The Microeconomics of Customer Relationships

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Despite considerable research on customer retention and word-of-mouth referrals, it has always been difficult quantifying their contributions to the bottom line. Using a metric known as “net promoter score,” the author believes firms can now measure the dollar value of customers based on satisfaction levels.

The author administered a survey designed to assess customer relationships to thousands of customers in six industries. He determined that customers tend to cluster into one of three categories: promoters, passives and detractors. Promoters represent more than 80% of the positive referrals a company receives, while detractors represent more than 80% of the negative word-of-mouth. NPS is determined by subtracting the percentage of detractors from the percentage of promoters. Using this data, a firm can quantify the value of a customer by tracking five categories: retention rate, profit margins, spending, cost efficiencies and word-of-mouth.

The firm can then use NPS to make strategic decisions by targeting its efforts to leverage the most value for its customer service dollar. For instance, American Express targets its promoters with premium credit cards in an effort to increase profitability, and GE sends cross-functional teams to its detractors in order to prevent the spread of negative word-of-mouth.

Fred Reichheld, a director emeritus and Bain Fellow at Bain & Co., is the author of The Loyalty Effect (1996) and Loyalty Rules! (2001), both published by Harvard Business School Press. His new book, The Ultimate Question, from which this article is adapted, will be published by Harvard Business School Press in March 2006. Contact him at Fred.Reichheld@Bain.com.

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