Excerpts from The Loyalty Effect [Part II]

TRUE NORTH

The first critical advantage loyalty leaders enjoy­­in an environment about as placid and predictable as the mid­winter North Atlantic­­is a steady and unchanging reference point for navigation. No matter how bad the weather, a company with one eye on the North Star need never experience confusion about where it is and where it wants to go. Of course, no company ever actually reaches a safe harbor. In business, there is no such thing. In business, the journey is everything. But the difference between sailing and drifting is precisely this strong sense of primary direction that guides daily decision making and long­term strategic planning. For loyalty leaders, the sense of direction can take a wide variety of forms, but all come down to the same underlying principle: the creation of maximum value for customers. Let's look at a couple of examples.

Northwestern Mutual

Over the past decade, the life insurance industry has seen chaotic and pervasive change­­new products, new regulations, new competitors, volatile interest rates, and investment markets­­and yet a few companies continue to prosper. One of the best examples is Northwestern Mutual. According to CEO Jim Ericson, the company prides itself on being "the policyholder's company" and believes that the best measuring stick with which to track its success is the policyholder persistency rate. By this measure, the value Northwestern Mutual delivers to its customers continues to improve, because customer defection rates continue to decline. Today, only 4.2 percent of first­year customers and 3.4 percent of renewal customers let their policies lapse. This is less than a third of the industry average.

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The secret to this success is a keen awareness of the true north. Jim Ericson puts it this way: "We have to deal with all kinds of change, but the one thing we're never going to change is our values. This place really is based on the loyalty of the employees to the idea that we are here to deliver value to the policyholder."1 It's easy to talk, of course. There are probably thousands of CEOs who will tell you what Ericson told me. The difference is that Ericson and Northwestern Mutual work always to make the talk come true, and they use defection rates to measure their progress. In executive meetings at Northwestern, the principle of customer value creation repeatedly pops up under challenging discussions, where it actually shapes decisions. The investment group is evaluating, say, a complex derivative product when one person suddenly interrupts the conversation with the question, they've all momentarily forgotten: "But how will it create policyholder value?" The discussion immediately refocuses on that one frequent question; when the answer is unsatisfactory, the group drops the idea.

This question and the answer to it seem to be the critical reference point in all the company's strategic planning as well as in its day­to­day decision making. Many years ago, for example, the company asked itself this question about product distribution. It came to the conclusion that the best way to deliver consistently superior value to customers was to sell only through its network of exclusive general agents, who are committed to the company's strategies and ideals. At the time, sales through independent brokers accounted for 40 percent of revenues. It's not hard to imagine the kind of compromise with the principle most companies would make in such a situation. But Northwestern chose the more courageous course and phased out broker sales, sacrificing a great deal of short­term cash flow for the sake of long­term policyholder value.

Or take a more recent example. In the 1980s, surging interest rates gave most life insurance companies an earnings windfall as investment yields soared. Some firms used the surplus to acquire more new customers. Others went on shopping sprees, buying banks, brokerage houses, finance companies, and credit card companies. Many awarded big management bonuses. But Northwestern Mutual directed the windfall right back to its existing customers. Forbes magazine commented at the time: "It is rare indeed to find a company devoting much effort to a program whose primary purpose is to improve the position of existing policyholders rather than to attract new policyholders. "2 Northwestern explained its decision by pointing to the credo adopted by its executive committee in 1888: "The ambition of the Northwestern has been less to be large than to be safe, its aim is to rank first in benefits to policyholders rather than first in size."3 Despite that lack of ambition, the company today has more than $300 billion worth of life insurance in force.

Northwestern Mutual has been sailing by the same star for more than one hundred years. Founded in 1857, the company faced its first crisis two years later, when a passenger train was derailed after striking a cow near Johnson's Creek, Wisconsin. Fourteen people died, including two Northwestern Mutual policyholders. The claims amounted to $3,500, but the total assets of the two­year­old company came to only $2,000. The policies specified a grace period of sixty days before the company was required to pay the claims. Instead, Northwestern's president borrowed the extra $1,500 on a personal note so he could pay the beneficiaries immediately.

