The Value Profit Chain

Treat Employees Like Customers and Customers Like

James L. Heskett, W. Earl Sasser, Leonard A. Schlesinger

• Publisher: Free Press
• Year: 2010
• Print ISBN: 9781476799988
• eBook ISBN: 9781439136126
• Topic: Business
• Subtopic: Customer Relations
• Index: Business

James Heskett, Earl Sasser, and Leonard Schlesinger reveal powerful new evidence that paying close attention to the employee-customer relationship will enable any organization to be a low-cost provider and achieve superior results -- proving that you can have it all, a goal thought inadvisable just a few short years ago. At the heart of this bold assertion is the authors' indisputable conclusion supported by thirty-one years of groundbreaking research: today's employee satisfaction, loyalty, and commitment strongly influences tomorrow's customer satisfaction, loyalty, and commitment and ultimately the organization's profit and growth -- a quantifiable set of associations the authors call the value profit chain.

In what may be the most far-reaching study ever undertaken of the strategic importance of the employee-customer relationship, Heskett, Sasser, and Schlesinger offer profound new insights into the life-long value of both employees and customers and the increasingly important concept of employee-relationship management. Readers will discover how organizations as diverse as aluminum maker Alcoa, travel agency Rosenbluth International, and the Willow Creek Community Church treat employees like customers (in the case of Willow Creek, volunteers as well). Conversely, the authors show how advertising agency Merkley Newman Harty and financial services provider ING Direct treat customers like employees, pursuing the ones they want most. At the Vanguard Group, Cisco Systems, and Southwest Airlines, both practices are common. The authors explain how these organizations and many others -- whether large or small, public or private, or not-for-profit -- achieve profitability and growth or the equivalent by leveraging results and process quality to deliver differentiated products and services at the lowest cost.

Timely, essential, and important reading, The Value Profit Chain should be readily accessible on the desk of every forward-thinking manager.

PART I

Achieving Value-Centered Change

MOST DECISIONS made by managers either destroy long-term value or don’t create any. This includes both tactical and strategic decisions, and it includes decisions made by well-meaning, intelligent, and even well-trained managers. It’s hard to believe this is the case in an era in which new concepts and how-to’s for planning, strategic development, and decision-making are trumpeted at a rate unknown in the past.

To be fair, most managers today don’t have a fighting chance to create value. They are often forced to plan, decide, and act without clear, coherent, or comprehensive roadmaps. They substitute goals for plans and strategies. They lose strategic focus in an effort to extend the reach of the organization, confusing products and services with results. Once the focus is lost, it becomes more difficult to know how (and even which) results are to be leveraged over costs, thereby resulting in misallocation of resources. They must operate without appropriate value-centered measures to tell them where they’ve been, what has worked well in creating value, and what is possible. Too often, they must move forward without agreed-on shared values that anchor a culture, itself an important element in a value-building strategy. As a result, they hire the wrong people for the wrong reasons, paying a frightful price not only in terms of lost time and progress, but in terms of strict limits on sustainable growth. Of course, to the extent that they are responsible for ensuring that this doesn’t happen, well-meaning managers are rightly held accountable for their own demise.

Some destroy value by failing to react to changes in the competitive, social, economic, or legal environment. Ironically, they are sometimes victims of their own past success. There is a strong temptation to resist significant change in a winning strategy.

Still others destroy value out of sheer greed and arrogance, as we witnessed in the recent fall of Enron. They are assisted in this process by inactive boards of directors who often provide insufficient oversight over accounting and other matters, as well as nonvocal shareholders who merely vote with their feet rather than hold management and directors accountable for their actions. They may parade their values in front of employees, but managers in these organizations are recognized whether or not they adhere to them. Fortunately, they represent a minority. In the process, however, they adversely impact customers and employees as well as investors, in fact all constituencies having anything to do with an organization.

There are significant exceptions. A handful of organizations have been created in recent years that are literally value-creating machines. It’s hard to believe, but many of them—FedEx, Cisco Systems, Home Depot, Microsoft, Wal-Mart, SAS, Vanguard Financial Services, and Southwest Airlines—all leaders in their respective industries, essentially are products of the last 30 years. They were built on elements of a value-centered framework that has stood the test of time. The concepts it encompasses are those underlying much of what we regard as success in today’s rapidly changing business environment. They work for constituencies both internal and external to the organization. They produce results for both nonprofit and for-profit enterprise, and they can stimulate a complete rethinking of the business, one that results in a new vision and mission.

These organizations were the product of people with both vision and the latitude to follow through on the vision. What about organizations that don’t have the luxury of starting from a blank page, those whose histories go back far beyond an era in which we’ve begun to make significant progress in understanding the true roots of value creation, or, in some cases, those saddled with the baggage of past mistakes? Here the task is much harder, but not impossible, as demonstrated by such organizations as IBM, Office Depot, and Texaco.

