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17/10/2017 The High Price of Customer Satisfaction

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The High Price of Customer


Satisfaction
Magazine: Spring 2014 Research Feature March 18, 2014 Reading Time: 25 min

Timothy Keiningham, Sunil Gupta, Lerzan Aksoy and Alexander Buoye

Managers often assume that improving customer satisfaction and


financial performance go hand in hand. The reality, however, is
much more complex.
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Satisfaction guaranteed or your money back. That business promise
has been made to consumers since 1875, when Montgomery Ward used
it to differentiate his mail-order catalog from other retailers.
Commitment to customer satisfaction is now a vow many businesses
make. It is common to find mission statements and marketing plans
that specifically address customer satisfaction; compensation systems
that incorporate satisfaction metrics into their bonus criteria; and
advertisements that trumpet customer satisfaction awards.

Customer satisfaction has become the most widely


used metric in companies efforts to measure and
manage customer loyalty. 1 The assumption is simple
and intuitive: Highly satisfied customers are good for
business.

However, the reality has not proven nearly so simple.


In fact, we have found that if you look across
industries at the correlation between companies

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customer-satisfaction levels for a given year and the


corresponding stock performance of these companies
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for that same year, on average, satisfaction explains
only 1% of the variation in a companys market return.

Another recent examination of the relationship


between satisfaction and stock performance by
Bloomberg Businessweek reported even worse results
than our own. In a 2013 article entitled Proof That It
Pays to Be Americas Most-Hated Companies, the
magazine reported that customer-service scores have Niche brands, such as the Five Guys chain of restaurants
specializing in burgers and French fries, often have higher
no relevance to stock market returns the most-hated customer satisfaction levels than their larger mass-market
competitors.
companies perform better than their beloved peers
Image courtesy of Flickr user mike fabio.
Your contempt really, truly doesnt matter If
anything, it might hurt company profits to spend
money making customers happy. 2 These findings were so unexpected that comedian Stephen Colbert
offered American corporations his faux help to get those customer satisfaction ratings right in the toilet. 3

Admittedly, the above examples represent overly simplistic examinations of the relationship between
satisfaction and stock performance. You would expect customer satisfaction to impact performance over
time, so simply looking at satisfaction and stock performance levels for the same year is not going to
accurately capture the complete relationship. 4 And academic research consistently finds that there is a
positive, statistically significant relationship between satisfaction and a host of business outcomes such as
customer retention, share of wallet, referrals and stock market performance. 5 We ourselves have written
numerous articles demonstrating this very fact. 6

The problem, however, is that the relationship between customer satisfaction and customer spending
behavior is very weak. 7 How weak? Our research finds that changes in customers satisfaction levels
explain less than 1% of the variation in changes in their share of category spending. Yes, the relationship is
statistically significant, but it is not very managerially relevant.

Because of findings like these, some managers have openly challenged whether the relationship between
unobservable measures such as customer satisfaction and observable behavior such as purchasing was
sufficiently strong to justify its use as the primary unobservable predictor. 8 Some consultants have gone
further, writing books or articles declaring satisfaction a waste of money. 9 And even in the scholarly
community, some academics have questioned whether customer satisfaction actually links to market
performance. 10

So weve reached a fundamental crossroads. Is customer satisfaction worth the cost? To find out, we
undertook an intensive investigation into the relationship between satisfaction and business outcomes,
gathering data from more than 100,000 consumers covering more than 300 brands. (See About the
Research.) Our investigation, in conjunction with our prior research and background in consumer
satisfaction, uncovered three critical issues that have a strong negative impact on translating customer

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satisfaction into positive business outcomes. Whats more, these issues are equally applicable for other
commonly used metrics such as the net promoter score (NPS, a way to measure customer loyalty). Given
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their scope, we believe these findings should inform every companys customer-service strategy.

About the Research


The primary data used to assess the relationship between satisfaction and business outcomes comes from
two sources. Data set 1 contained American Customer Satisfaction Index data from 2000 to 2009 across
137 NYSE-, AMEX- and NASDAQ-listed U.S. companies. We tied these measures to stock returns
collected by the Center for Research in Security Prices at the University of Chicago. Additionally, for a
subset of this data, we appended market-share data obtained from various industry-specific sources.

