In 1996, the executives at Barnes & Noble offered Jeff Bezos the opportunity to sell amazon.com to them. After all, he was still losing money, and they'd be doing him a favor to buy his business before they launched Barnes&Noble.com with their much stronger brand. He declined. How did it work out for everybody? Today, Barnes & Noble has a market cap of $771million, while amazon.com's market cap is $142 billion (with a b).
That's the difference between a well-run product-centric company (B&N) and a pretty well-run customer-centric company, B&N has great stories and cafes and products and is constantly doing cool things to find customers for those products. Bezos (and amazon.com) have customers, and are always looking for ways to find more products for those customers and make it a good customer experience. I live on the upper west side of Manhattan and have bought a refrigerator from amazon.com, who also delivered and installed the thing.
This reminds us that "customer experience" is not just a way to treat customers politely or be nice to them or even sometimes wow them. Customer strategy is in fact increasing the value of the company by increasing the value of the customer base. And customer experience is an important part of executing that strategy.
When it comes to understanding how customer experience creates financial value for a business, there are basically two approaches to the issue-a simple, philosophical approach, and a quantitative, analytical approach. The simple approach is to state your company's value proposition as a straightforward quid pro quo:
1. You want to create the most possible value from each customer.
2. On the whole, a customer is likely to create the most value for you at about the point he gets the most value from you.
3. The customer gets the most value from you when he can trust you to act in his own interest.
Therefore, to maximize the value your customers create for your business, you need to earn and keep their trust-that is, to act in their interest and to be seen doing so. It is then that their experience is maximized, and their value to the firm is also maximized.
The quid pro quo model for justifying trustability is a commonsense approach that can be usefully employed by any business, not just high-end, billion-dollar online firms. Simply choose whatever action is most likely to generate a customer's trust and the customer experience will follow.
A homebuilder we know has applied this model very profitably. When you build a home for sale to someone else, some states require you to guarantee the structure for some period of time (usually twelve months or more).[i] During this warranty period the builder is required to fix all structural flaws or defects at itsown expense. Now homebuilding is a business that has very few repeat customers, but this particular homebuilder generates about twice as many referrals of new customers as his competitors do simply by acting in his current customers' best interest. When a home warranty period has thirty days remaining until expiration, the builder contacts the homeowner and reminds him or her. Then he suggests that he can send a team over to examine the house for any defects, in order to ensure that they are repaired within the warranty period.
The reason a quid pro quo like this works is not that it generates current-period earnings, because it doesn't. In this case, it clearly costs the homebuilder something to fix defects that his customers might otherwise have forgotten to ask about until after the deadline, when they'd have to pay to make corrections on their own. But the quid pro quo generates immense long-term value. Customers have memories. Whether you remember them or not, they remember you. So when you treat a customer well today-say, by reminding him that his warranty is almost up or by preventing him from inadvertently paying too much-the customer will remember this in the future, and will likely change his future behavior as a result, perhaps buying more from you himself or referring friends and acquaintances to you.
It is your relationship with an individual customer, in other words, that provides the "missing link" between your company's short-term, current-period earnings and its long-term, ongoing value as a business enterprise. Apply this philosophy to enough customers and you'll be able to overcome the temptation of short-termism.
But how much can you really afford to spend today in order to create a good experience for the customer, based on her expected future change in behavior? This is a question we have to answer with numbers. If the first approach to the question of how trust-based customer experiences create financial value is a philosophical approach, the second is a quantitative, analytical approach. Here's how to think about it:
Every business executive knows that customers are financial assets. Each customer is like a tiny bundle of future cash flow with a memory. And, as is the case with any other financial asset, every customer has a certain value, based on the cash flow he can be expected to produce for the business over his lifetime.
The usual term for this customer asset value is lifetime value (LTV). And while no one can ever know with certainty how much cash flow any particular customer will generate in the future, increasingly sophisticated analytical tools do allow businesses today to model their current customers' likely future behaviors statistically, based on what previous customers have done-that is, similar customers in similar situations. It will never be completely accurate, of course, because no matter how good the analysis is, predicting the future is impossible. But as data become richer and analytical tools become more capable, this kind of modeling has become more and more practical for a variety of businesses.
The inputs for calculating any customer's LTV include, among other things, her loyalty to the brand (or her probable longevity as a customer), her willingness to buy additional products or services from the company, the positive or negative recommendations she makes to her friends, and the cost of serving her. And even though the results of statistical modeling are imprecise, they are still useful enough that you would be hard-pressed today to find any senior business executive anywhere who hasn't at least thought about these facts:
- All customers have lifetime values;
- Customer lifetime values are different, meaning that some customers are more valuable than others; and
- Customers not only spend money today (current earnings for the company), but their experience today will likely increase or decrease their lifetime values (future earnings).