Chapter 1

The Value Profit Chain

A HANDFUL OF ORGANIZATIONS have created extraordinary value for customers, employees, investors, and others. The way they’ve done it follows identifiable patterns. The remarkable thing is not how successful they’ve been. It is rather the fact that there are so few who’ve done it.

■ Advocate for the Investor

The Vanguard Group¹ of mutual funds was founded on the premises that mutual fund investment managers (1) through their investment decisions destroy as much value for investors as they create and (2) through their behaviors destroy value for investors by running up high management fees, in part for their own enrichment. In response, its strategy, since its founding, has been to (1) avoid to the extent possible making investment decisions for its investors and (2) through a variety of policies and practices, minimize costs and management fees incurred by its mutual funds. The results have been nothing short of remarkable. They have been achieved by an organization that its founder, John Bogle, describes grandly as embodying “the majesty of simplicity in an empire of parsimony.”²

As an investor, if you check the management fees associated with various mutual funds, you will find that those of the Vanguard Group of mutual funds are invariably lower than the average for all others, in fact lower by a factor of 3 or 4, depending on the type of fund. On this score, there is no comparison. As a result, even though many of the Vanguard funds perform in the middle of the pack in terms of investment performance, comparatively low fees add so much to the compounded value of Vanguard’s customers’ holdings that they invariably are found near the top on this measure. It requires that an investor hold the fund long enough to reap the advantages of low costs. This is all right with Vanguard’s management; it doesn’t encourage short-term investors to invest in its mutual funds. In fact, it institutes various policies designed to discourage them from investing with Vanguard. This is part of a process by which Vanguard delivers superior value to the customers it seeks, at the same time growing at the fastest rate of any major mutual fund group in the industry over the past decade.

As you might imagine, Bogle, Vanguard’s first chairman and CEO, is not popular in the mutual fund industry. He has refused consistently to join the club of high-cost, high-fee competitors. As a result, it has been more than a decade since he was asked to address the industry’s top managers. The head of at least one high-profile competitor hasn’t spoken to him in years.

Vanguard’s rapid growth rate attests to the fact that it is perceived as delivering investment results to investors. With such low operating costs, however, one might assume that Vanguard’s service is compromised, or that employees display dissatisfaction with lower salaries, nonpalatial facilities, and the like. After all, they all must fly coach while in the company’s employ and forgo reserved parking spots, leased autos, and an executive dining room—unheard of in the world of financial services. In fact, Vanguard’s base compensation levels, although not published, are probably no greater than the industry average, but employee dissatisfaction and turnover are much lower. Why? Because the company also delivers high value to its employees by treating them with respect, rewarding them with substantial bonuses for saving money for investors, and providing a stable, positive working environment in a growing organization.

■ Agent for the Customer

A visit to the weekly management meeting at Wal-Mart Stores in Bentonville, Arkansas, is noteworthy in many ways.³ The first is probably the day and time, Saturday morning at 7:30. One reason for this is that Wal-Mart’s operating executives are thought to generate little value holed up in their offices all week. Hence, they spend nearly every week on the road from Monday morning through Thursday evening, reserving only Friday and Saturday morning for meetings in Bentonville.

The second thing a visitor notices is the size of the meeting room, filled with nearly a thousand people. The big room is necessary because of the relatively broad criteria for who may attend: members, their relatives, and invited friends of the Wal-Mart “family,” a word still used frequently in an organization that now includes more than a million employees and several million family members. Third is the circus-like atmosphere of the meeting, with “ringmaster” and since retired Chief Operating Officer Don Soderquist (who happened to be leading the meeting that one of us last observed) introducing vendors with new merchandise, interacting in a somewhat orchestrated fashion with selected guests in the audience, and leading the Wal-Mart cheer (one of several programmed during the morning). The cheer, at one point given by the latest graduating class of young management trainees from the the company’s Walton Institute—“Give me a W, give me an A, give me an L, give me a squiggly (with a roll of the hips) …”—culminates in the shouted question, “Who’s number one?” “THE CUSTOMER!”

Of even greater significance is that in the midst of this hoopla a great deal of information about the week’s, month’s, and year’s performance is communicated, decisions are actually made, and a visitor comes away from the meeting with a sense that there is truly a family spirit to the meeting. Both retired and active managers are in the room. Employees have brought their children and parents with them. Exchanges among audience members are encouraged along with questions put to senior executives gathered near the front of the auditorium. A meeting that one of us witnessed began with the introduction by Don Soderquist of a store manager we’ll call Bill Smith, manager of Wal-Mart store number 1038 located somewhere in Washington. Bill had been invited to the meeting with expenses (including a ride to and from Bentonville in a corporate aircraft) arranged by his regional manager so that his accomplishment of increasing soft goods sales by 20% over the previous 6 months could be recognized. As Bill stood up and reported his results, someone in another part of the auditorium requested a “roving” microphone to say, “Bill, I used to work with your dad, and I can tell you he wouldn’t be satisfied with a 20% increase.” Whereupon Bill replied, “I couldn’t agree more, Joe; this is just the beginning.” (A host provided assurance that the exchange between managers hadn’t been rehearsed.)