Data set 2 contained 161,552 consumer satisfaction ratings and category spending levels across 315
brands. This data was collected by a large market research company as a part of its global norms database.

The breadth of these two data sets allowed us to examine the nature of the relationship between
satisfaction and business outcomes, as well as satisfaction and consumer spending. The first step in the
analysis was to measure the strength of association between satisfaction levels and the various outcome
measures collected. Additionally, as data set 2 provided customers satisfaction ratings for all brands they
used, we examined relative satisfaction levels and their relationship to customers category spending
levels. Relative satisfaction metrics were created by transforming a customers absolute satisfaction levels
for the brands used into ranks; specifically, the brand with the highest satisfaction level was ranked 1, the
second highest 2 and so forth.

Issue 1: Money-Losing Delighters


High customer-satisfaction ratings are typically treated by managers as being universally good for business.
Our findings indicate, however, that the benefits are not nearly so clear-cut. There is a downside to
continually devoting resources to raise customer satisfaction levels. Why? Because managers are rarely able
to accurately quantify the cost associated with increasing customer satisfaction scores from, for example,
8.7 to 9.1 on a 10-point scale, nor are they able to determine precisely what such an increase is actually
worth. 11

It turns out that the return on these investments is often trivial or even negative. 12 Although we find that
improved satisfaction can increase sales revenue, the additional costs frequently outweigh the benefits. For
example, a large beverage distributor in the midwestern U.S. found that the return on its satisfaction efforts
was negative. Despite increased revenue from more satisfied customers, customer service costs increased by
10% as a result of the program, which overwhelmed any benefit from increased sales. 13

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If we look at one key factor that drives customer satisfaction low prices it is easy to see why this is the
case. Our analysis of the U.S. credit union industry finds that the primary reason credit union customers
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prefer these institutions to banks is price specifically, credit unions charge lower fees and offer higher
interest rates on deposits than banks. 14 The result is that credit unions typically have among the highest
customer-satisfaction level of any industry investigated by the American Customer Satisfaction Index, or
ACSI. 15

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In general, satisfaction and price are almost always inversely related. As a result, lowering price tends to be
one of the easiest ways to improve satisfaction levels. But for most products and services, the potential for
dropping price while still remaining profitable is limited and low prices are often not good for businesses.

For example, the majority of customers of a large financial services company we examined were highly
satisfied. The problem was that over two-thirds of these highly satisfied customers were also unprofitable to
the company. The customers high satisfaction was driven largely by the belief that they were getting
exceptional deals and they were. Products were often priced below cost. Every time the company
mispriced its offer, customers bought in large quantities. As a result, not only were these customers
unprofitable, they were also some of the companys largest customers. Adding insult to injury, as large
customers they also expected a great deal of ancillary services to be automatically provided by the company
for free.

In another example, our analysis of Groupon social coupon offers found that the relationship between
customer satisfaction and merchant profitability is frequently negative. 16 In fact, four of the six top-
performing categories of Groupon offers in terms of satisfaction were money losers for the merchants.
Because of their high customer satisfaction, however, they generated a huge demand. These four categories
accounted for 50% of total Groupon volume!

These findings point to an important truth about the relationship between customer satisfaction and
customer profitability. While customer satisfaction and profitability are not mutually exclusive, they dont
have to be aligned, either. Managers typically have many competing alternatives for improving satisfaction.
They could provide a better customer experience or offer more innovative products, for example. Not all
alternatives will be profitable. Furthermore, not all customers can be profitably satisfied. Some are not
willing to pay the necessary price for the level of service being offered. Others demand a level of service that

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more than offsets any revenue they provide. The bottom line is that there is no substitute for understanding
the profit impact of your efforts to improve customer satisfaction. Armed with this information, managers
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can make the right and sometimes difficult decisions for their businesses.

In the case of the financial services company, the information our analysis revealed caused the company to
change its product-pricing strategy to ensure that products were not sold at a loss. Managers also reached
out to unprofitable customers to frankly discuss the fact that the company was losing money on the services
provided and inform the customers that there would now be a cost for using them. Initially, almost all of the
customers chose to stop using the services, arguing perhaps disingenuously that they didnt really need
or use them. And as expected, satisfaction levels initially declined as a result of the change.

