Zero Defections: Quality Comes to Services

Zero Defections: Quality Comes to Services

by Frederick F. Reichheld and W. Earl Sasser, Jr.

The real quality revolution is just now coming to services. In recent years, despite their good intentions, few service company executives have been able to follow through on their commitment to satisfy customers. But service companies are beginning to understand what their manufacturing counterparts learned in the 1980s—that quality doesn’t improve 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 scrap 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”—keeping every customer the company can profitably serve—and they will mobilize the organization to achieve it.

Customer defections have a surprisingly powerful impact on the bottom line. They can have more to do with a service company’s profits than scale, market share, unit costs, and many other factors usually associated with competitive advantage. As a customer’s relationship with the company lengthens, profits rise. And not just a little. Companies can boost profits by almost 100% by retaining just 5% more of their customers.

While defection rates are an accurate leading indicator 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 prevent defections is to outperform the competition continually. By soliciting feedback from defecting customers, companies can 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 improvement.

Charles Cawley, president of MBNA America, a Delaware-based credit card company, knows well how customer defections can focus a company’s attention on exactly the things customers value. One morning in 1982, frustrated by letters from unhappy customers, he assembled all 300 MBNA employees and announced his determination that the company satisfy and keep each and every customer. The company started gathering feedback from defecting customers. And it acted on the information, adjusting products and processes regularly.

As quality improved, fewer customers had reason to leave. Eight years later, MBNA’s defection rate is one of the lowest in its industry. Some 5% of its customers leave each year—half the average rate for the rest of the industry. That may seem like a small difference, but it translates into huge earnings. Without making any acquisitions, MBNA’s industry ranking went from 38 to 4, and profits have increased sixteenfold.
The Cost of Losing a Customer

If companies knew how much it really costs to lose a customer, they would be able to make accurate evaluations of investments designed to retain customers. Unfortunately, today’s accounting systems do not capture the value of a loyal customer. Most systems focus on current period costs and revenues and ignore expected cash flows over a customer’s life-time. Served correctly, customers generate increasingly more profits each year they stay with a company. Across a wide range of businesses, the pattern is the same: the longer a company keeps a customer, the more money it stands to make. (See the bar charts depicting “How Much Profit a Customer Generates over Time.”) For one auto-service company, the expected profit from a fourth-year customer is more than triple the profit that same customer generates in the first year. When customers defect, they take all that profit-making potential with them.