Loyalty Rules!
A Conversation with Frederick Reichheld

By John Milton Fogg

Reichheld debunked the notion that loyalty was dead. He put loyalty economics on the map."--The New York Times. Fred Reichheld, Bain & Company Fellow, is widely recognized as one of the world's leading authorities on business loyalty and is a frequent speaker to major forums and groups of senior executives. Audiences around the world consistently rate him as an outstanding communicator. His two books, The Loyalty Effect and his latest, Loyalty Rules!, top everyone's list of international business best-sellers for good reason. Consider this: a five percent improvement in customer retention rates will yield between a 25 to 100 percent increase in profits across a wide range of industries--and you'll understand why loyalty has become more than just a new business buzz-word. Indeed, it has risen in esteem from being a vague (if honorable) notion or lip-service platitude, to its new station as a highly prized business stratagem. And when it comes to loyalty, Frederick Reichheld literally wrote the book--wrote both of them,
in fact. You can learn more about Frederick Reichheld, his books and work on the Web, at www.loyaltyrules.com.

-- JMF

Frederick, what first got your attention about loyalty? When did it occur to you that loyalty matters?

It probably goes all the way back to my Ohio childhood. Growing up in the Midwest automatically bred into me the point of view that in most walks of life, loyalty is an absolutely essential trait. As I came East to go to college and ended up getting into business out here, I often found that this value seemed to be something people actually disagreed with. The more common view seemed to have become one that sees loyalty as irrelevant--if not downright foolish--as a strategy for personal success.

 

Foolish in what way?

Skeptics would say, someone who is loyal is just waiting to be abused--and they are abused, whether it's by their cellular phone company, who gives the worst prices to loyal customers, or magazine subscriptions, who do the same thing.

 

Or airlines.

Right. The notion that someone would actually watch out for your interests if you were loyal has become a bit of a rare thing, except for companies such as Vanguard Mutual Funds--where they actually go out of their way to reward people who have been long-term loyal customers.

State Farm and a few others, whom I've written about--and who, interestingly, have grown much faster than their competitors--have had wonderful financial results and are either leaders in their industry or on the trajectory toward becoming leaders. These companies who have been rewarding loyalty have been doing a great job. But somehow, in the larger business community, this is missed, forgotten, or camouflaged by everything else that's going on in business.

 

Do you have thoughts as to why that is so?

I struggled with this question for a long time, and here is what I finally concluded: Loyalty is one of those notions that is fundamentally important to human existence, and yet it has been much ignored. Most people can't even say what loyalty means, although it gives them goose bumps. When they think about loyalty to their country, their church, their family, they instinctively know that it's obviously important, and yet when you talk about loyalty in business, they sort of struggle with the idea.

For example, one CEO said, "When my board of directors talks to me about my 'loyalty,' I know that what they're really saying is that they don't want to pay me market rates for my work. When my people come to me and talk to me about 'loyalty,' I know what that means, too: it means they don't want me to hold them accountable for market-competitive results."

 

Is there something in it, Frederick, that sounds servile, as if the person being "loyal" is placing himself under somebody's thumb?

We have to distinguish what people mean when they use the term: does your saying you see me as a "loyal employee" mean that you want me to do whatever you tell me to do? That's not really loyalty, it's something more like unthinking obedience!

 

So, how do you mean the term?

I think the true term "loyalty" is value-neutral, just like the term "freedom."

Freedom can be a good thing, if you use it
to do good things--but it can be a bad thing if you use it to do bad things. The same is true of loyalty.

Some customers have been loyal to lousy companies that gave them terrible value or lied to them. The same thing has been true for employees. So loyalty isn't necessarily a force for good unless it is loyalty to a certain set of ideas or principles, what I've called "rules" in my book, Loyalty Rules. It's the rules themselves that are worthy of loyalty, and those rules that are worthy of loyalty in business are some pretty basic ideas: ideas such as telling the truth, rewarding people for the right results, being open and honest, being clear about what your values are. When you get the rules right and your leaders embody those rules, then loyalty makes an enormous difference as a force for good, and becomes the actual key for driving profits and growth.

 

How so?

Any successful business relationship is based on mutual benefit; building a community of those relationships means that you need to have
consistent standards of mutual benefit. You
can't have just investors winning, or put only customers first; you can't run the company to benefit employees--to the exclusion of customers, stockholders and the rest of your business ecology.