Within three months, however, virtually all of these customers willingly paid to have the services in
question restored. Paradoxically, after they paid to have the services they initially received for free,
satisfaction levels increased to their prior levels. Customers not only recognized the value of these services
after being without them but were also willing to pay for them.

Issue 2: Smaller Often Equals Happier


Given that higher satisfaction levels are believed to result in higher customer spending, we might expect a
strong positive relationship between satisfaction and market share. The reality for many business sectors,
however, is quite the opposite. 17 In fact, research finds that high satisfaction is a strong negative predictor
of future market share. 18

We often see examples of this inverse relationship between satisfaction and market share. For example,
McDonalds consistently ranks below Burger King and Wendys in industrywide customer satisfaction
comparisons. For the 18 years that ACSI has tracked these companies, Wendys has always had the highest
satisfaction level of the three, while Burger King has been second and McDonalds third 17 times. Wal-Mart
has a similar story. Since 2007, it has recorded the lowest customer satisfaction scores of all discount
retailers tracked by ACSI. Target, Sears and J.C. Penney all consistently outperform Wal-Mart on this
customer satisfaction measure year after year. 19 Despite low relative satisfaction levels, however,
McDonalds and Wal-Mart have by far the largest market shares in their respective industries.

The primary reason for this seemingly counterintuitive finding is that the broader a companys market
appeal relative to the offerings of competitors, the lower the level of satisfaction tends to be. Why? Gaining
market share typically comes from attracting customers whose needs are not completely aligned with the
companys core target market. As a result, smaller niche companies are better able to serve their customers.
Companies with a large market share, on the other hand, must by their very nature serve a more diverse set
of customers.

Consultants have prodded managers to benchmark their performance relative to high-satisfaction brands.
The argument is that customers judge a companys performance not just by the performance of direct
competitors but also by the service they receive from the best companies in other categories. There may be
some truth to this, but often the comparison is not managerially relevant, and these best-in-class

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examples reflect niche brands in categories where there is high customer involvement. While there may be
things to learn from their stories, trying to achieve the satisfaction levels of these best-in-class niche brands
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would be counterproductive for many organizations.

In addition, increases in a companys customer-satisfaction ratings often happen as the result of a decline in
market share. For example, an examination of the ACSI data shows that Burger Kings satisfaction levels
rose over the same time period that it was losing share to McDonalds and Wendys. Kmart scored its
biggest year-over-year increase in customer satisfaction (and its highest ACSI score since tracking began) as
it was preparing its bankruptcy filing because of large-scale customer defections.

Should managers not care about customer satisfaction in the pursuit of market share growth? No they
should care. If market share is the goal, then managers need find the right balance between customer
satisfaction levels and broad customer acceptance.
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Issue 3: The Importance of Being No. 1


The overriding reason that companies measure satisfaction is the belief
that higher scores result in a greater share of a customers wallet. The
unfortunate reality, however, is that our research indicates that
knowing a customers satisfaction level tells you almost nothing about
how she will divide her spending among the different brands used. As a
result, changes in customer satisfaction levels are unlikely to have a
meaningful impact on the share of category spending customers allocate
with your brand.

Why? Single-brand loyalty, which was common in our parents and


grandparents generations, has been replaced with loyalty to multiple
brands in a category in many sectors. 20 Because of this divided loyalty,
more customers partially defect (in other words, they give more of their
business to a competitor) than completely defect from a business or
brand. As a result, improving customers share of spending with your
brand tends to represent a far greater opportunity than efforts to
improve customer retention.

For example, a study of the hotel industry by Deloitte found that, on


average, approximately 50% of hotel guests spending is not with their preferred hotel brand. 21 A study of
the banking industry by McKinsey found that, on average, only 5% of bank customers actually close their
accounts each year and that the corresponding loss represents just 3% of total deposits. On the other hand,
35% of customers reduce their share of deposits, and that corresponding loss represents 24% of total bank
deposits. 22

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Unfortunately, because of the weak relationship between satisfaction and share of wallet, managers are
typically unable to identify what their companies must do to capture a greater share of customers spending.
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Managers tend to believe that customers who rate themselves as completely satisfied are more likely to
give the lions share of their spending in the category to their brand. As a result, managers frequently assess
their satisfaction levels as the percentage of customers who rate their satisfaction at the highest level. (In
the case of NPS, customers rating themselves a 9 or 10 on an 11-point (0 to 10) recommend intention
scale are classified as Promoters.) The goal then becomes to get that number up higher.

