The Loyalty Effect by Frederick Reichheld

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  1. Reichheld lays out a very convincing argument for why creating an ecosystem which attracts and rewards loyal customers, employees and investors is the ultimate moat for any organization
Key Takeaways
  1. Loyalty Based Management is essential to create a value-add, profitable, sustainable company and it requires loyal customers, employees and investors.
    1. Loyalty leaders follow two basic precepts – nurture a clear sense of company mission based on value rather than profit; use the power of partnership to align, motivate and manage the members of the business system
    2. A company’s top goal should be to create as much value as possible, never profit. Profit is solely a downstream effect of creating enormous value
    3. Loyalty Based Management is a slow, steady, never ending process.
    4. Loyalty, in every case, must be earned. It is never given
    5. Loyalty is a character trait – can’t be created, only reinforced
    6. Loyalty leader examples – Leo Burnett, Chick-fil-A, State Farm, Lexus, Maryland National Bank, USAA, John Deere, Nike (attracting right investors), American Express
  2. 8 central tenets to Loyalty Based Management
    1. Building a superior customer value proposition
    2. Finding the right customers
    3. Earning customer loyalty
    4. Finding the right employees
    5. Earning employee loyalty
    6. Gaining cost advantage through superior productivity
    7. Finding the right investors
    8. Earning investor loyalty
  3. There are many “hot” management trends but loyalty leaders tend to ignore these and stick to a variation of the Golden Rule
  4. Employee/customer retention
    1. Employee/customer retention is a key gauge of company health. Even a seemingly insignificant increase in retention can have an exponential impact on profitability
      1. Relative retention is a better predictor of profits than market share, scale, cost position or other moats
      2. Defection is often the most powerful hidden force for low profitability
      3. It is much more expensive to serve a new customer than an old one
  5. Hiring well is crucial. Once you get the right people on board, you have to make sure to continually educate, train, inspire and incentivize employees to make creating value for loyal customers their top goal.
    1. Incentives should get employees to want to learn themselves, improve over time and teach others.
    2. Learning leads to value creation which leads to loyalty and back to learning. It is a virtuous cycle and the entire ecosystem must be designed around customer loyalty
    3. Partnership is the best way to align employees goals with company’s – letting employees share in the profits will unlock all their potential, creativity and hard work and put it towards value creation. Sharing value creates value
    4. Try to hire from within to inspire more junior employees
    5. Creating a loyal ecosystem boosts employee morale and energy
    6. Longer employee tenure has supernormal benefits as they become better with their job over time, get to know customers more intimately, can teach the younger generation, make fewer mistakes, volume increases, profit per customer up, referral rates increase, time savings up, motivation/pride in a job well done increase. On top of it, all these effects compound over time
  6. Today’s corporate focus on short-term results almost always works against Loyalty Based Management. Many loyalty leaders often ignore short term results, instead invest for the future wellbeing of their customers and employees which will eventually benefits investors
  7. Measurement
    1. Stresses the importance of having hard numbers which can be measured over time in order to realize the enormous benefits loyalty produces. Break customers down into different classes, view actual defection rates over average
    2. Measurement tough but at the heart of vision/strategy and it helps make the obscure more concrete
    3. Ultimate form of customer satisfaction is repurchase loyalty
    4. Deciding what to measure and how to link incentives is a primary role of management
    5. Most important metric is Net Present Value of current customers (discounted stream of profit net of acquisition investment)
    6. Most companies would not argue against loyalty but few truly understand how valuable it is and therefore under invest in it
    7. Revenue per employee is an important metric to keep track of. The goal should be to lower cost as a percentage of revenue, not lower overall
      1. Cost improvements must eventually make their way to the customer
    8. What percentage of a customer’s wallet (wallet share) you have is a great metric to track overtime
  8. Loyal customers give companies the benefit of the doubt and tolerate occasional mistakes
    1. Some customers are inherently more loyal. Aim for these groups and take into account customer’s age, income, profession, where they live, affinity groups, education, etc.
    2. Carefully choose the sales channel to attract the right (not necessarily the most) customers
    3. Avoid certain customers as they cause headaches and are more expensive in the long run. Price discounts, coupons and other promotions tend to attract these types of customers
  9. “We are all preaching an unspoken sermon with our lives.” What do you want yours to be?
  10. Top draw for attracting the right people is to have character and integrity coming from the top
    1. “Talented people work hardest when they’re proudest of what they do, when their jobs are interesting and meaningful, and when they and their team members are recognized for their contributions and share in the benefits.”
  11. Productivity = pace of creation
    1. Growth of productivity vital and a company improves it through employee education, training, and employment / compensation policies
    2. Goal of automation should be to empower, not displace employees
    3. It is counterintuitive but paying up for the best employees reduces costs in the long run (see benefits of employee tenure above)
    4. In Loyalty Based Management, compensation mirrors productivity – bigger pie is created and it removes unproductive employees
  12. Importance of loyal investors
    1. Many loyalty leaders are private and those that are public have big insider ownership (from 15-50%)
    2. Management has dozens of ways of measuring the value they deliver to investors but few, if any, ways to measure the flow of value from investors to the company
    3. Short-term investors who do not share the businesses’ values impart a high cost on the company
    4. 4 principal ways to attract right investors – educate current investors, shift investor mix to institutions that avoid investment churn, attract the right kind of core owner, go private
    5. Don’t cater to Wall St. and short-term earnings estimates, do things which will help the company long-term even if painful today
  13. True mission of a business is to create value, not profit
    1. Continuous employee learning/training is core to adapting and continuing to add value
    2. Studying failure is vital – must track and dissect when you are healthy or else it is already too late
    3. Must teach people who are aligned and want to learn (importance of hiring right employees)
    4. Success is getting the right customers and keeping them
  14. Reward loyal customers with additional discounts and other perks
  15. Crucial Questions
    1. Why are people defecting?
    2. Why doesn’t the present system deliver better value?
    3. Is the company bringing in the right customers and employees?
    4. Has management built a genuine partnership for creating and sharing value?
    5. Does this partnership align individual and organizational interests?
  16. Do what you say you’ll do, live up to commitments and try to exceed them as often as possible
What I got out of it
  1. Seems to me like setting up an organization, culture and incentives that rewards loyal customers, employees and investors is the only way to run a sustainable, long-term, value-add, win-win company. Highly recommend!
Two great articles on loyalty. One from Bain discussing customer churn and another from Forbes discussing how some customers are more important to keep than others