InformationWeek: The Business Value of Technology

oyalty might seem like a quaint idea with no place amid the harsh realities of a downturn. Fred Reichheld argues that it takes times like these before a company knows if it's built employee, investor, or customer loyalty. Reichheld, author of The Loyalty Effect (Harvard Business School Press, 1996) and the upcoming Loyalty Rules! (Harvard Business School Press, this summer), thinks technology firms are among the worst in promoting loyalty among customers and employees. And he warns that technology such as customer relationship management tools can make matters worse. Unless a company starts with committed employees who believe in creating loyal customers, tools such as CRM just make it easier to abuse customers for short-sighted, short-term gain.

Reichheld spoke with managing editor Chris Murphy about how his ideas fit today's tough economic times.

InformationWeek: Is loyalty a luxury for the good times that companies can't afford in bad times when they feel they must make layoffs?

Fred Reichheld: My philosophy is to avoid layoffs at almost any cost. The only time you know whether you've got loyalty is in the tough times. It's the only test of loyalty. Loyalty is staying there when it's not necessarily in your best interest in the short term. It's those tough times that make loyalty so obviously valuable, vitally necessary.

IW: How can your ideas about loyalty help people?

Reichheld: My hope is that more and more managers and executives start to realize that you can't grow a business successfully in the long-term without building in loyalty. It's not a luxury. It's something that you must invest in [during] the good times so that you have it in the bad times. Otherwise, you have nothing. And people just run for the next-best opportunity. It's economically rational to invest in loyalty. Companies that have done it are phenomenally successful in terms of growth and profits.

IW: What are loyalty's key principles?

Reichheld: I break them into six. There's one, however, that's overarching: leaders have to act in their partners' best interest. They need to put the success of their partners ahead of their own selfish interest. That seems like it's at odds with how most people go at business. Business is about the pursuit of self-interest. Great leaders build the right kind of partnerships, so they share in the success of the partners. They work very hard to find win-win solutions. As opposed to extracting maximum value from customers, squeezing your suppliers, and bullying your employees into doing what you want, great leaders always search out opportunities where both partners can win in delivering better value to a customer. A great example is Harley-Davidson Inc., whose managers could have easily squeezed their unions when they decided to build a plant in Kansas City, Mo. They could have gone to a right-to-work state because Harley-Davidson is very strong and unions are weakening everywhere. Instead of trying to kill the union, they brought them into the process to search for the next plant. Harley managers sought an even better partnership with the union and structured things in work groups that made more sense. Ten union presidents in Kansas City sit in the same office as the plant manager. They've got better productivity in their Kansas City plant. They actually have the unions trusting them more than they did in the original plants because management didn't ditch them when they could. Don't take advantage of a partner just because you've got a leg up at this point in time.

IW: What else?

Reichheld: The No. 2 principle: be very picky about your partners and customers. It's not out of arrogance; it's out of humility. Managers know they cannot provide outstanding value and opportunities to just anybody. They're clear about where they can build mutually beneficial relationships. They're real picky on who they hire; picky on who their customers are and who they invest in as customers. They're picky about who gets promoted within an organization--it's how those people behave that are the role models that attract or repel others.

No.3, they keep things simple by having smaller teams than their competition. They resist the tendency to let things get big. One of my favorite examples of this principle is Enterprise Rent-A-Car. Once a branch, Enterprise has grown to be the largest car-rental company in North America. Enterprise managers remain flexible, adaptable, and fast on their feet. Like a cell that divides, the branch splits when it gets to a certain size. Most competitors have teams that are double in size, and therefore, more complex, more hieratical. People on big teams feel less needed because they believe they're not vital to the company's success, and therefore, it's a less meaningful role for them.

No. 4, offer incentives that reward loyalty. Most incentives today actually abuse loyalty. The best deals are reserved for new customers or to switch people [to a company's product or service]. Good companies make it worth people's while to stick with them. On the customer side, Vanguard Mutual Funds is a great example. They give a price cut if you've been a loyal customer. Simply by having been in there, you get better deals than people who come in today.

IW: You certainly see it all the time on the career path.

Reichheld: If you're a loyal employee, you get taken for granted. Most people get to the top in organizations, it seems, by career surfing their way around. How can you expect people to stay, dig in, and be loyal when you abuse their loyalty? You don't find loyal employees without loyal customers, and vice versa.

The fifth principle is to be open, honest, and direct, which fits very nicely with the Internet economy that makes information available to everybody. It's much harder to keep secrets than it used to be. Spin control and PR don't flush any more.

Cisco is a great example, with its open bug database. Whenever a problem occurs with a Cisco product or service, their customers, suppliers, or own employees post it to a bug database that the company has created. It's then opened to the public, including journalists, which is pretty courageous. One of the key components of making a relationship worthy of loyalty is that you can trust your partners to be honest.

I call the final principle preach what you practice. The notion of loyalty is so misunderstood; most people think it's a joke in business today. If you're to make loyal relationships a linchpin of your strategy, you have to be very clear about the principles and why those principles make economic sense. Otherwise, you'll get dismissed as a nut or as someone who's not telling the truth. Good companies tend to be very clear about what their principles are and they make them a magnet for hiring the right kind of people. Most businesses today are a little sloppy. They say my principle is maximizing shareholder value and they think that puts them on the high ethical ground. It doesn't. The shareholders are no more important than customers or employees.

IW: Are companies that lay off employees abusing loyalty?

Reichheld: In a case like Cisco, where they worked like crazy to avoid layoffs but now they're boxed into one, it hurts. But it hurts a lot less than at places where they go to the layoff button when they need earnings or need to impress their analysts groups. Most people understand that layoffs are unavoidable in certain circumstances. If employees see that managers bend over backward to avoid layoffs and they don't benefit personally from layoffs, then employees realize that's part of life. But there are way too many companies that jump into layoffs because they think layoffs can push up earnings this quarter and their stock options will be worth more. That's a good way to destroy any semblance of loyalty. When executives behave in a selfish manner, they're not going to get loyalty from their customers, employees, or partners.

IW: How do companies handle economic cycles?

Reichheld: The best loyalty companies use the tough times to hire the best people. They don't stop hiring completely. They just stop hiring anybody except outstanding candidates.

IW: What's the relationship between loyalty and technology?

Reichheld: A lot of customer relationship management tools are really weaponry in disguise. They're designed to cram more stuff down a customer's throat, cross sell them because they're vulnerable. Or, "Gee, this is the kind of customer who doesn't seem to be price sensitive, so let's charge him more." The kinds of customer relationship tools that have value tend to reward customers for their loyalty or find ways of adding more value. Vanguard uses customer relationship tools to identify customers who have been with them for at least 10 years in order to give them better pricing. That's a very powerful tool. It's for the right purpose; it's the right objective. When people tell me they're putting a lot of money into CRM, I try to get to the objective of what they're going to accomplish with it so I can make a judgment whether it's a thing that's going to build loyalty or destroy it. I've been excited and frustrated about loyalty because so few people understand it. It's dismissed as an anachronism in the Digital Age, but it's the essence of success. People think, "Oh, loyalty is of the past." Unless you have people who you can trust to behave according to a certain set of principles, you can't cope with the amount of change that successful companies need today. Loyalty is actually about the future.