The problem with looking solely at a companys satisfaction or NPS score is that it is a poor indicator of the
relative preference that customers have toward the brands they use. For example, imagine that your brand
has two customers: Janet and John. Both rate their satisfaction with your brand a 9 on a 10-point scale
(where 10 is the highest). Virtually all managers would consider this a good score. Using the NPS
classification system, both Janet and John would be considered Promoters of your brand.

Janet and John, however, also use two other brands: Brand A and Brand B. Janet rates her level of
satisfaction with Brand A 9 and her satisfaction with Brand B 10. John, on the other hand, rates his level
of satisfaction with Brand A 7 and Brand B 8. Even though Janet and John both rate your brand a 9,
your brand is Johns clear first choice. For Janet, your brand is tied for last. The result is that John allocates
a substantially higher share of his category spending with your brand than Janet does.

This type of situation happens all the time. For most industries, customers divide their spending among
multiple competing brands. But not all brands are equal in satisfying customers. We would naturally expect
preferred brands to get a greater share of customers spending in the category. So the measure that really
matters isnt your percentage of delighted customers or promoters. What matters is the relative rank that
your brands satisfaction level represents vis--vis your competitors. 23 In other words, the highest
satisfaction rating a customer could give to a brand would be assigned a 1, the second highest a 2, and so
on.

While the idea of ranked satisfaction might seem radical, it actually builds upon what researchers have
known for a long time: Satisfaction is relative to competitive alternatives. 24 In fact, our research finds that
the relationship between satisfaction and share of wallet is a function of satisfactions relationship to the
relative rank. 25 The problem is that we havent applied this knowledge to how we actually measure and
manage customer satisfaction.

Our research finds that simply transforming absolute satisfaction levels to relative ranks tends to explain
more than 20% of the variation in customers share of category spending. That is a remarkable
improvement, given that absolute satisfaction levels tend to explain only 1% of the variation in share of
wallet.

The problem with using ranked satisfaction levels, however, is that unlike the percentage of top box
satisfaction levels, average rank is not easy to interpret, nor is it easy to rally the organization around. That
is because we think of ranks as whole numbers for example first, second, third place, and so forth. A
companys average rank, however, is almost never a whole number. As a result, it is hard for managers and
front-line employees to internalize. An easy way to get around this problem is to track the percentage of

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customers who give your brand their highest satisfaction rating among all brands that they use. In other
words, is your brand really a customers first choice, or do customers view your brand as being the same as
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or worse than competitors? The percentage of members who rate a brand better than all other competitors
used correlates strongly with share of wallet.

Making Satisfaction Work for You


These three findings show that it is easy for customer satisfaction and profitability to become misaligned.
That doesnt have to be the case. Below we present strategies that managers can easily implement to ensure
that those two goals remain in alignment.

Value to the Company vs. Value to the Customer

At their core, customer-company relationships are about the exchange of value. The value that a customer
provides to the company is the flow of profits over time. For the customer, value is the satisfaction obtained
from the companys products and services. Not all company-customer relationships, however, represent a
fair exchange. After analyzing your customers levels of satisfaction and their corresponding profitability,
you can place each of them into one of four categories. (See Customer Satisfaction vs. Customer
Profitability. 26 )

Customer Satisfaction vs. Customer Pro tability


Sorting customers into four categories based on each customers satisfaction and profitability to the
company can help managers develop effective strategies for each customer category. (Note: The high/low
distinction is relative to other brands in the category.)

We call customers who do not get much value from the company and in turn provide little economic value
to the company lost causes. If the company cannot migrate these customers to higher levels of profitability,
it should reduce its investment in these customers or even fire them.

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By contrast, star customers get high value from the companys products and services and provide value to
the company by way of higher margins and strong loyalty. These are the companys ideal customers, and the
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key here is to continue to delight them.

The other two cases show unbalanced, and therefore unstable, relationships. Vulnerable customers provide
high value to the company but do not believe that they are getting a fair value in return. Managers need to
invest in these customers through better product offerings, additional services, and the like. The key is to do
this without overkill in other words, without turning them into unprofitable customers.