It is the third point that we should pause to reflect on for a minute. When a customer changes her future behavior based on the good or bad experience she has with you today, or based on her good or bad feelings about your business today, her lifetime value will go up or down. This increase or decrease in LTV represents economic value that is being created or destroyed by the customer's experience, today. So every day, with every customer experience your company delivers, customers are creating and destroying both current value (costs and profits) and long-term value (changes in their lifetime values).
Suppose you have a very valuable customer, for instance, who calls you to complain about something, and for some reason you don't handle her complaint very well, with the result that at the end of the call she hangs the phone up in disgust. She had a bad experience. She no longer trusts you. There can be little doubt that her LTV declined as a result of the call. The amount of this LTV decline can be thought of as the shareholder value destroyed by this unsuccessfully handled complaint. You won't realize the actual cash effect of this event until sometime in the future, when the customer doesn't return to buy more things, and maybe some of her friends do a little less business as well. But the value destruction occurred today, with the phone call. The question to ask is whether the cost saved by not handling the customer's complaint better was more or less than the decline in her lifetime value. And while the statistical modeling can be complex, in the end this is a straightforward calculation.[ii]
If you could add up all the lifetime values of all your customers, including those you have now and all the customers you will ever have in the future, the result would be something we call "customer equity," and it represents the real economic value of your business as a going concern. So for the manager of a company, this means there are two different ways to create genuine economic value for shareholders:
1. You can generate current-period earnings (short-term value), and
2. You can add to your customer equity (long-term value).
Every dollar added to customer equity by a good customer experience is a dollar added to a firm's shareholder value. Economically, after we apply a discount rate to account for the time value of money, this dollar is equivalent to a dollar of current earnings-it is a dollar of value generated now, although the cash effect won't be felt until some later point. And the link between today's customer experience and tomorrow's cash effect is the individual customer relationship. [iii]
Ideally, you would want to take actions today that feed both current earnings and customer equity, as when you sell something to a customer and the sales process itself inspires more confidence or trust in the customer's mind, increasing the likelihood that the customer will come back to buy again. In their study published in MIT Sloan Management Review, V. Kumar and Denish Shah's research concluded that "certain marketing techniques can influence a company's stock market valuation-if the techniques increase customer lifetime value."[iv] However, even when you forgo some current earnings it may be the case that customer equity is increased by an amount that will more than offset this loss, and using today's metrics and methodologies, this increase in customer equity is documentable. Sometimes it's even acknowledged by stock market analysts. In 2006, for instance, an analyst for American Technology Research, Shaw Wu, said of Apple's first-quarter slump, "We are not too bothered" by the dip, because, "from our checks, Apple's sales representatives have been instructed to not push PowerPC Macs on customers who want to wait for Intel versions. In this day and age where making numbers is important, we believe Apple is in a rare group of companies willing to sacrifice its near-term revenue opportunity for greater long-term success by developing customer trust." (I've added the italics here.)[v]
Earning the trust of customers often does require an upfront investment like this-forgoing the profit on a customer mistake, for instance, or reminding a customer that the warranty is almost up and almost certainly incurring some immediate costs in the process. But these kinds of "investments," done prudently and carefully, can almost always return many times their cost in terms of increased customer equity. The increase in your company's customer equity is the financial benefit you will get from earning and keeping the trust of your customers.
In a nutshell, two different kinds of current-period business success are on every company's menu, and it's critical to know the recipe for both:
- Good current profitability, while generating more customer trust and customer equity (have your cake and eat it too); or
- Good current profitability, while eroding customer trust and customer equity (use your cake up so there's nothing left).[vi]
Who will your customers flock to when their choices include companies that embrace trustability in their charter and do not include an obsession with short-term numbers? And how will your short-term success compare with the long-term value created by companies capable of balancing the short term with the long term?
John Stumpf, the CEO of Wells Fargo, describes the period when he entered banking thirty-five years ago as being like the classic Frank Capra movie It's a Wonderful Life. Since then, Stumpf notes, trust has declined sharply as many institutions have become "practically anti-customer" and institutions are focused on how to rebuild customer intimacy and trust. For B2B and B2C, he says, trust is the basic element of any healthy relationship. He notes that Wells is a huge organization; it does business with one in three Americans. A customer with Wells now averages six products and contacts the bank eighty times a month, including ATM, mobile, and online touches.
