Loyalty? Now There's A Notion


The Hidden Force Behind Growth, Profits, and Lasting Value

By Frederick F. Reichheld Harvard Business School -- 323pp -- $24.95

A management book about loyalty? To many, that concept--at least in today's ever-turbulent workplace--is as dated as the pet rock. A decade's worth of massive downsizings have demonstrated that Corporate America is no longer loyal to its employees. Managers and executives, meantime, have slowly discovered that it would be terribly naive to be loyal to employers who willingly discard people even when profits are up.

It is not only in the workplace that loyalty seems dead. It also appears to be a lifeless notion among bargain-hunting customers and fast-money investors who seem more fickle than ever. The upshot: U.S. companies now lose half their employees every four years, half their customers in five years, and half their investors in less than 12 months.

One person who hasn't given up on loyalty is Frederick F. Reichheld, a consultant who has made a business of convincing at least some companies that they would be wise to begin employing what he calls loyalty-based management. Indeed, the author of The Loyalty Effect heads up the worldwide loyalty practice of Bain & Co., a consulting firm known for its hardheaded analytical approach.

With economic anxiety in the air, the issue of loyalty or the lack of it is certainly topical. Reichheld believes many of today's managers have caved in to pressures from "short-term investors" to maximize returns by exploiting customers--by reducing quality, say, or raising prices too rapidly--and mistreating employees. "It is management's over-attentiveness to the demands of these short-term investors that is stalling growth at many companies," he asserts. "This hurts not only customers and employees, but is equally detrimental to long-term investors."

But does loyalty really pay off? Reichheld is a believer. He points out that agents for State Farm Mutual Automobile Insurance Co. stay with the company more than twice as long as agents with competitors, and they achieve productivity levels 40% higher than the industry norm. Customerretention rates at State Farm exceed 95%. Chick-fil-A, a fast-food chain with more than 600 outlets, boasts turnover of store operators of 4% to 6% a year in an industry in which the average churn runs close to 50%. Even though store operators earn 50% more than those of competing chains, Chick-fil-A has been able to finance a major expansion without going deeply into hock.

To the author's credit, The Loyalty Effect acknowledges that a company that simply holds onto employees isn't going to produce superior returns: Deadwood still has to get chopped out of organizations. But to Reichheld, the fundamental goal of a business is not profit but "value creation." Companies create value by understanding that they can only retain loyal customers with a base of loyal employees. By decreasing defection rates of customers, employees, and investors, companies can achieve "prodigious growth in profits and cash generation," he says.

Under this model, profit is a consequence of value creation, a result rather than a purpose. "Profits alone are an unreliable measure because it is possible to raise reported short-term earnings by liquidating human capital," he writes. "Pay cuts and price increases can boost earnings, but they have a negative effect on employee and customer loyalty and so shorten the duration and worth of those assets."

How convincingly does Reichheld make these arguments? While they will certainly have resonance to an ever-growing number of disenchanted managers, there are some flaws in his reasoning. For one thing, most of the author's examples are privately owned companies that do not face constant pressure from outside investors and stock-market analysts. Publicly held companies, Reichheld says, need to specifically market themselves to long-term investors and to find an investor angel, a Warren Buffett type who is willing to buy a large stake in the company.

Another problem is what may well be the single biggest hurdle to loyalty-based management: conventional accounting systems that fail to measure the value of loyal customers, employees, and shareholders. Reichheld suggests developing alternative balance sheets to measure such things as the costs of acquiring customers and training new employees. But a reader is left wondering whether the creation of such systems would deliver real value or simply result in some grand social experiment.

Strip out the loyalty focus of this book, moreover, and you find very few fresh ideas and far too many business cliches. Reichheld, for example, reminds us that business must serve its customers, that people are a company's most valuable asset, that you can't manage what you can't measure, and that you should treat others the way you'd like them to treat you.

Sadly, though, many corporate leaders seem to have forgotten that short-term profit is not a primary business objective nor a goal that will cause the troops to rally. If Reichheld's book simply leads a few chief executives to be more mindful of the ill effects of large-scale layoffs and customer turnover, it will have succeeded in resurrecting a concept that seems rather foreign in the 1990s.

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