Qualityworld

Satisfaction's what you need

'Profit in business comes from repeat customers; customers that boast about your project or service, and bring friends with them'. Deming's words have never been more pertinent than in business today, where companies are scrambling for customers in a depressed economic climate. Stephen Hampshire business development manager at the Leadership Factor, explains why loyal customers are the best kind

Building customer satisfaction is the next logical step in a chain that leads from product and process quality towards a complete mutually-beneficial relationship of loyalty and trust between customer and supplier.

It is difficult to keep in mind the fact that a quality focus has not always been a given. We are now surrounded by various quality models (six sigma, ISO 9000, the excellence model etc) and it is easy to adopt them as an end in themselves, forgetting who is supposed to be at the heart of these initiatives - the customer.

Customers have benefited hugely from the emphasis that quality now has in industry but traditional methods of ensuring consistent product and process quality are no longer enough. Most organisations now have a quality focus - so how do businesses stand out from the crowd? The potential answer is to redefine what is meant by quality, and to redefine it in terms of what the customer wants.

What is important to customers? Product quality? Process quality? The quality of the relationship? All of these are important, but only as a means to an end from the customer's point of view. What the customer is interested in is results. In their recent book, The Value Profit Chain, Heskett, Sasser and Schlesinger use this example: 'Customers don't buy quarter-inch drills; they buy quarter-inch holes.' It does not matter how good your drills are, or even how well you service and maintain them. If a competitor comes up with a better and cheaper way of making quarterinch holes customers will be lost. This is why it is so important to constantly strive to find out what customers' priorities are.

Internally-focused quality was a differentiator 20 years ago. Now, moving the focus to customers is the source of differentiation, and it is this differentiation from competitors that leads to customer loyalty.

Case studies

One of the best known examples in the public domain concerns the Canadian Imperial Bank of Commerce (CIBC) which built a service profit chain model demonstrating that each two per cent increase in customer loyalty would generate an additional two per cent in net profit. Achieving this was worth $70 million additional profit to CIBC in one year. They also quantified the causal links in the chain back from customer loyalty to customer satisfaction and to employee satisfaction. For example, they found that to produce an additional two per cent gain in customer loyalty an improvement of five per cent in employee satisfaction was required.

A retailing example is Sears Roebuck who, using a similar profit chain modelling approach to that adopted by CIBC, demonstrated that a five per cent gain in employee satisfaction drives a one per cent gain in customer satisfaction which, in turn, leads to an additional 0.5 per cent increase in profit.

Loyal customers equal profits

Why is customer loyalty valuable to a business? The most immediate manifestation of loyalty (although it can also arise from a lack of alternatives) is repeat business or retention. It has been shown by the American Consumer Association and others that it costs somewhere between five and 20 times more money to attract a new customer than it does to keep an existing one (see figure 1).

Figure 1. Link between customer relationship and profit Source: F Reichheld, The Loyalty Effect

What accounts for this difference? A number of factors normally play a part:

almost all of the cost of acquiring customers (marketing costs and the costs of establishing a relationship) fall in the first year of a relationship
the base profit of sales is usually constant over the whole course of a relationship - but will not normally begin to offset customer acquisition costs until some time into the relationship, often in the second year
the longer customers stay with you and the more loyal they are the more likely they are to try new products, as you cross-sell and they come to think of you as a trusted supplier and their first port of call
long-term customers tend to be cheaper to service, as they have come to understand how you operate and know what to expect
loyal and satisfied customers will recommend you to others - a huge benefit since referral customers are free (in terms of acquisition costs) and research has also shown that referral customers are the best customers, since they tend to have a similar profile to your existing loyal customers
in the long term a loyal customer base will be prepared to pay a price premium for the perceived benefits that you offer over competitors. Customers have been shown to evaluate relationships in terms of the value that they receive and loyal customers will trust you to provide good value

A pizza for life

The key is to understand the value of customers to your business based on the whole lifetime of their relationship with you, rather than on the traditional 'transactional' approach. Perhaps the most famous example of this in action is Domino's Pizza, where employees were encouraged to treat the customer not as someone buying an $8 pizza, but as a long-term pizza eater with a potential lifetime value of around $4,000.

Concentrating on the relationship rather than each individual sale also allows an organisation to swallow very high acquisition costs, since it can be confident that these costs will be recouped in time.

So what is the lifetime value of a customer? For Domino's Pizza it was estimated at $4,000, Carl Sewell estimated it at $332,000 for his luxury car business - clearly it depends strongly on your market. So how do you calculate it?

