnings.
A second distinctive Bain principle is the emphasis we place on
partnership. We have always found that the most fruitful consulting
relationships grew from collaborative partnerships with clients, and
we learned long ago that partnership is the best way to shepherd our
own company through good times and bad. Over the years, in short,
we've discovered that partnership is one of the pillars of productive
loyalty and therefore of loyalty-based management, a subject we
discuss in depth in Chapters 5 and 10.
Another Bain tradition is close analysis of the microeconomic forces
that drive a company's cash flow, primarily because a rigorous, fact-
based study of these forces can help paint a clear picture of
competitive threats and opportunities. Loyalty economics, the focus of
Chapter 2, is one of the analytical frameworks we have found
especially useful. The analytical rigor in all the economics sections of
this book is representative of the Bain approach.
A fourth hallmark of the Bain approach that bears on loyalty is our
constant effort to understand what customers value and how well
competitors are delivering that value. Since we often find satisfaction
surveys and the other standard tools of market research inadequate to
this task, we have developed several tools of our own. One of these is
failure analysis, especially as it applies to customer and employee
defections. Another is the defector matrix. Both are described in
Chapter 7.
Loyalty as we conceive it is critically important as a measure of value
creation and as a source of growth and profit, but we stop well short
of claiming it to be a cure-all or a magic bullet. Bain's practical,
results-based orientation has made us enormously skeptical of
management fads and of the consulting based on them. We have been
around long enough to see an awful lot of fashionable business ideas
come into vogue then fall into disrepute. As a result, we train our case
teams to use the tools that best fit the job and never to rely entirely on
any single approach, including loyalty. The goal in every case is to
develop a rigorous and thorough understanding of an entire business
system and to identify the forces that drive competition today and
those that will drive it tomorrow. Loyalty is often an important
element in this picture, but it is rarely the only element.
One of our most unusual opportunities at Bain & Company comes
from the proximity of Bain Capital, a separate private equity
investment firm formed by several Bain consulting alumni in 1984.
Our ongoing
Page x
interactions with Bain Capital and with some of its portfolio
companies have given all of us a bit more insight into which tools and
analytical structures really do make money for shareholders and not
merely for the consultants who promote them. In addition, many of us
have invested substantial portions of our savings with Bain Capital, as
limited partners. We too have come to understand that the consultant's
view of value creation may sometimes differ sharply from the pupil-
dilating perspective of investors with their own money on the line.
Bain Capital has reinforced our skepticism toward many popular
management concepts. The firm has made some of its most successful
investments in companies jettisoned by large corporations because top
managers saw a poor "strategic fit" or a mismatch with the
corporation's overall "core competence," or because the business was
not earning its "risk-adjusted" cost of capital. In case after case, Bain
Capital was able to help create enormous value despite the popular
theories, and these experiences have been a rich source of learning for
Bain & Company consultants.
Learning and intellectual capital are of course at the heart of
consultingperhaps the purest form of an intellect-driven businessand
some of the most important lessons I have learned about loyalty came
from observing our own company. In my nearly twenty years at the
firm, I have seen it grow from one small office on Boston's waterfront
into a company of fifteen hundred employees spread across twenty-
three offices around the globe. In my opinion, the key to the firm's
success has been its loyalty to two principles: first, that our primary
mission is to create value for our clients, and second, that our most
precious asset is the employees dedicated to making productive
contributions to client value creation. Whenever we've been perfectly
centered on these two principles, our business has prospered. Our
most difficult times have been those few periods when we
inadvertently drifted off center. In each such instance, however, the
reaffirmation of our loyalty to primary principles produced a
remarkably swift return to the path toward growth, profit, and lasting
value.
Acknowledgments
Obviously, the lessons I have learned
Page xi
from the firm's clients and from my colleagues have shaped my
thinking about business. However, I want to make it clear that I, not
Bain & Company, wrote this book. It is principally a product of my
own experience, of the lessons I have learned from family, friends,
and teachers, and of the inner dimensions of personality and spirit that
have caused me to seek the truth in my own peculiar way. My partners
have given me enormous latitude to say what I think, and I am deeply
grateful to them. I hope the final product is worthy of their
confidence.
In addition, I want to thank the executives of the companies we have
identified in this book (and in the articles that preceded it) who
generously contributed their time and their insight. These include Mitt
Romney, Josh Beckenstein, Bob White, and Mark Nunnelly of Bain
Capital; Bill Lynch of the Leo Burnett advertising agency and Phil
Scaff, formerly of Leo Burnett; Dick Chitty, Fred Arnow, Don
Esmond, George Borst, and Dave Illingworth of Toyota/Lexus;
Charlie Cawley, David Nelms, and Craig Schroeder of MBNA; Steve
Robinson and Dan Cathy of Chick-fil-A; Ed Rust, Jr., Vince Trosino,
Chuck Wright, Kurt Moser, and Sandy Colee of State Farm; Ben
Edwards of A. G. Edwards; John Wilson and Tod Krasnow of Staples;
General Robert Herres, Herb Emanuel, Staser Holcomb, and Paul
Ringenbach of USAA; Jim Ericson, Bob Carlson, and Dick Hall of
Northwestern Mutual Life; Carl Sewell of Sewell Village Cadillac;
and Royce Yudkoff of ABRY Communications.
I especially want to thank Tom Tierney, Bain's managing director, for
his encouragement and support over the past two years. A number of
Bain partners were kind enough to read portions of the manuscript at
various stages of its development, and their suggestions and criticisms
have improved it greatly. They include Bob Bechek, John Donahoe,
Dave Johnson, Charlie Jones, Louise O'Brien, and Chris Zook.
Important external perspectives were added by Bob Charpie, Royce
Yudkoff, and Ralph Willard. Finally, the criticisms offered by Tom
Jones and Christopher Lovelock in their capacity as reviewers for the
Harvard Business School Press were extremely helpful.
That very few of these criticisms were directed at the writing itself is
thanks in great part to the excellent job performed by my editor, Tom
Teal. Formerly a senior editor at the Harvard Business Review, Tom
identified fuzzy thinking in more than a few of my early drafts, and
his writing skills have helped to make the manuscript far more
readable than I could ever have managed on my own.
John Nichols, minister of the Unitarian-Universalist Society of
Wellesley Hills, helped me think through the nonbusiness dimensions
of loyalty. His network of Unitarian minister colleagues provided a
unique intellectual resource in the form of a stack of sermons on
loyalty.
