Strategy & Leadership
January/February 1999

Employee Loyalty: A Key Link to Value Growth

by Robert Duboff and Carla Heaton

This article has a very straightforward message: engendering loyalty among valuable employees is imperative.

There have been numerous articles and books that send this same message, but with the subject of "customers" in place of "employees." We do not intend to replace that imperative with this one. In fact, we believe they are inevitably linked, at least for services firms. To develop effective, long-term relationships with profitable customers, these firms must also develop effective, long-term relationships with valuable employees who are able and willing to serve those customers.

The point is not unique. Ritz Carlton's credo, "Ladies and gentlemen serving ladies and gentlemen," gets it just about right. However, we have not found, in any source, a defense of the premise on economic terms: nor have we found much information on processes that strive to improve a firm's performance by focusing simultaneously on employees and customers. We intend to provide the financial evidence that motivates businesses and strategy, and describe the processes companies can use to reap the economic benefits.

There is impressive evidence that retaining valuable customers, as well as valued employees, is directly connected to value growth. It is clear that losing valuable customers and/or valued employees costs incremental dollars - if only in having to recruit and orient new customers or employees.

The correlation between employee loyalty and shareholder value has surfaced in several studies:

  • Mark Huselid analyzed over 3,000 companies to conclude that those with programs on employee motivation had higher stock-price to book-value ratios than other companies. Some programs showed as much as a $41,000 increase in market value per employee. Those with significantly more effort, i.e., one standard deviation increase, experienced a 7 percent decrease in turnover. 1
  • Fortune looked at the 100 best companies to work for in America and found five-year annual returns of 27.5 percent vs. 17.3 percent for others in the Russell 3000 listing. 2
  • Ernst & Young found that investors have eight measures that matter, one of which is "companies which attract and retain the very best people." 3
  • Welbourne and Andrews studied the five-year survival rate of initial public offerings (IPO) and found higher rates among companies that cited employees as a key competitive edge and which judged themselves higher on relations with their employees. 4
  • Jeffrey Pfeffer conducted a review of over 100 field studies of organizational change and concluded that "in three-fourths of the cases, significant increases in economic performance were observed." 5

On the customer side, there is a wealth of data, some about the lifetime value of good customers: others, such as The Loyalty Effect by Frederick Reichheld, directly computes the positive effects of customer loyalty. The book cites the importance of employee loyalty but does not calculate the interaction of customer and employee. 6

A study by our sibling firm, William M. Mercer, comes closer. The firm conducted a survey of senior human resources executives in large enterprises and reported that "more than half of [study] participants see poor customer service as a consequence of attraction and retention problems. This translates into costs, as well as losing customers altogether." 7

Sears is one company that has worked on this issue to the extent of developing a sophisticated model which "stresses that a five-point improvement in customer satisfaction . . . in turn will drive a 0.5 percent improvement in revenue growth." 8

While the linkage between these two factors is logical (i.e., if untoward turnover in either valuable customers or employees is bad, then, in the aggregate, untoward turnover in both is worse), little attention has been given to this relationship. For example, Kotter & Heskett report that companies which emphasize three groups (customers, employees and stakeholders) outperformed those that focus on only one or two. However, that study seems to take each variable as if they were independent.9

Mercer Management Consulting is now analyzing data that builds the case that there are interactions between customers and employees - particularly in management consulting, financial services, casinos, and telecommunications - for the most important customer segments. The clearest evidence of this interaction is the ripple effect that happens when a valued employee leaves. In a dramatic example, when a popular casino host changes casinos, many of the high rollers move, too. In our work with a global bank, we noted a similar effect when key customer service people left. The point is, customer loyalty is often at least somewhat dependent on a specific relationship with a contact employee. Thus, the cost of losing such an employee includes the weakening, if not loss, of key customers as well.

Mercer has seen this effect (as have others) even within lower value customer segments. In telecommunications, retention efforts using the same employee following up from a call center have a positive multiplier on customer retention and even on upsell efforts. Similarly, analysis of bank branches has shown that when employees in the branch believe that the branch has an "imperative" to provide quality service, the customers of that branch, responding independently, report receiving higher levels of service.

The converse is less observed, and harder to quantify. However, there are employees who leave a firm out of frustration with customers and their demands. At a minimum, Mercer research suggests that employees who are able and willing to serve target segments do so better (and to higher mutual satisfaction) than do those who lack either the skills or the motivation. Furthermore, we have seen the interest of each constituency in the other. In fact, having line employees help us identify how to enhance customer loyalty and vice versa has unleashed powerful and effective new ideas.

Thus, it is evident that, at least in the industries mentioned previously, the best practice is to work on customer and employee retention in an integrated and simultaneous manner. This typically requires cultural change. First, business leadership has to recognize the value of loyal employees as well as loyal customers. Few businesses focus on both. Second, the company must overcome the traditional practice of focusing on customers in marketing and/or sales divisions, while a separate organizational unit focuses on employees. Real value growth can be achieved only when these significant barriers have been overcome.

