Organizations continually ask the age old question, “How do we, as an organization, increase profitability?” Profitability is critical to the success and longevity of the organization. However, profitability is actually a lagging indicator as it’s based on a series of past decisions and activities. Therefore, rather than focusing on how to increase profitability, we believe the focus should be on a forward looking indicator—growing and maintaining a loyal customer base.
We have found if there are improvements in an organization’s customer retention rates, it results in extraordinary improvements in profitability. Frederick F. Reichheld and W. Earl Sasser, Jr., authors of Zero Defections: Quality Comes to Services, state, “A 5% increase in customer loyalty can produce profit increases from 25% to 85%.” These almost unbelievable results would suggest that there must be a powerful force, the emotional connection to your customer, which needs to be understood and effectively managed.
Creating a strategy that focuses on customer loyalty suggests there is a linkage between all elements of a business system: your contributors, customers, and investors with the ability to generate profits. Loyal customers repeatedly purchasing your product or service is what creates business growth and profit. However, your practices and processes that generate loyal customer relationships must be in place before you begin to see a profitable impact. This model does not work in reverse, although many organizations by their actions appear to think the reverse is possible.
Focusing on customer loyalty as a strategy is important because it will initiate a series of positive outputs that will cascade through an organization such as:
- Revenues and market share grow as your best customers (loyal customers) make repeat purchases and recommend you to others who also will potentially become loyal as well. How do you measure and manage your loyal customer base?
- Contributor retention increases due to their pride and satisfaction with their role, which in turn creates a loop that reinforces customer retention through familiarity and better service. Customers like doing business with people they have a trusting relationship. How do you measure your team members’ loyalty?
- As costs go down and revenues go up, that is how profits increase. Improved profits provide resources to invest in contributor development and compensation (further increasing and ensuring retention), and in new features and products that enhance customer value. Profits are important not just as an end in themselves. They also allow the organization to improve value and provide additional incentive and reasons for contributors, customers, and investors to remain loyal to your organization.
- Costs begin to shrink as the expense of acquiring and serving new customers and replacing old customers declines. Remember, acquiring a new customer costs 5 times more than retaining an existing customer, and in our experience no industry or size of an organization is exempt from this formula.
This loyalty model effectively provides insight to success versus declines in any organization. It is clear the companies or organizations with the highest retention rates (retention of loyal customers) also earn the highest profits, maintain viability, and see faster growth. As mentioned earlier, loyal customers reduce costs. In one study, it was found that in most service organizations, word-of-mouth advertising accounted for one-third to one-half of all new customers. Relative customer retention also explains bottom line implications better than market share, scale, cost position, or any variables usually associated with a competitive advantage.
So, what should your organization do differently? Perhaps a good place to start would be to find better ways to create and sustain a loyal customer base. While there will be an investment of resources and time, the advantages will be enormous for your customers, employees, and investors. Strictly from a financial perspective, revenues increase from improved service quality tend to be 10 to 20 times the costs associated with fixing the challenge.
What strategies do you need to implement today?