To learn how to keep customers, track the ones you lose. ’ Zero Defections: | a Quality Comes to Services -_ by Frederick F Reichheld and W. Earl Sasser, Jr. Thie real quality revolution is just now coming to services. In recent years, despite their good inten-- tions, few. service company executives have been |+ able to follow through on their commitment to sat- isfy customers. But service companies are beginning to understand what.their manufacturing counter- Parts leaned in the 1980s—that quality doesn’t im- Prove unless you. measure it. When manufacturers began to unravel the costs and implications of scrap’ heaps, rework, and jammed machinery, they realized that “quality” was not just an invigorating slogan but the most profitable way to run a business. They made “zero defects” their guiding light, and the quality movement took off. : Service companies have their own kind of scrap heap: customers who will not come back. That serap heap too has a cost. As service businesses start to measure it, they will see the urgent need to reduce it. They will strive for “zero defections”~keepinigevery customer the company can profitably serve—and they will mobilize thd organization to achieve it. * Customer defections have a surprisingly powerful ‘mpact on the bottom line. They can have more todo with a service company’s profits than scale, market , ¢ . HARVARD BUSINESS REVIEW. September-Oectober 1990 share, unit costs, and many other factors usually as- sociated with competitive advantage. As a custom- er’s relationship with the company lengthens, profit: rise. And not just a litele. Companies can boost prof- its by almost 100% by retaining just 5% more of their customers. Defecting customers send aclear signal: profit stump ahead. While defection rates are an accurate leadinig indi- cator of profit swings, they do more than passively indicate where profits are headed. They also direct managers’ attention to the specific things that are causing customers to leave. Since companies,do not hold customers captive, the only way they can pre- Frederick F Re:chheld is a vico president in the Boston of* fice of Bain «? Company and leader of the ficm's customer. retention practice. W. Earl Sasser, Jr. is a professor atthe Harvard Business School. . A 105vent defections is to continually. By soliciting feedback from defecting customers, companies cain ferret ‘out the weaknesses that really matter and. ‘strengthen them before profits start to dwindle. Defection analysis is therefore a guide that helps companies Manage continuous improvenient, : _* . + Charles Cawley, president of MBNA. America, a _Delaware-based credit card company, knows well how customer defections can focus a company’s at; tention on exactly the things customers value. One momning in 1982, frustrated by letters from unhappy ing went from 38 to 4, and profits have increased sixteenfold, naa evaluations of investments designed to retain cus. tomers. Unfortunately, today’s accounting systems do not capture the value of a loyal customer. Most outperform the competition~ into huge earings. With- | out making any acquisitions, MBNA‘s industry rank. « and ignore expected cash flows over a customer's life- time. Served correctly, customers Senerate increas- ingly more profits each year they ‘stay with a com- pany. Across a wide range of. businesses, the pat- tem is the same: the longer a company keeps a cus- tomer, the more money it stands tomake. (See the bar charts depicting “How Much Profit a Customer Gen. ‘erates over Time!’) For one auto-service company, the expected profit from a fourth-year customer is ‘more than triple the it that same customer genei- ates in the first year. When customers defect, they take all that ° -_- It may be obvious that acquiring a Hew customer entails certain oné-time costs for advertising, pro- motions, and the like. In credit cards; for example, companies spend an average of $51'ta recruit a cus, tomer and set up the new account. But there are miany more pieces to the profitability puzzle. ! ‘To continue with the credit card example; the~ | newly acquiredcustomers use the card slowly at first and generate a base profit. But if the customers stay a which turns profits up sharply. We this trend in each of the more than 100 companies in two doz- “en industries we have analyzed. For one industrial distributor, net sales per account continue to rise ' into the nineteenth year of the ip. As-purchases rise, operating costs decline. Check- moreefficiently. One small financial consulting busi- ‘systems focus on current period costs and revenues.| ness that depends on personal relationships with el Crédit. ‘0 lit Cord BEST COPY AVAILABLE * FOR REPRODUCTION 1 2 3 4 Sear How Much Profit d Customer Generates over Time | «Industrial Lou sein nayec ents has found that: are more sfficient Ices,” oF eee Also, cofnpaiies with long-time customeis(can of- . shaves more for their products a services Macy people wil pay more to stay in a hotel they kono a 10so002 doctor they trust than to takeachanee os. ‘less: F account, If, for instar leaves after less expensive compe: ‘veloped stich a loyal can for the customer's canfidence in the ie I i sitet The compari chat has de- ‘boon from long’ Projected profit streams into ince, ‘the credit card customer. the first year, the takes a'$21 ‘recy re Sey more years, his or her value to the Company rises sharply. It is equal to the net Present value ¢ i the first five years, or about $106. ° lowers its defection rate, the av= nship lasts longer and profits, |. Sale. Executives *tncistiat| : chargeapremiun |, dou- ts |, Dies aetin and profits rise 75% ~fom 8300 ta Sear: ‘ card bus Al : th (See the share "ihy am ie Company. (See ¢ art “Why Customers Profitable over Timé” While the relative im- Fast ha tese Btlects varies from industry eo te acne aul ha ge term customers Senerate increasing tt ‘ + To calculate.a customer's real ‘worth, a: comipany, must take all of these i ints 7 ea nan teeme np an Costs drop by tlvo-thirds from the first year to the second because kustomers know “what t@ expect from the consultant and have fewer questions or problems. In addi the consultants _ I se are familfar with. the custofner's financial situation and investment climb steeply. One to appreciate just how re- spore rftatetoshangerin dc ee draw’a defection urve, (See the graph, “A Credje’ Card Company’s Defection Curve."