The first step in creating an integrated customer/employee retention plan is to establish principles for the analysis and implementation of the dual focus. The following principles are based on lessons from companies that have been successful in developing these long-term relationships.

Focus on specific segments. Too often when companies decide to combat turnover they implement a policy or program which applies across the board. Such responses typically are a waste of money because even if they are motivating to some, they are available for everyone, including customers or employees that may not be profitable to retain. Segmenting the entire base of customers or employees is critical, both to ensure the potential return of each investment and to focus the program so it will motivate the optimal target. This is even more critical if the company is going to match targeted customers with specific types of employees.

Bribes alone are rarely effective. Over the long-term, coupons or bonuses unaccompanied by changes in the fundamentals of the relationship don't work. Emphasize building loyalty, not reducing churn or turnover. Good long-term relationships must work on both a rational, left-brain basis - such as price/value or compensation/work effort and impact - and an emotional, right-brain basis through which the customer or employee feels good about the relationship.

Systematically prioritize efforts based on ROI. As strong as initiatives may be initially, most programs wear out, and motivational factors change over time - often due to competitive moves. Continuing success at loyalty requires continuous assessment and a willingness to adapt as needed. Conceptually, these lessons can be described as an approach to answering specific managerial questions as shown in Exhibit 1. Once the direction is set, the method of developing an effective process can begin. The typical steps of the process are displayed in Exhibit 2.

Since beginning a journey is often the hardest part, we might elaborate on the diagnostic phase. The initial activities are designed to ensure that the effort capitalizes on what is already known. Usually, companies have a great deal of knowledge about the issues at hand, but is rarely codified in a useful way. Thus, the first step is to gather relevant data and information and then interview managers of all key functions about their experiences, their hypotheses, and any data they have accumulated.

In this work, Mercer starts with a set of issues to structure the inquiry. On the customer side, there is a set of questions that every company needs to answer. On the employee side, Mercer has developed a shorter set of issues clustering around whether employees are able and willing to perform the necessary work.

The goal is to define the key attributes of the customer(s) and employee(s) that the business wants to retain over the long term. Then, among these segments, the drivers of loyalty must be determined. Finally, the critical incidents - the key encounters, the "moments of mutual truth" - must be uncovered so that ultimately the business can prioritize, train and monitor the growth of loyalty at the component parts. (See Exhibit 3.)

Examples of these moments of mutual truth include:

  • Checking in at a hotel.
  • Having a ticketing problem at the airport.
  • Waiting in line at a theme park.
  • Signing-up for a new communications service.

Each of these encounters has an impact on both the customer and the employee. The impact is heightened proportionately by the number of people in queue, the time of day, and the degree to which the customer feels important. Understanding which moments have the most impact allows companies to focus their efforts accordingly. If the drivers and the moments are not known and documented, then additional research is needed.

Once the information is assimilated, it should be codified on-line or in print and organized in a way that is useful and capable of being easily updated in a "Knowledge Book" format. This knowledge forms a solid basis for hypothesis generation that fuels the remaining steps in the process. The process is then refined through the continuing interaction between the insight-generating communication with employees and customers and feedback loops shown in Exhibit 1.

While learning the long-term impact obviously takes time, it is important to continually monitor results and learn what is working and what isn't. Such measurement must center on the segments of focus, and the assessments must be both behavioral and attitudinal. The studies cited at the beginning of this article demonstrate that there is a value-growth reward for improving relationships with valuable customers and valued employees as depicted in Exhibit 4. The incremental competitive advantage awaits those who can do both.

Companies delay in improving loyalty on both fronts at their peril. In a world where talent, not assets, create a competitive edge, the premium on employee loyalty has risen. And the loyalty of the most profitable customers can make or break a firm. When greater employee loyalty and customer loyalty get linked together in a virtuous cycle, companies can substantially improve the rate of shareholder value growth.

Notes

1 Brian Friedman, James Hatch, and David Walker. Delivering on the Promise: How to Attract, Manage and Retain Human Capital (New York: The Free Press, 1998).
2 Linda Grant. "Happy Workers, High Returns," Fortune, January 12, 1998.
3 Jonathan Low and Tony Siesfeld, "Measures that Matter: Wall Street Considers Non-Financial Performance More Than You Think," Strategy & Leadership, March/April 1998.
4 Brian Friedman, James Hatch, and David Walker, Delivering on the Promise: How to Attract, Manage and Retain Human Capital (New York: The Free Press, 1998).
5 Jeffrey Pfeffer, The Human Equation: Building Profit by Putting People First (Cambridge, Mass.: Harvard Business School Press, 1998).
6 Frederick Reichheld with Thomas Teal, The Loyalty Effect (Cambridge, Mass.: Harvard Business School Press, 1996.)
7 "Attraction and Retention: Some Employer Perspectives," William M. Mercer, Inc., Internal Document, 1998.
8 Richard T. Quinn, "The Employee-Customer Profit Chain at Sears Roebuck & Company," Harvard Business Review, 1998.
9 John Kotter, (James Heskett, Contributor), Corporate Culture and Performance (Cambridge, Mass.: Harvard