The Nature and Value of Loyalty

The basic idea of loyalty, says Pete Fader, is “the tendency to do something again and again and again, in the absence of switching costs. So, in other words, loyalty isn’t just lock-in. Loyalty isn’t just that you are doing the thing again and again, but you’re doing it by your own volition, that you have lots of alternatives. They might be cheaper, they might even be better! But the fact that you choose to stay with this particular product or vendor despite all the incentives and ability to go away, that’s loyalty.”

Pete is a professor of marketing at the Wharton School of the University of Pennsylvania and a past guest on the podcast. Most of his academic career has focused on analyzing marketing and operational data to predict how customers will behave in the future. He is also cofounder of Theta Equity Partners, a company that offers customer-based corporate valuation—a way of valuing firms based on the quality, and loyalty, of their customer base. 

“Unfortunately,” he says, “too many firms mistake loyalty with lock-in, that, ‘Hey, they’re doing the thing again and again and again.’ Little do they know that they’re only doing it because they’re being held hostage. That’s not loyalty.”

Pete’s most recent work, which lays out the essential techniques for valuing a business based on customer relationships and transaction metrics, is an article he wrote with his colleague, and a recent guest on the podcast, Dan McCarthy. It’s called “How to Value a Company by Analyzing Its Customers” and was published in the January/February 2020 issue of the Harvard Business Review. Pete and Dan’s article appeared alongside my own as part of a spotlight section called “The Loyalty Economy.” 

“Recognizing the multifaceted nature of loyalty, the different ways that it manifests and recognizing that its multifaceted nature not only makes it harder to measure, but makes it that much more powerful than anyone ever gave it credit for. The need, the desire to see how it varies across individuals and how it manifests in different ways for those individuals, that’s where all the action is. And to be honest, we’re still not that far along compared to some of the ideas that Fred [Reichheld] laid out back in 1996 when he wrote The Loyalty Effect. That was like 500 years ago!”

This episode is the first in a two-part conversation I had with Pete, and it continues our series on how to value customer relationships, and how companies can apply those techniques to accelerate growth and profitability. 

You can listen to my conversation with Pete on Apple Podcasts, Spotify, Stitcher or your podcast provider of choice, or through the audio player below.

In the following excerpt, Pete explains what barriers often keep companies from adopting useful toolkits for managing customer loyalty, and where companies need to pay more attention to successfully implement such tools.

Rob Markey: Why do you think it is that so few companies have fully adopted a toolkit for managing customer loyalty? What’s behind that?

Pete Fader: Oh, it’s all driven by what Wall Street asks for and demands. It’s all that kind of quarterly mindset, and the way that we’re evaluated really is on the basis of, “Volume high, costs low.” That’s it. And all the other things that we’re doing, whether it’s the product innovation, and supply chain efficiencies and so on, is just to help us achieve those goals—sell more stuff, more cheaply. And by the way, those are fine goals! But they’re incomplete. And they reflect an era where we couldn’t really see or measure anything else. But today we can.

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Rob Markey: Let me play devil’s advocate for a minute, and give you the argument that I hear from CEOs, business unit presidents, CFOs. What I hear them say is, “We’re not stupid. We actually manage our business for long-term value. And yes, we have constraints that are imposed on us by the fact that we’re a public company and we have to meet a certain set of expectations. But we absolutely manage for the long term. We make smart investments. We have NPV models, we do business cases, and we’re always making good trade-offs.”

Pete Fader: Well, you know, for the most part, that is true. And so let’s take a great big pivot to a lot of the work I’ve been doing recently, with Dan McCarthy. We do all this work to do these bottom-up valuations. So, let’s value a company, not from the top down, but based on how many customers they’re going to acquire, how long they’re going to stay, how often they will spend, how much they’ll spend. And a lot of people out there harp on the exceptions. For the most part, things line up. In some sense the exceptions are remarkable because they’re exceptions. So whether it’s because of good measurement that’s just not seeing the light of day or just good instinct on the part of senior managers, it’s not so bleak. But at the same time, I don’t want them just to keep their head in the sand and say, “I got this covered. We don’t need to do any of that stuff because it tends to work out reasonably well.” It could work out better. The numbers could line up even more closely, and some of the tactics that they take could lead to better outcomes.

Rob Markey: You know, I thought you were going to say something different, I thought that you were going to say that in many cases it is true, but in many other cases, people are just fooling themselves.

Pete Fader: Oh, and there’s no question about that. And those are the easy examples. That’s why I’d rather not lead with something like that. But I’m pleased that they are more exception than rule.

Rob Markey: When you encounter management teams that are interested in applying these tools but haven’t yet, what are the things that have been barriers to their adoption before you start to work with them or talk to them?

Pete Fader: I used to think the main barriers were things that I kind of think most about, which would be: the availability of the data, the quality of the data and the internal capability to basically run these models, see these metrics. I used to think that if we can get past those things, if we can just get them to wave the magic CLV wand, then money will come raining down from the sky. And that’s just so ridiculously naive. I don’t need to tell you, because you’re much closer to the front line than I am. And so the main barriers are the things that I know least about, which would be the cultural kinds of things: the ability for the company to get the right kind of alignment, very often between finance and marketing, to get even the CEO completely on board with it instead of having her just dismissively let the “crazy kids in marketing” do whatever they want to do, to make the proper investments in the data collection and storage and analytical technologies instead of just viewing those things as costs. So a lot of the big barriers are much tougher and much higher in the org[anizational] chart than the tactical, nerdy, analytical things that I tend to focus on.

Net Promoter System®, Net Promoter Score®, Net Promoter® and NPS® are registered trademarks of Bain & Company, Inc., Fred Reichheld, and Satmetrix Systems, Inc.

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