We owe our team members a full customer view so they help each client get the most from their relationship with us. Our hardest work should be behind the scenes; we should become intuitive about how to help each client. We have to balance our long- and short-term goals; for example, we had to spend a lot on our operating system but that allows us to see each client completely and individually. It's not a customer's job to become profitable to us; it's our job to get the roadblocks to customer profitability out of the way. For a customer to trust us, we have to take the customer's perspective and also get the details right. Even if we do it right 99.9 percent of the time, if we're down for that one customer, then for that customer, we're down 100 percent of the time.[vii]--John Stumpf, CEO, Wells Fargo
And something more to consider: The competition for customer goodwill is already heating up. In the past, your for-profit company has been competing against a bunch of other companies hell-bent (like you) on making their own short-term numbers. But in the future, more and more productive activity is going to take place based on social goals in addition to economic ones. Cooperatives and nonprofits have always existed, of course, but two trends are driving more and more economic activity in this direction. First, as the cost of interaction plummets, volunteer and not-for-profit activity gets easier and easier to organize, and second, people in developed countries simply want to give back, to contribute to others, and to make a difference. Whether it's consumers texting on their mobile phones to contribute $3 at a time to aid a disaster recovery effort, or software engineers volunteering some of their spare time to write code, your next "competitor" might just be an organization more interested in the welfare of your customers than you are. Ask Microsoft what it's like to compete with Linux, the free computer operating software created and updated entirely by volunteers, for instance.
How will you design "customer experience" against competitors whose customers count on being reminded if they try to order the same thing twice, like the amazon.com Kindle? Or who preemptively offer refunds if they make a mistake, like Jet Blue? Or whose customers are loyal to the third generation, as are those of USAA?
[i] As of 2011, only some U.S. states (including Connecticut, Louisiana, Georgia, New Jersey, and Mississippi) legally required homebuilders to provide a structural warranty, although most homebuilders voluntarily offer some kind of limited warranty in their sales contracts. Typical coverage is a one-year warranty for labor and materials, two-year warranty for mechanical defects, and a ten-year warranty for structural defects. (Ilona Bray, "Holding Your Builder Responsible for New-Home Defects," Craig T. Matthews & Associates, available at: http://www.ctmlaw.com/articles/holding-your-builder-responsible-for-new-home-defects.html, accessed September 22, 2011. Also see "Special Problems in New Home Construction," available at: http://real-estate.lawyers.com/residential-real-estate/Special-Problems-in-New-Home-Construction.html, accessed September 22, 2011.)
[ii] In their book Analytics at Work: Smarter Decisions, Better Results, Thomas H. Davenport, Jeanne G. Harris, and Robert Morison emphasize the importance of evolving more and more sophisticated and discerning analytical capabilities that provide deep insight based on facts and defensible predictions (Harvard Business Press, 2010).
[iii] You may want to have a look at Return on Customer: Creating Maximum Value From Your Scarcest Resource (Crown Business, 2005), by Don Peppers and Martha Rogers, Ph.D., for a comprehensive discussion of the statistical, mathematical, and practical issues involving calculation of up-or-down changes in individual customer lifetime values. As an operating business creating value for shareholders, customer equity is virtually the same as a company's economic value, because the economic value of any business is the discounted net present value of all future cash flow yet to be generated by the business.
[iv] V. Kumar and Denish Shah, "Can Marketing Lift Stock Prices?" MIT Sloan Management Review, Summer 2011, pp. 2426, determined that lifetime-value-increase marketing activities lift stock prices. Also see the research by Janamitra Devan, Anna Kristina Millan, and Pranav Shirke, "Balancing Short- and Long-Term Performance," Research in Brief, The McKinsey Quarterly Number 1 (2005), 3133, for a discussion of the characteristics of S&P 500 companies that performed well in both the long term and short term from 1984 to 2004, compared with those companies that performed well in only one or the other.
[vi]Look at it this way: If your stockbroker came to you at the end of the year and summarized your dividends and interest payments for the year, but refused to tell you whether the underlying value of your stocks had gone up or down, you'd fire that stockbroker because it would be impossible to make investment decisions based only on knowledge of current cash flow. And yet, companies that operate only on current-quarter earnings reports without also demanding to know whether underlying customer equity is going up or down are basically making the same mistake. See our discussion of these issues in Don Peppers and Martha Rogers, Ph.D., Rules to Break and Laws to Follow (John Wiley & Sons, 2008), pp. 8084.
[vii] We talked with John Stumpf, CEO of Wells Fargo, about trust and banking on June 23, 2011.