Free riders are the mirror image of vulnerable customers. These customers get superior value from the
companys products and services but are not very valuable to the company. Managers first need to
determine why free riders are low in value to the company. Is it because the share of wallet that they
contribute to the company is small or because they cherry-pick items only when they are on sale?

If the issue is small share of wallet, managers need to focus on up-selling and cross-selling to these
customers. In the case of cherry-pickers, managers need to establish clear cost controls and purchase
restrictions to increase profit margins. For example, it may be reasonable to cut service levels to these free
riders and reallocate those resources to vulnerable customers.

Market Share vs. Customer Satisfaction

As noted earlier, the relationship between customer satisfaction and market share is negative in many
industry categories. Without a good understanding of the nature of the relationship in your industry and of
where your company stands vis--vis competitors, it is very difficult to effectively manage the customer
experience in the pursuit of market share.

The place to begin is with an analysis of customers level of satisfaction with not only your company but also
with your competitors, as well as your and your competitors market shares. With this information, you can
place each of those competitors into one of four categories. (See Customer Satisfaction vs. Market
Share. 27 )

Customer Satisfaction vs. Market Share


Managers can gain insights into competitive strategy by analyzing customers level of satisfaction not only
with their company but also with its competitors in relationship to each companys market share. (Note:
The high/low distinction is relative to other brands in the category.)

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If one or more companies fall into the high market share, low customer satisfaction category, the industry
most likely demonstrates a negative relationship between customer satisfaction and market share.
Companies with high market share and low satisfaction combinations are, as we discussed before, mass-
market brands. These companies have a wide range of customers with a diverse set of needs. Given the
breadth of different customer needs served by mass-market brands, it is impossible for these companies to
precisely meet the needs of all or even most customers. As a result, some core benefit such as price,
convenience or product assortment needs to be sufficiently strong in order for customers to sacrifice having
their needs met more completely.

Because mass-market brands focus on the general needs of a wide audience, they typically find themselves
competing with smaller, more focused competitors that better target the needs of specific segments of
customers. These niche-brand competitors by necessity must have higher satisfaction levels to survive. Yet
because these companies target a smaller segment of customers, their market share is relatively low. For
example, niche fast-food burger restaurants like Five Guys have higher satisfaction levels than any of the
big three burger chains (McDonalds, Burger King and Wendys) because of the smaller companies almost
exclusive focus on burgers and fries. Clearly this strategy has proven highly successful for Five Guys, but the
limited menu also makes it virtually impossible for the chain to achieve overall market-share leadership in
fast food.

In some categories, there are brands that exhibit both high customer satisfaction and high market share,
which we refer to as high-loyalty brands. For example, Google has consistently received higher customer
satisfaction ratings than its competitors in Internet searches while capturing almost two-thirds of U.S.
search activity. High-loyalty brands, however, are similar to mass-market brands in that they face
competition from niche brands.

How are these brands able to avoid the relatively poor customer satisfaction score that mass-market brands
typically receive? It is interesting to note that high-loyalty brands frequently are found in the technology
sector, a dynamic market. Competitive intensity combined with rapidly changing and improving product
offerings means that these markets are in constant flux. As a result, customers have not habituated to the
products offered. But this is a double-edged sword. Because the markets are in a high state of flux, winners
can quickly lose ground as companies such as BlackBerry have discovered.

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There are also brands that despite relatively low satisfaction and low market-share levels are able to
compete successfully. These conditional-use brands, as we refer to them, are able to compete effectively
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either because they uniquely offer items needed to complete the consumers shopping basket in the category
or because some market barrier makes using a preferred brand difficult. For example, many retailers and
restaurants compete largely through the convenience of their locations relative to competition.

Given that each quadrant of the satisfaction/market-share matrix represents a viable business strategy,
simply comparing average satisfaction levels across brands in a category offers little real insight. So how
should a 40% share Brand A compare itself with a 10% share Brand B in terms of satisfaction? A simple rule
of thumb is to compare satisfaction levels of customers that correspond to equivalent market shares for
both brands. So, in this case Brand A would take its top customers that constitute 25% of its revenue (if it
had only those customers, it would have a 10% share), and compare their satisfaction level with that of
Brand B. If they are comparable, then Brand A is fine. If, however, their satisfaction level is significantly
lower, then Brand A managers need to assess the risk of losing these customers to competitors and work to
mitigate that risk.