There are at least two possible approaches. A good starting point, particularly if the aim of the exercise is to grab attention and focus the organisation on the importance of customer loyalty, is to use a 'back of the envelope' approach. Although simplistic this will give you a guide, and usually makes an impact. You can estimate any of the figures that you do not have exact data for. This is how Domino's Pizza did their calculations:

Customer lifetime value = average customer lifetime × average purchases per year × cost of purchase $4,000 = 10 years × 50 pizzas × $8

The alternative is to calculate the detailed course of an average customer lifetime, something like table 1. You should really discount the final profit figures to give the net present value of these future profits, but the results are still impressive. The results can vary widely depending on the market, but they have been shown to work in all sectors, for service organisations and for manufacturers.

Table 1. Average customer lifetime
		year 0	year 1	year 2	year 3	year 4	year 5
Revenue	Product A		£10,000	£13,000	£14,400	£17,280	£20,736
	Product B			£5,000	£6,000	£7,200	£8,640

Cost	Product A	£3,500	£8,000	£9,600	£11,520	£13,824	£16,589
	Product B			£4,000	£4,800	£5,760	£6,912

Profits	Base profit on product A	-£3,500	£2,000	£2,000	£2,000	£2,000	£2,000
	Increased sales of product A			£400	£880	£1,456	£2,147
	Cross-selling profits			£1,000	£1,200	£1,440	£1,728
	Reduced overhead allocation			£360	£432	£518	£622
	Profit from referrals			£600	£600	£600	£600
	Total Profit	-£3,500	£2,000	£4,360	£5,112	£6,014	£7,097
	Cumulative profit	-£3,500	-£1,500	£2,860	£7,972	£13,986	£21,083

Figure 2. The value profit chain

A few companies have managed to build robust statistical models linking key components of the value profit chain that is central to relationship-based thinking (see figure 2). The value profit chain represents the linkages that have been proved to exist between the way management treats employees, the way employees treat customers and business success. Each oval in the diagram represents a value equation (which in the case of customers can be interpreted more or less straightforwardly as a 'what you get for what you give' trade off ). The customer value equation:

Value = (Results + Process) ÷ (Customer access costs + price)

A customer survey is the tool for assessing where you are positioned against this equation, and ideally should also include elements of competitor analysis in order to understand your standing in the market.

How to keep them satisfied

In order to be successful it is essential to differentiate yourself from your competitors. Purchasing decisions are essentially a question of value for money, so you must differentiate yourself either on price or on benefits conveyed to the customer (or both). Price is often the default choice but it dooms you to commoditisation. If you can persuade customers that you are offering them the best solution tailored to fit their needs, at a fair price, then you will have a much more profitable and loyal customer base.

KPIs for the 21st century

Management guru Tom Peters said: 'In the customer arena, we believe that regular, quantitative measurement of customer satisfaction provides a much better lead indicator of future organisational health than profitability or market share change.'

A more wide-ranging conclusion of the Harvard Business School is that in most markets the single, most important determinant of corporate financial performance is not traditional indicators such as size, economies of scale, or market share, but a company's ability to continually improve the satisfaction, retention and commitment of its employees and customers.

Professor Claes Fornell of the University of Michigan Business School, the developers of the American customer satisfaction index (ACSI), is in no doubt that customer satisfaction is an economic indicator. He has reported that the top 50 per cent of companies in the ACSI generated an average of $42 billion of shareholder wealth (market value added), against $23 billion for the bottom 50 per cent. Based on the ACSI database, a one per cent increase in customer satisfaction drives a three per cent increase in market value. As Professor Fornell says, the reason for this is simply that: 'Our economic system works. It was designed with the idea that sellers should compete for buyers' satisfaction. Satisfied customers reward companies with, among other things, their repeat business, which has a huge effect on cumulative profits'.

The first link in the value profit chain is between employee value and customer value, and this is no coincidence. Abundant research indicates a link between how employees feel and how they behave towards customers, and this inevitably has a significant role to play in how satisfied customers are. The first step towards customer focus is internal - you must deliver value to your employees. Once you have a workforce that is firmly aligned behind the organisation's strategy, and engaged enough to deliver the service your customers require, a firm customer focus becomes relatively easy to implement, and you will see swift rewards.

Throughout the whole of this process an essential foundation is regular, reliable measurement upon which to base decisions, and to serve as a basis for setting priorities and sharing best practice.

Customer satisfaction measurement is at the heart of the value profit chain, and represents the tool by which internally-focused quality models can begin to look at organisations the way the customer sees them. In time the value profit chain will ensure that satisfying customers today will create satisfied shareholders tomorrow

Biography

Stephen Hampshire is business development manager for The Leadership Factor, and has been instrumental in developing its methodology in satisfaction and loyalty measurement, specialising in advanced statistical analyses required for modelling. He has written about and presents seminars on 'Analysing and reporting customer satisfaction data' and 'Customer loyalty'.