A. G. Edwards

While Northwestern's legacy of putting the policyholder first goes all the way back to 1859, most loyalty leaders have much younger traditions. Lexus and MBNA are newcomers. A. G. Edwards and USAA operated for decades before shifting to a loyalty­based orientation. At each of these companies, however, it was a commitment to the notion of value creation that formed or eventually came to form the cornerstone of the business system.

Ben Edwards III, the current CEO of A. G. Edwards and great­grandson of its founder described how his management team came to focus on loyalty long after the firm was founded. In the mid­1960s, when the firm had about four hundred employees (it now has ten thousand), Edwards' father developed heart trouble and moved to Florida, leaving young Ben Edwards in charge of a company that was, in Edwards' words, "drifting and vulnerable." The executive team held a series of off­site retreats to reconsider their core partnership and the company's strategy and operating principles. After several emotional sessions in which members addressed their own management styles, relationships, and personal objectives, the ten executives agreed to spend two days a month at a Ramada Inn outside St. Louis discussing the company's strategy, direction, market position, and fundamental objectives. What emerged over the next two years was first, a consensus about the firm's mission­­to deliver financial services of superior value to customers­­and second, a growing conviction that to act as the best possible agent for its clients, the company would have to fundamentally redefine the broker's role.

Historically, the primary corporate goal had been to maximize profits. But it became clear in the meetings in St. Louis that that goal was inconsistent with the new mission. At a typical brokerage house, the trading desk acts as an essential profit center, and corporate executives earn an override on those profits. The trading desk tries to make as much as it can on each customer trade, rather than give the absolute lowest price to the customer whose interests the company is pledged to promote. The conflict of interest is apparent. As profit to the trading desk grows, value to the customer diminishes. As we pointed out in Chapter 4, in­house mutual funds create another conflict by encouraging brokers to push company funds even when better alternatives are available and appropriate.

Having made a commitment to act like the customer's actual agent, A. G. Edwards now took the radical step of eliminating all these practices. Headquarters ceased to be a profit center. Financial incentives that worked against the interests of the client were weeded out; the firm stopped manufacturing its own products. According to Ben Edwards, "We decided to view profits as a necessity, but not as a goal. Committing ourselves to our customers allowed us to have fun running the business as well as we possibly could. Our top managers began to like and respect each other more, and we all felt energized, often putting in fourteen-hour days. We also decided to put all the cash we generated back into the business. To our surprise, when we removed profits as a goal, profits went up!"4

This new view of its mission prompted A. G. Edwards to redefine what it meant by loyalty. "When most brokerage houses talk about broker loyalty," Edwards explains, "they mean that their brokers are loyal to headquarters by pushing the more profitable in­house fund groups. But to us, that is disloyal behavior because it means the broker is not acting in the customer's best interests."5 Loyalty leaders like A. G. Edwards tends to think of loyalty not as loyalty to the company but as loyalty to a set of principles that stand ahead of profit. It is this higher­order loyalty that energizes employees, builds customer retention, and, paradoxically, generates cash flow and profits.

The firm's basic principle is that it exists to deliver value to the customer, and its dedication to this principle produces the kind of behavior guaranteed to mystify and depress competitors. A. G Edwards is still the only brokerage that refuses to sell in­house products. In Chapter 1, we saw how State Farm paid more than its policies required to bring hurricane­damaged homes up to code, because as CEO Ed Rust, Jr., explained, "Our goal is to take care of our policyholders. That's what we're driven by."6 As Dave Illingworth of Toyota/Lexus pointed out, "The more you focus on the bottom line, the harder it is to hit."

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USAA

Another company that has earned its way into the front ranks of loyalty leaders by adhering to the principle of putting customer value first­­followed closely by employee value­­is USAA. Founded in 1922 to provide auto insurance to military officers, USAA's performance was lackluster for decades. Always right on claims and on price, the company was dreadfully weak on customer service. When retired general Robert McDermott took over the helm in 1968, policy paperwork and service commitment were in such a mess, he almost changed his mind about taking the job. On any given day, the chances of finding a particular file were only fifty­fifty, and the company employed twenty to thirty college students to come in every night and search for missing records in the piles of paper that covered hundreds of desks. Moreover, morale at the company was abysmal. The average employee stayed with the company only eleven months, and many did little but punch their timecards in and out.