Satisfaction and Customer Advantage

The overriding reason for managements focus on customer satisfaction is as a source of competitive
advantage. At some level, managers expect high satisfaction levels to cause customers to prefer a brand to
competitive alternatives. Clearly, there is some truth to this. As with all management truisms, however, the
devil is in the details.

What really matters is whether or not your customer satisfaction rating is higher for your brand than for
competing brands that a customer also uses. The lions share of a customers wallet goes to his or her first-
choice brand. Therefore, it is vital to understand how a brands satisfaction level translates into being a
customers first choice. By analyzing customers levels of satisfaction and their corresponding first-choice
selection, you can place your company and each of your competitors into one of four categories. (See
Satisfaction vs. First Choice.)

Satisfaction vs. First Choice


Most of a customers spending goes to his or her first-choice brand. By analyzing customers levels of
satisfaction and the percentage of customers who would classify a brand as their first choice among
competitors, you can place your company and each of your competitors into one of four categories. (Note:
The high/low distinction is relative to other brands in the category.)

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For customers who are both highly satisfied and prefer your brand to all others, you are the star brand in
the category. Here the strategy is simple: Continue to delight these customers. At the opposite end of the
spectrum are brands that are low in satisfaction and in first-choice preference. This is the underlying
foundation that results in the conditional-use brands discussed earlier. The strategy here should be to
maintain unique items that would be difficult or unprofitable for competitors to incorporate into their
offering, or to find ways to erect market barriers that make access to a preferred brand difficult.

For those customers where satisfaction is high but first choice is low, high satisfaction levels are masking
customers real perceptions of the brand. Managers typically tout the fact that customers are highly
satisfied, but the reality is that the brand is one of several that the customer uses and views as being
basically equivalent, which is why we refer to them as parity brands. The strategy for these brands must be
differentiation from core competitors; in other words, you must give customers a reason to believe your
brand is better.

There are also brands that despite low satisfaction still represent customers first choice. These low-service
category brands compete successfully either through price leadership or because the category has few
competitors. These brands can compete successfully provided that significant price leadership can be
maintained or there are sufficient entry barriers for competitors. For example, the American Customer
Satisfaction Index consistently shows Wal-Mart to have the lowest satisfaction levels of all major grocery
retailers in the United States. Yet our research finds that the percentage of its customers who consider it
their first-choice grocer is high relative to competitors. And despite it being a low-service category position,
this strategy has paid off handsomely for Wal-Mart. It is now the largest grocery retailer in the United
States, with groceries contributing 55% of its sales. 28

Wal-Marts buying power and its cost-effective supply-chain management allow it to keep prices low while
maintaining healthy margins. 29 For many companies, however, this is an inherently difficult position to
maintain. In an era of open access to information, wide access to markets and easy price comparisons, cost
leadership strategies often come at the expense of acceptable financial returns. As a result, competitive
markets tend to pressure companies to raise their satisfaction levels to remain customers first-choice
brand.

The Limits of Customer Satisfaction

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No company can last for long without satisfied customers. But misguided attempts to improve satisfaction
can damage a companys financial health. So while satisfaction is important, it does not mitigate the need
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for sound business strategy and fiscal oversight.

What is clear from our research is that there is not one right way to improve satisfaction. Different
approaches are required depending upon the profiles of the companys customers and the nature of the
competitive environment. Moreover, it may even be necessary to accept lower average satisfaction levels in
the pursuit of greater market share by appealing to a larger, less homogeneous customer base. This
contradicts the message of many programs discussed in the popular business press regarding the
relationship of satisfaction (and NPS) to business performance.

Fortunately, these issues are solvable. But they require that managers recognize and address each of the
issues that can negatively impact the relationship between satisfaction and business performance.
Increasing satisfaction levels can be a useful component of a companys strategy, but it doesnt have to be.
Often it isnt compatible with market share growth or even good business.
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ABOUT THE AUTHORS


Timothy Keiningham is global chief strategy officer and executive vice president at Ipsos Loyalty, a market
research company. Sunil Gupta is the Edward Carter Professor of Business Administration at Harvard
Business School in Boston, Massachusetts. Lerzan Aksoy is an associate professor of marketing at
Fordham University in New York. Alexander Buoye is USA head of loyalty analytics and senior vice
president at Ipsos Loyalty.

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