| This shows clearly how small movements in a company’s defec- that. customer more than ping. n gut 108300 As the defection ratsdropsanathor sn the average life span af acustomer n 6nshi The credit d business is.stot unique. jhe shape of defection curves vary across induce ie derby ce Rede it tions by just 5% generated its nen banks pak geen MO pe Fri Sethe chare"Réducing Defecticas 5% Boca Profits 25% to 85%.) MBNA America has found that a 5% improvement in ion rates. its average customer value by more thant 125%, * { 4 of jonesnancially | reduction. 2% decrease in defection Tate, Low-defection strat, gies can overwhelm low-cost strategies. - And un | ‘and profits provides a ‘guidg to lucrative growth. It is common for a business to lose 15% to 20% of its cus- tomeis ¢ach year. Simply éutting defections.in half * will more: rate, Cémpanies with high retention rates that waht. toexpand ‘| quiritiglow retention competit and reducing their defections, poy oe Defections Management ot Although service companies ly can‘t—and shouldn't try to-eliminate all defect ) they can fections, ‘companies must pursue that goal dinated w: Spot customers who leave and then to analyse and acton the'information they provide. \ 108, to investments in service cost reduction, for which the objectives have been moretangible, “02 =p Peso en. - Knowing that defections are closely linked to prof. itsalso helps explain why some companies that have relatively high unit costs can still bequite profitable. Companies with loyal, long-time customers can fi- | outperform it costs and high market share but high customer - chum. Forinstnce,in the credit card businéss/4 10%" ‘quality versus things like |. competitors with Tower unit” Yj... Watch the.door. Managing for +| Zero defections requires mecha- nisms to find customers who have ; ended their relationship with ‘the company—or are about to end it. While compiling this kind of cus- tomer data almost always involves the use of information technology .| of some kind, mgjor investments innew systems are’ sary, - | The more critical issue is | whether, the business regularly } gathers information about custom eys, Some companies already do. Credit magazine ‘buns diet st mal if ‘surers, cell companies, -and.banks, for example, alll collect - réams of data-ds a matter of course, ‘They have at their disposal the ‘names and addresses; purchasing histories, and telephone numbers of all. ‘custom: | ers. For these businesses, exposing defections is rela. tively easy. Ie's just a matter of organizing the data, " Sometimes, defining a “defection” takes some work. In the railroad business, for instance, few cus. ‘ ore for the insight they provide. Customeseny “accurate statements, fal od leave can provide a view of the busines that isun- |, A’company that is losing customers because of available tothoseon the inside. And whatevercoaen ‘Tong lines can estimate what perpentage ofciercse. } one individual to defect may cause many others to- Xe would save by buying new cash resisters, andiver, f {illow. The ideais tousedefectionsasancaty ge “Ing atleetion curve to find the dollar value ofa ing signal to leam froin defectors why they leh he . ing them. Then, using ctandard investment, lalysi company and to use that information to improve ment dont as compare the costa the new eqs the business, 2 ment with it x “Ach ‘service quality doesn’t mean.slavishly do customers tends to be concrete and ~Keeping alf customers at any cost. There are ane, aa : f: é g g i i 3 g i : i F to articulate their reasons, and some Bis. decided not to waste its eflrts seeking tren, ane can getat the rootcause.. |. business Iesold iés bakers not to write policies ec ati! information is useful in a variety of ways; as peigbanies that have switched carriers mote than the Staples example shows. Staples ‘tracks twice in the past five years, rot defections, so'when customers stop doing business Conversely much of the information used to find there or don’t buy certain products, the store notices | defecrors it immediately and-calls to get = ‘can point tocommon traits ‘feedback. It may be clue that : Petitive factor management can ox. . Plore further, If it finds sufficient | .. * Staples may cut prices on- those items. This information is highly valited because it pinpoints ihe uncompetitive products and Saves the chain from Jaunching ex- rene broad-brush Promotions Pitching everything to-everybody, « Staples’s telemarketers try todis- tem tehich merchandise its cus- :tomerf'want and don’t ‘want and "| Why The company uses that infor | Mation to change its buying stock | nd to target its catalogs and cou- * Pong more Precisely. Instead of run- | ping coupons in the t, for instance, i¢ can insert them in the “BEST COPY AVAILABLE "FOR REPRODUCTIONtheir inability to, mitment to service ‘BEST COPY ’ frustrated by follow through on their public com. ives quality Since defection rates ar measurable, YY are manageable, Managers can es- tablish meaningful targets and monitor progress. But managing for Many Business leadets Have been force and