McDermott made radical changes. The first was to give an unequivocal top priority to customer service. He implemented a set of programs to automate policy and claims processing; greatly expanded the list of financial services the company offered and broke the bureaucracy up into five groups that competed with each other on service quality and productivity. McDermott spent $130 million on technology to produce a nearly paperless company in which every service representative has instantaneous access to every customer's records­­including computer images of hand­drawn sketches of accident scenes. Above all else, however, he insisted on delivering value, service, and loyalty to the customer.

For example, nearly every life insurance policy in the world has a so­called war clause, which lets the company off the hook in the case of combat deaths. USAA policies have no such provision. That may seem obvious in a company that serves military officers, but USAA pushes the logic of loyalty a step further. During Desert Storm, the company allowed policyholders to increase their coverage and actually sold new policies to people on their way to the war zone. (Of the fifty­five officers killed in that war, everyone was a USAA member.) At the same time, the company encouraged members to downgrade their auto insurance policies since cars that sit home in the garage don't need liability coverage. USAA set up hotlines to serve members with special needs associated with the emergency and went out of its way to assure them that their insurance would not be canceled because of late payment due to the war. When auto losses turned out to be even lower than expected, the company declared a 25 percent rebate on auto policies for everyone who served in Desert Storm.

The second thing McDermott did was invest heavily in employees. USAA spends $19 million (2.7 percent of its annual budget, double the industry average) on training and education. The company's seventy­five classrooms are filled every evening, and some 30 percent of employees take courses in any given year. Furthermore, the training has a goal. New skills and increased competence lead to promotions for almost half the workforce every year. USAA has also pioneered progressive employment practices, like the four­day workweek for virtually all employees. The company's 286­acre headquarters includes tennis courts, softball diamonds, jogging trails, a driving range, and three artificial lakes. USAA has become probably the most desirable employer in San Antonio.

McDermott retired in 1993, but the company's new CEO, Robert Herres, another ex­general, is equally committed to USAA's concept of true north. McDermott enriched jobs with education, career opportunity, empowerment, higher job content, decentralization, and a battery of extra morale­boosters. But at the root of his and now the company's view of work is the conviction that what makes people happy in any job is doing better work­­giving customers more value, creating stronger bonds with them. In short, what drives USAA is valued, not profit. In an interview in the Harvard Business Review in 1991, McDermott said, "The mission and corporate culture of this company is, in one word, service. As a company objective, service comes ahead of either profits or growth."8

In general, loyalty leaders feel that their commitment to an ethical mission­­placing customer benefit above their own short­term profit­­gives them an advantage in coping with change. Whereas academics have turned business ethics into a complicated debate, loyalty leaders see it very simply. They do what they say they are going to do; they live up to their commitments and often exceed them. Most importantly, they always try to act in their customers' best interests. This behavior not only energizes the organization, but it also gives everyone in it an easy­to­read road map in times of confusion and heightened competition. Knowing who you are and where you're going is not just ethical window dressing, it's a competitive advantage.

Northwestern Mutual's CEO Jim Ericson recently attended a roundtable on ethics at the Harvard Business School. When he said he saw ethics as a strategic advantage for his company, most of the other participants were skeptical. Doing business ethically was desirable, they all agreed, but there was no denying that it often constrained profits.

Ericson does deny it, and Northwestern's experience bears him out. In fact, superior ethical underpinnings give all loyalty leaders an advantage among employees and customers that translates into higher profits, not profit constraints. Ericson recalls that when he was recruiting young lawyers for Northwestern's legal department, one of the key benefits he stressed was integrity. "Our morals at this firm stop our way before the law does," he used to tell recruits. "You'll never lose any sleep here because this company is going to do the right thing."9 He wasn't talking only about following federal guidelines. He meant that employees could rely on the company to dedicate itself to a higher mission than profit­­the mission of creating value for customers. That mission is a big part of what customers are buying when they do business with the company and one of the principal reasons they come to Northwestern Mutual to stay.

Also Read: Excerpts from The Loyalty Effect [Part I]