The loyalty economy: Are you undervaluing your customers?
The true purpose of a business, Peter Drucker said, is to create and keep customers. Most managers understand this, but few behave as if they do. Under relentless earnings pressure, they often feel obliged to produce quick profits by compromising product quality, imposing onerous fees and otherwise shortchanging their customers. This short-termism erodes customer loyalty, reducing the value customers create for the firm.
It should not be this way. Earning customer loyalty is firmly in the interest of both shareholders and management. My research shows that “loyalty leaders”—companies at the top of their industries in net promoter scores or satisfaction rankings for three or more years—grow revenues roughly 2.5 times as fast as their industry peers. Yet companies and investors continue to prioritize quarterly earnings over customer relationships, for three main reasons: Public company financial disclosure rules and corporate accounting practices require little to no reporting on customer value; most firms lack the capabilities needed for managing it; and organizations’ traditional structure puts functional priorities before customer needs.
Now, though, at least some investors and CEOs are beginning to acknowledge the idea that customers are the ultimate source of corporate value. In August 2019, the Business Roundtable, representing many of the largest U.S. firms, issued a statement on the purpose of the corporation in which members put delivering value to customers, among other goals, on equal ground with creating shareholder value.
I have identified four broad strategies that loyalty leaders rely on for superior performance. Those leaders create systems for measuring customer value and invest in the necessary enabling technology, use design thinking methods to build customer loyalty, organize the business around customer needs and engage the organization and stakeholders—employees, board members, investors—in the transformation. Before we examine each one, let’s take a closer look at customer value.
Accounting for customers
I use the term “customer value” to mean the total lifetime value of a company’s customer base. Companies can increase this value by acquiring more customers, earning more business from existing ones and so on. Customer-focused leaders such as Amazon.com’s Jeff Bezos have long understood the importance of concentrating on customer value as an asset rather than pursuing short-term profits or quarterly earnings.
Companies can destroy customer value in a variety of ways: To boost revenue, enterprise software companies sometimes charge corporate customers change fees that can raise the total cost of ownership to as much as three times the original bid. To cut labor costs, call centers often give agents incentives to minimize call-handling times. Such tactics may even lead to short-term earnings growth. But they also scare off potential customers, encourage defection and make the company vulnerable to poaching by customer-centric competitors.
Given the importance of customer value, leaders should track it as rigorously as they track other key assets, such as inventory. They also should disclose it in their quarterly and annual earnings releases in consistent formats so that investors can make informed judgments about company performance. But most companies wrongly believe that measuring customer value is too difficult or costly. They continue to rely on a centuries-old accounting tradition that emphasizes physical and financial assets, neither of which offer much visibility into the value of a company’s customers.
As investors wake up to the importance of customer value, however, many growth-stage companies preparing for an initial public offering now explicitly direct investors’ attention to success in growing the value of their customer base. Some public companies, such as AMC Entertainment Holdings and American Express, increasingly report various types of customer value metrics. This is a start, but because there are no customer-value reporting standards or requirements, investors still have an incomplete picture.
Over the years the International Accounting Standards Board and others have attempted to improve reporting on intangible assets including customer value. Those efforts have consistently run into challenges related to valuation methodology, among others. I propose an approach to disclosure that simplifies the accounting task for companies and places the burden of valuation onto investors.
What investors need to know
While we await clear standards and rules, companies should take the lead, disclosing information about the progress they are making growing customer value as part of their earnings releases. Only then can investors systematically reward those investments. Three new, auditable metrics would suffice in most instances:
— Number of gross new customers acquired during the reporting period and number of net new customers remaining at period end.
— Number of existing (or tenured) active customers (existing customers are those who have been customers for a year or more; active customers have made a purchase in the past year).
— Revenue per new and existing customer.
Managing for customer value
Let’s turn now to the four strategies used inside a company to achieve consistent and sustained growth in customer value.
1. Develop robust customer-value management processes and toolsTo engage employees in the work ahead and to sell investors on the necessary investments, leadership first needs a clear understanding of the size of the prize: the current total lifetime value of the customer base and the potential financial value that lies in increasing customer loyalty. New accounting tools and technologies enable managers to model customer value and report regularly on the impact of their actions.
For example, to improve the loyalty and profitability of new customers, managers need periodic reports on the performance of each new-customer cohort. How much did it cost to acquire new customers in each cohort? What percent of customers in each remains active? What is the revenue per customer? By comparing the performance of different cohorts, managers can monitor real-time improvements. Managers can also use analytics and reporting to track how experiments and changes in products, pricing and services affect each cohort’s performance over time.
2. Combine design thinking with loyalty-earning technologiesCompanies earn loyalty when they anticipate and meet customer needs. Doing this depends on two sets of capabilities: design thinking and careful application of cutting-edge technologies.
“Design thinking” is about seeing the world through customers’ eyes and learning through direct observation. Managers, front-line employees and even C-level executives should engage in the exploration and design process. Design thinking combined with a constant flow of customer feedback helps product groups create highly personalized offerings. The goal is not simply to induce customers to buy. It is to improve their lives so effectively that the company earns their trust and continued business.
Data, analytics and artificial intelligence capabilities are key to human-centered design. Consider how an insurance company might use AI to enrich service interactions. A customer, Mary, calls with a question related to a recent claim. Before she even speaks to a live rep, the AI-enhanced routing system predicts what her need is on the basis of her profile data, latest mobile and web interactions, and recent purchases. The system uses this context to route Mary not to the next available agent but to the one whose interaction style and technical proficiency are best suited to the issue at hand. Once the call is connected, an AI-enabled coaching system analyzes Mary’s tone of voice and rate of speech during the call and provides guidance to the agent in real time about ways to improve her experience.
3. Organize around customer needsRich customer-value data and design-thinking practices will remain locked in silos unless companies embrace new operating models that push decision-making down to front-line employees, reduce cross-functional friction and focus the organization on customers.
Large companies have long employed operating models built around functional and product expertise and accountability. Finance, sales and other functional departments generally control resource allocation, goal setting and decision-making. This structure fosters localized accountability and expertise. However, the model also gives rise to silos, each of which seeks to optimize its own performance. In-group bias—the tendency to favor one’s own group and view others with suspicion—leads to conflicts among silos.
Instead of fighting or ignoring in-group bias, some companies now harness it for the benefit of customers by aligning cross-functional teams around a specific customer need. Although members are drawn from different functions, they are fully dedicated to the team. Many digital-native firms, such as Warby Parker, are organized around teams whose “products” are better described as customer experiences, including try-on programs in which eyeglass frame options are shipped to customers’ homes for consideration. Team members, whatever their functional provenance, view addressing the customer need as their primary goal, with individual performance measured and rewarded through their contributions to the team’s results.
4. Lead for loyaltyThe job of leadership in any major organizational shift is to articulate an inspiring vision and engage every employee in the work ahead. The first thing leaders must do is get everybody on board. Building the case for customer value should be easy: When a company focuses on loyalty, it makes customers’ lives so much better that they keep coming back, and they bring their friends. Employees become inspired by the satisfaction that comes from making customers’ lives better.
Furthermore, loyalty leadership requires ongoing attention to the actions of employees across the organization—changing decision criteria, supporting policy changes and celebrating customer loyalty wins. This signals commitment to customers and gives employees confidence that the loyalty strategy is not an empty promise.
This article originally appeared in Harvard Business Review.