Why Your CFO Should Care about Net Promoter

Some of you may have heard Fred Reichheld discuss his aspirations for Net Promoter. He'd like to see it become a standard financial measure that is regarded as highly as revenue on the income statement or cash on the balance sheet. In this post, I argue for the proper accounting of customer loyalty and explain why, in its absence, managers make sub-optimal decisions. Yes, this is that dreaded moment they told you about in high school, where algebra could save your life.

Net Promoter has already become something of a de facto loyalty standard, given its widespread adoption. It has the potential to become an important financial standard as well. But this begs a fundamental question: why does the business community care so much about standards?

I'll take my cue directly from FASB, the financial standards body in the U.S. Here is a portion of its mission statement:

"...standards are essential to the efficient functioning of the economy because decisions about the allocation of resources rely heavily on credible, concise, transparent, and understandable information. . .  Information about the operations of individual entities also is used by the public in making various other kinds of decisions."

The Benefits of Standards Are As Significant in the Marketing World

The benefits of standards are as significant in the marketing world as they are in the financial world. Being able to compare results accurately across companies is not just a big deal--it's the biggest deal for a successful company. If you are trying to build a world-class company, you had better know what exactly makes an organization  "world-class".

But even more acute than the need for standards is the need for some kind of financial measure to encourage managers to engage in long-term value creation. (For those of you who are afflicted with a desire to trade stocks daily, "long term" is defined as more than the current quarterly results.)

Do corporate officers focus on short-term results to the detriment of the long term? Don Peppers and Martha Rogers clearly think so, citing survey results that say four out of five CEOs are willing to "destroy value" when necessary to make their quarterly numbers. I haven't seen any good data on this (who would own up to such a thing?), but let's imagine it was only half that number.

Granted, today's Sarbanes Oxley regulations don't help. With management unable to "manage" their quarterly numbers like they did in the 1990s there is even more focus on managing the operation for a quarterly outcome. And do you think that increased personal exposure for officers, coupled with increased litigation, drives short-term thinking?

Today's Accounting Standards Do a Poor Job of Representing All Assets

The fact is, today's accounting standards do a poor job of representing all the assets on the balance sheet of modern corporations. And if, as I suggested in my previous blog, intangible services are increasingly playing a part in the value-creation strategy for the company, shouldn't elements such as customer loyalty, with it's high correlation to future growth, be visible on the balance sheet? Shouldn't investors be screaming for it?

If you are still not convinced that there are opportunities for value creation through approaches outside of public accounting, consider the rapid growth of private equity firms. Private capital investments in U.S. public companies grew from $18 billion to $66 billion during the six-year period from 2000 to 2005--and could be double that once they add up numbers from 2006. Why? One theory is that U.S. regulatory changes have made it increasingly less attractive to be a publicly listed company, at least in the U.S. It's also certainly true that investors are seeking more aggressive returns than they believe they can achieve from broad investments in the stock markets. Really clever people have been spending a lot of time thinking of financial arbitrage strategies and taking advantage of low interest rates.

But I think another reason for these massive private investments is that management can make better long-term decisions about value creation when they operate outside the gaze of public investors. In other words, private equity companies see value in companies that fly under the radar of the public investment community.

How Does This Relate to Net Promoter?

How does all this relate to Net Promoter? Quite simply, there is a direct connection between customer loyalty and financial strength. That's why Rupert Soames, the CEO of Aggreko, commonly evaluates his managers on financial results as well as Net Promoter scores. He sees the connection between long-run value and short-run value. Investors typically only look at financial results, revealing a major disconnect between the right management actions and the right short-term financial actions. Smart guys in the private equity world use this disconnect to create tremendous value for private investors.

What's the take-home point for the CEOs of public companies? Even if you can't get investors to recognize customer loyalty as an asset, it's still the right way to run the company!

How do you successfully gauge customer loyalty? To start with, you need an open standard. Many customer loyalty metrics are either closed or proprietary, meaning that there is a secret formula for calculating loyalty. Think of the absurdity of closed standards in the financial world. Would we tolerate it if companies had unique formulas for calculating revenue? You could argue that this is precisely what happened during the economic melt down of 2001. No -- the only way we will get a genuine customer loyalty metric is through an open standard. Of course, if you had built a company around the idea of a "better" way of measuring EBITDA through a "secret formula," you wouldn't be too keen on open standards or, for that matter, on any standards. Thus it should come as no surprise that several market researchers ferociously attack Net Promoter: their own formulas must be defended!

Ensuring a Truly Comparable Standard Is a Standards Body

The second thing we need, in order to ensure a truly comparable standard, is a standards body. In the absence of a standards body, many companies may claim that they followed the formula, but through accident, lack of knowledge, or deliberate action they didn't quite get it right. Is this happening today? No. Whenever companies announce a Net Promoter Score, we can compare their data to the Net Promoter database, which includes aggregate scores from many other companies in that same industry. In some cases the difference is staggering.

I very much doubt this is a result of deliberate attempts to mislead the business world. The fact is, the Net Promoter Score, while well defined at its most basic level, is sensitive to context. Many key issues -- sampling approach, top down versus bottom up, and so on -- will require more definition to continue to develop it as a standard. This is why we are now investing in certification for practitioners. If we can build a common vocabulary, beyond the simple formula, then we can move toward a standardized, comparable metric that is easy to use and consistently applied.

Prediction: NPS Has the Potential to Put Corporate Officers Back in the Driver's Seat

Here's my prediction: Net Promoter as an effective, open standard has the potential to put corporate officers at public companies back in the driver's seat. That's why it should be a hot idea with both the CEO and the CFO. As 1to1 magazine put it, "The CFO is no longer the enemy." However, we will only get there if the Net Promoter community embraces standards and open measurement.

Stay tuned for another ripper topic in my next blog: CRM and Net Promoter. I bet you never thought that you could win so many friends--the CEO, CFO, and the CIO--all with one business tool!