Prescription for
cutting costs

Loyal relationships

By Fred Reichheld

In the current downturn, many companies are tightening belts. But
too many are missing their biggest opportunity to keep costs down:building loyal relationships with customers and other stakeholders.
How do loyal relationships translate into cost savings? Consider
the cost of serving a long-standing customer versus the cost ofcourting one. Across a wide range of businesses, customers generateincreasing profits each year they stay with a company. In financial
services, for example, a 5% increase in customer retention produces
more than a 25% increase in profit. Why? Return customers tend
to buy more from a company over time. As
they do, your operating costs to serve them
Chick-fil-A has so effectively
mastered the economics ofloyalty it can afford to pay
store operators double or
triple its industry’s averagecompensation and still give
10% of profits to charity.

decline. What’s more, return customers referothers to your company. And they’ll often
pay a premium to continue to do businesswith you rather than switch to a competitor
with whom they’re neither familiar nor
comfortable. Of course, not every customer
has potential to be profitable and long-standing.
Cost-effectiveness dictates that you segment

clients to identify the subset that holds this potential, so you cantarget your investment in relationship-building.

Fred Reichheld is a fellow of Bain& Company, and author of Loyalty
Rules! How Today’s Leaders Build
Lasting Relationships, Harvard
Business School Publishing,
September 2001.

Consider the case of Vanguard, the mutual fundindustry cost leader. When Jack Brennan took overLoyalty leaders develop annual report cards

as CEO in 1996,Vanguard’s flagship S&P 500 Index

on suppliers and dealers with as much care

Fund costs were just 0.20% of assets. By 1999, theyas they give to annual reports for investors.

had declined to 0.18%—a 10% improvement. Oneof the reasons is that Brennan, like his predecessor,

measures including sales, sales growth, and profits.

John Bogle, is committed to customer retention.

The stores whose performance falls into the bottom

And Brennan’s particular passion is selecting the15-20% of all Chick-fil-A units automatically getright kinds of customers up front—the kinds withextra attention from company consultants. Customer

high potential for long-term relationships with thesurvey frequency is doubled, and improvement plansfirm. For example, a few years back,Vanguard

are developed with each operator. Operators andrejected an institutional investor that tried to invest

employees receiving the added scrutiny understand it$40 million in a fund, because Vanguard suspected

is meant to help them get back on track; they knowthat the customer would soon churn the investment,that long-term relationships require honest, two-creating extra costs for all the existing customers.

way communications and learning, and they value

The customer complained to Brennan, who supported

the company’s commitment to that goal. The

the decision and used it as an opportunity toultimate result, of course, is a dramatic saving inunderscore the need to be selective about customers.

hiring costs; Chick-fil-A’s average store operator

Loyalty leaders also reduce costs by building trustingturnover rate is 5% versus the competition’s 35-40%.

relationships with employees. Consider Chick-fil-A,

Customers, employees, suppliers, distributors,

a chain of quick-service restaurants that has sochannel partners—almost every stakeholder in youreffectively mastered the economics of employee

company is a potential cost-reduction crusader.

loyalty that it can afford to let store operators earn

If you facilitate a supplier’s operations by being

compensation that’s double or triple industry averages,

flexible about delivery times, for example, thatwhile generating enough cash to grow the chainsupplier might be more willing to flex for yourand give about 10% of profits to charity. Those

special need. And over time, as you build trust, thatcompensation standards help grow loyal employees

supplier will likely be loyal to you even if one of

who nurture attractive client relationships.

your competitors offers a more attractive short-term

Performance feedback, too, bolsters loyalty. Every

contract. You’ll both save on switching costs; andstore operator can easily find out (right on the in-if you’re attentive, you’ll maximize the efficiencystore computer) his or her standing in comparisonof your transactions as your relationship matures.

to the other 600 or so Chick-fil-A operators on

B a i n & C o m p a n y, I n c .

Prescription for cutting costs:

Loyal relationships

2

What are the secrets of the loyalty leaders?

The companies that best understand cost savings
through loyalty take very deliberate steps. A few
you might consider:

Identify ways to help underperformers:

Develop annual relationship report cards on
suppliers and dealers (and customers and employees)with as much care as you give to annual reports
for investors. Test a 360-degree feedback system,

Modify customer-aacquisition incentives:

starting with senior managers and rolling out toReward your sales teams and marketing channels

all employees.

for acquiring customers that stick. Consider
commission or bonus reductions if customers
defect before 18 months.

Use the Internet:

Loyalty leaders such as Vanguard have shifted
almost half of their customer transactions to theReallocate marketing investments:

Web. Make sure your Web site is so simple to

Systematically rank all of your customer

use that many customers will prefer this fasteracquisition campaigns on the basis of theirand cheaper alternative.

yield of loyal customers. Shift resources towards
programs that attract the richest mix of loyal
customers. (Many firms today are wasting half
their marketing expenses on disloyal customers
who will never stick around long enough to
pay back the acquisition investment.)

No company is immune to the pressures of themarket. But companies that focus on building
loyal relationships that by their very nature keep costs
to a minimum are far better positioned to remainstrong in the face of market turbulence.

BAIN & COMPANY, INC.
Corporate Headquarters
Two Copley Place
Boston, Massachusetts 02116
1 (617) 572 2000

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