Maudlin as this behavior may sound, a sense of pride and belonging actually seems to pervade the group as it files from the room at the conclusion of the meeting, with knots of attendees remaining behind to exchange greetings and converse with one another, not unlike a congregation at the conclusion of a church service.

Perhaps the most telling clue to the continuing success of Wal-Mart is the massive tote board extending much of the way across one side of the large room. The board’s flashing lights report a huge updated number every second. What is it? Sales? Profits? Number of employees? It’s none of these. Instead, the number reports the amount of money saved for its customers by Wal-Mart during the year. The board is an icon of one of the organization’s most important core values, “serving as agent for the customer,” a core value that spurs Wal-Mart’s buyers to get the best value from their vendors, something done in the name of the customer, not the company. This helps explain why Wal-Mart’s vendors describe what its buyers are like in such terms as “tough,” “brutal,” and “demanding” (but also “fair”). When negotiating on behalf of customers—a selfless endeavor—buyers can be very tough and demanding.

When an organization serves as the agent for the customer, value pervades everything it does. For example, one of the things many people remember about a visit to a Wal-Mart store are the employees at the door, often senior citizens, who greet customers and bid them good-bye. Most customers regard this as a “nice touch” that doesn’t cost the company too much money. In fact, its greeters were placed there originally in part to save the company money in the form of reduced shoplifting. The idea originated from a 1980 visit to a Wal-Mart store in Crowley, Louisiana by erstwhile company founder Sam Walton and one of his senior executives, Tom Coughlan, when they were greeted by an elderly gentleman stationed at the door by the manager. According to Coughlan,

The store, it turned out, had had trouble with shoplifting, and its manager was an oldline merchant named Dan McAllister, who knew how to take care of his inventory. He didn’t want to intimidate the honest customers by posting a guard at the door, but he wanted to leave a clear message that if you came in and stole, someone was there who would see it.⁴

True, it’s unlikely that any of these elderly gentlemen and ladies could stop a shoplifter, but their mere presence at the door seems to have repaid their wages many times over. Thus, Wal-Mart enhances customers’ perceptions of its service while reducing its costs and enabling it to deliver merchandise at even lower prices.

Other shoppers may remember the Wal-Mart slogan, “Everyday Low Prices.” Again, a policy that appears designed primarily to deliver low prices to customers also produces lower costs for the company. By avoiding the sales peaks and reduced margins resulting from periodic price promotions, Wal-Mart is able to create regular flows of merchandise that save inventory carrying costs for both itself and its suppliers.

Wal-Mart works with its suppliers in other ways as well. Several major suppliers, such as Procter & Gamble and General Electric, have joint agreements under which sales and inventory information is exchanged on a constant basis, shipment is made in carload quantities to storage points maintained by the supplier, the transfer of ownership of shipments to Wal-Mart is delayed to the last possible moment, and payment for shipments is actuated instantaneously by suppliers at the point of transfer, thereby reducing the costs of accounts receivable for them. As a result, costs are minimized for Wal-Mart, its customers, and its suppliers.

What about employees? Surely they don’t work for Wal-Mart because of plush offices (relatively small spaces in a converted warehouse), high salaries and wages, or lavish perquisites. Although wages at Wal-Mart are not high, all employees are given an opportunity to participate in a plan offering ownership of the company’s stock. This perhaps explains the presence of a daily posting of Wal-Mart’s stock price in all of its stores, a reminder to both customers (many of whom are shareholders) and employees of the company’s performance. In some organizations, this emphasis on stock price could lead to short-term behavior or, even worse, a potential loss of savings. At Wal-Mart, it seemed to create a spur to better performance during a period of several years when the stock price plateaued. As a matter of fact, Wal-Mart has the lowest rate of turnover of its employees in the large general merchandise discount retail chain business.

This is a value-centered organization at work. Value is created for customers, to whom Wal-Mart directs its efforts. Value is created for the right kind of employee, those who place the sense of family that the organization tries to create ahead of high wages. Value is certainly created for investors (including many employees), who have received handsome total returns on their investments during most of Wal-Mart’s years as a publicly listed stock. Value is created for vendors, with whom Wal-Mart’s management has helped work out ways of preserving profitable relationships while reducing the prices charged the company for its merchandise.

In its pursuit of value, Wal-Mart has been criticized for destroying value in the communities it serves by putting small competitors out of business and sucking the life out of traditional downtown retail centers by locating its facilities where it can obtain the large tracts of land needed to accommodate 250,000-square-foot stores and t...

Table of contents

• Cover Page
• Title Page
• Acknowledgments
• Contents
• Preface
• Introduction
• PART I Achieving Value Centered Change
• PART II Getting Management’s Attention
• PART III Engineering Value Profit Change
• PART IV Cementing the Gains
• Afterword
• Compendium of Value Profit Chain Research Ordered by Value Profit Chain Component
• The Value Profit Chain Audit
• Methods of Estimating Customer Lifetime Value
• Notes
• Index
• About the Authors