using defections as a pri- mary performance measure, - ° ° -Everyone in-the Organization must understand that zero, defections is the goal. Mastercare, the auto: 40 You by the customer” It also has a cus- plans. In the two target miarkets where thiS approach tomer adVocate who sits in onal major decision has been used, results ‘are 800d. Employees have re- making sessions to make ‘Sure customers’ interests ‘| sponded. enthusiastically, and 25% more customers are represented, : : say they intend to return, . {tis important to make all employees understand | _ Senior executives at MBNA. America Team from the lifetime valueofacustomer Phil Bressler, theco- | defecting customers, Each one spends four hours - Catt Of five Domino's Pizza stores in Montgomery | 2 month in a special “listening zoom” monitoring '; Maryland; calculated that regular customers | routine customer service calls as well as calls from “wre worth more than $5,000 over the life ene AVAILABLE «+ FOR REPRODUCTION year franchise 4 der taker, . that number, For him, were valuable was not nearly as potent as ° thatit really hitshome” emphasize the importance of keeping example; being pressured into repair So and solve the customer's problem maximize sales, Videos and these different definitions ‘of good: : “Mastercare’s message toemployees includes a can- “did admission that Previous, well-intentioned incen- tives had ‘inadvertently caused ‘employees to run the business the change. And it builds by Great-West Life Assurance TREE “customers who are canceling their credit cards: contract. He made sure that évery or- amount: “Tes so much more than they etre | Mastereare his redesigned ies eniployce training to many. they had not planned on, '| + ‘Mastercare now trains store ers to identify. rather than to role-playing dramatize~ ‘Service, ~ Wrong way; now it is asking them to credibility among employees . sharing its strategic goals and customer outreach Pays brokers a premium ‘fortowering customer ’ defection x ‘HARVARD BUSINESS REVIEW September October 1980,perenne tnt ntrr os creat ne name Beyond conveying a sense of urgency, training should teach employees the spécifics of defections analysis like how to gather the information, whom to pass it on to, and what actions to take in response. Ip one. branch banking system, retention data is sent monthly to the regional vice presi- dents-and branch managers for review: It allows the regional vice presidents to identify and focus on Employees will be more motivated if incentives _| -are tied to.defection rates, MBNA, for cxample, has determined for cach départinent the one or two things that have the biggest impact on keeping cus- tomers. Bach department is nieasured daily on how day's performance is posted in sever- al ‘throughout the building. Eachday that the company hits 95% of these peiformanice targets, .MBNA contributes moncy toa bonus pool. Managers use the pool to pay yearly bonuses of up to'20% ofa ‘that fall short of their-targets to find out where the problem lies." . ; Great-West Life Assurance Company of Engle- wood, Colorado also uses incentives effectively. It pays a 50% premium to group-health-insurance bro- Jeers that hit customer-retontion targets. This system |: gives brokers the incentive to look for customers ‘who will stay with the company fora long time. * Having everyone in the company work toward keeping customers and basing rewards on how well they do creates a positive company atmosphere. En- couraging employees to solve customer problems ‘and eliminate the source of complaints allows them tum. The overall exchange is more rewarding, people enjoy their work more. Not just custo! ‘bur also employees will want to continite their yéla- ’ tionship with the business. MBNA is besieged by ap- plicants for job openings, while a competitor a few miles away is moving some of its operations out of the state because it can’t find enough employees. branches that most need to improve service quality, -) and it gives branch managers.quick feedback-on well performance targets are’ met. Bvery moming, |. .| the previous person’s salary. The president visits departments ' to be “nice’” and customers treat them better in re-. “Thé success,of MBNA shows that it is possible to- | achieve big improvements in both service quality and profits in a reasonably short time. But it also shows that focusing on kéeping customers instead of simply having lots of takes effort. A company = Employeas ke fo workfora companythatkeepsits customers. : \f for moré applicants than jobs. - can leverage business performance and profits through customer ions only when the notion corporate fe snd when all ogi onal ‘concept: zero defections: oW toactonit. © abe per er ‘of the microeconomics of defection. ‘time in comparison with competitors, and a clear understanding. ; Ultimately, defections should be a key perfor: funda- ‘mafice measure for senior management and a mental companent of incentive systems. Managers should know the company’sdefection rate, what hap- pens to profits when the rate moves up or dowa, and why defections o&cur. They should make sure the entire organization understands the importance of keeping customers and encourage employees to pur- sue zero defections by tying incentives, plaining, and budgeting to defection targets. Most important, ‘managers. should use defections as a vehicle for ‘continuously improving the quality.and value of the services to customers. . Just as the quality revolution in manufacturing } had a profound impact on the competitiveness of companies, the quality revolution in services will create a new set of winners and losers, The winners |. will be those who lead the way in managing ti zero defectioris. - Reprint 90508