It has to be a fair set of rules, such that anyone and everyone who is touched by that business has to have an opportunity to build a win-win relationship. The success of the business ought to be evaluated on that basis.

In most businesses today, the only worthwhile and reliable measure of success is profit accounting--and accounting simply does not capture the entire nature of the relationship. It's one important dimension, but it's not sufficient. When profits go up, perhaps there were a lot of people doing all sorts of things that made those profits go up for the moment--such as abusing their partners and stealing value from the relationship.

 

It sounds like loyalty requires history, like a track record--is that true?

No; believe it or not, I think loyalty is actually about the future, more than the past. Some people criticize loyalty as being fixated on the past and looking in the rearview mirror--but I think that the reason you are loyal lies in what you believe the future holds.

Now, the past is often a good predictor of the future, so absolutely, person's history and track record is one of the things to consider: how has she lived up to her commitments, by what sorts of rules has she lived her life? But loyalty is actually a bet: you are betting that by putting something ahead of your own selfish short-term interests, in the long term, you will be better off.

 

Can you give us an example?

Take a customer at Vanguard Mutual Funds, say, or at Enterprise Rent-a-Car, who discovers that he could get a better deal on something at a competitive company. Now, you would expect he might just jump ship and go to the competitor; but experience at these companies says he will tend not to. Why not? Because he believes that if he brings that better deal to the company's attention, the company will fix it and get back into a place where they are the best value. The customer knows that it's worth taking the time to give the feedback--and even to live temporarily with second-best price or second-best value, because through the relationship, the benefits will overwhelm the costs.

 

Do your loyalty leaders--I think you referred to them as "loyalty royalty" when you were citing examples of companies that really were excellent in this area--do they have to do everything right?

No, they just have to do it better than the competition. The guy with the most loyal customer base is the one who gets the economic benefits of lower costs, higher customer returns, higher gross. In the real world, of course, no one is perfect, and the loyalty leaders are far from perfect--but they are far ahead of the competition. That's why they're growing faster and making higher margins. At the same time, they can afford to pay their people higher compensation and invest more in customer value.

 

When I think of loyalty in business it makes me think of "loyalty to the firm," as in employee loyalty, but you base some of that on finding the right customers. Can you speak about that?

Being selective is vital to having relationships worthy of loyalty. Anyone with any humility at all has to recognize that it's hard to be the absolute best value to someone. If I'm thinking honestly about how hard is it for my company to be the world's best value to a particular customer, I will quickly realize that we can't just do it for just any customer. We're going to need to have a very clear focus on what kind of customer we're going to provide value for, exactly how we're going to be the best, and how we can build a system or community that over time will deliver the best quality or value. Exercising that focus, by selecting the right customer and selecting the right employee, so that we give ourselves an economically rational prospect of win-win relationship, requires truly picky selectivity.

 

It seems that that might strike some as scary, because you're limiting your market.

Yes--and yet, when you look at the loyalty leaders, you find that their average growth rate exceeds their competition by more than 100 percent! That is, their average growth rate is more than double the rate of the competition. Many--and probably most--loyalty leaders are market leaders today. State Farm is twice the size of their next biggest competitor, Allstate. Vanguard is not number one yet, but they will be. Enterprise Rent-a-Car is the biggest in the car rental industry. Blockbuster Mutual Life is the biggest in life insurance. So, while it would seem that being selective would limit your growth, it is in fact the key to growth!

 

Are there cornerstones of loyalty for you?

To arrive at cornerstones of loyalty, you go back to the basics and say, Okay, loyalty to what? Is "business loyalty" an oxymoron, because loyalty means self-sacrifice and business means pursuing self-interest?

Then you find yourself walking through a hierarchy: let's see, there's loyalty to yourself. There's loyalty to other individuals. There's loyalty to a team, and perhaps, to an organization or community of teams; then there's loyalty to a set of ideas or beliefs.

And none of them make any sense! Loyalty to yourself is selfishness. Loyalty to some other individual is patronage. To a team?--it depends on what the team stands for. In the end, the only thing that makes sense is loyalty to a set of ideas about what is the basis of a good relationship. You come to the question, "What do I stand for?"

When you get those principles clear, then you can evaluate how well you're doing at building loyalty, and, when you're failing, on which of the principles you are coming up short, and what you need to do to fix that shortcoming.

Most companies don't make it clear what they stand for. It naturally follows that their customers--and many of their employees--presume that the company must stand for making as much money as they can without going to jail. Which is not something worthy of anyone's loyalty--which in turn is why most companies today enjoy a very low level of loyalty.

 

And those things that would be worthy of loyalty are...?

Treating people fairly. Telling the truth. Being open to others' opinions and perspectives, being honest. Rewarding people appropriately and valuing their true loyalty appropriately. Setting high standards of achievement. These are all things worthy of loyalty.

 

You speak about rewarding loyalty performance or loyalty-based compensation. How do you do that?

In relation to customers, Vanguard is a good example. Vanguard charges one-third less for a long-term investor in their S&P 500 Index Fund than they do a short-term investor.

In relation to employees, perhaps one of the best examples would be Enterprise Rent-a-Car. Enterprise Rent-a-Car measures customer feedback for all 5000 of their branches and rank orders every branch every month. They won't promote anyone from a branch that's below average. If you think about what they're actually doing with this policy, here is what it translates to: they are giving the customers a vote in whether the service they received was good--and that customer vote determines whether or not an employee will become eligible to be promoted to a position of authority and leadership.

 

Wow.

At Vanguard Company, every six months they survey all of their front line staff; they rate their leaders on how well they've lived up to the eight values the firm endeavors to live by. Those ratings determine who is eligible for promotion.

 

Can you share those eight values with us?

I don't know that I have permission to do that fully, but I can give you some examples: open, honest, and direct communication; putting the client's interest first; never having a closed mind; the sorts of basic values that you would expect. Helping to create extraordinary teams or being part of extraordinary teams is one of them.

At Bain & Company, we call this constellation of values a company's "true north"--it means aligning your values toward the things we believe in.

To make that real, they give votes to the front line staff. Why? Well, it would be easy for people at the top of the firm to evaluate how good a salesman is--whether he runs a profitable office, whether his clients finds more services...such things are easy to track with accounting. But what we want to reward is people who are able to achieve those things by living the values of the firm; and the best people to go to in order to find out who is doing that are the people on their teams, who work with them day in, day out. So we give the power of the ballot to those individuals who know best.

 

Are there things that we can do, as customers or prospective employees or prospective partners, to ascertain whether or not this is an opportunity, a company that's worth a try?

That is in part the purpose of my next book: to develop a measurement that is so simple and practical that, my hope is, it will become a standard.

It turns out that in most industries, you just ask one simple question, "Would you recommend them to a friend?" and rate it on a scale of one to ten.

People who give nines and tens, I call "promoters"; they're the people who are sufficiently impressed with the value they've gotten and how they've been treated that they would refer a friend. Those companies who have a high percentage of promoters in their customer base are the best companies; that's the right way to pick.

Simply talk to customers whom you respect or who have a similar situation to yours, and find out if they would refer this business. Referral networks are far more reliable than advertising or public relations.

If you don't have that data, then I'd say, look for defection rates. If you're able to find that data, then you would probably want to do business with the person or company in that industry who has the highest customer retention rate and the lowest defection rate.

 

What do you see for the future of loyalty? You certainly believe in it, because you've invested your reputation and your work in it.

I think the value of loyalty will become clearer as the Internet gains a greater hold. As communication becomes easier and easier, knowing whom you can trust becomes even more vital. We're going to find that people who can build effective communities in that world are the ones who know how to build loyalty.

Ebay is a classic example: a wildly successful, high-growth firm. Meg Whitman, the CEO of Ebay, says that the core of the company, their secret ingredient, is loyalty. They've been able to take the ultimate frontier, where people never even meet one another face to face, and turn it into a trustworthy place to do business. They created a set of rules of behavior that in turn created a community of mutually beneficial relationships.

I think we will move inevitably toward a business environment dominated by communities, where Internet communication plays a bigger and bigger role; and on Ebay, you can see how powerful a force loyalty becomes in such a world.

 

Anything else for you, sir?

I would just add this: people in business need to think very carefully about what loyalty means and how they'd measure it. Eventually, their firms will need to be able to measure loyalty as carefully as they do profits--if they hope to build superior levels of loyalty.

Based on our most recent research, it's impossible to grow a business without customer loyalty. It is simply too expensive to fill up a leaky customer bucket, and you never really get anywhere. When you observe that the firms who have leading loyalty in their industry are growing twice as fast as their competition, you can't help but see that there's a message there.

If you care about growing your business, you better figure out how to build the best customer loyalty.