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Archive for April, 2010

I have recently became interested in a hedge fund that invests in satisfied customers. The CSat Fund (http://www.csatfund.com/home.html) invests in the top-performing companies by industry in terms of customer satisfaction. The investment strategy is simple; the fund managers invest in companies that are in the top 20% by industry, provided that the satisfaction of that company is at least better than the national average customer satisfaction score. 

Within the last month, Barron’s wrote an article noting the incredible performance of the fund. Barron’s – Happy Stocks: March 22nd, 2010 

Growth of $100 in the CSat Fund vs. S&P 500

 

The CSat Fund delivered an astounding cumulative return of 235% over the past 10 years. This is compared to the Standard & Poor’s Index return of negative 23% over the same timeframe. 

My Take: This fund clearly puts its money where its mouth is, and the results are compelling. It’s clear that companies with the most satisfied customers are the most profitable in the stock market. Also this fund has demonstrated that satisfied customers are an asset to companies in that they deliver high returns in up-markets but also reduce the risk in down-markets. The reason that risk is reduced is that satisfied customers are the most reluctant to defect and the most likely to buy more. These favorable traits were borne out in the performance of the CSat fund in both up and down markets. The CSat fund tracked proportionally less than the S&P 500 in down-markets, but tracked upwards proportionally more than the S&P 500 in up-markets. In down-markets the correlation of the CSat fund to the market was 74%; in up-markets it was 115%.1 

Source Notes
1Fornell, C. (2007). The Satisfied Customer: Winners and Losers in the Battle For Buyer Preference. New York: Palgrave Macmillan. 

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This weekend’s launch of the Apple iPad has made me think a great deal about Apple’s most important asset, their customers.  Apple has developed their customer asset to the point that they can introduce a new product, such as the iPad and virtually guarantee huge sales, regardless of the quality of the product that they would deliver. Of course, if a product like the iPad were to deliver inferior quality this would adversely affect how their customers will behave towards future product launches.

The customer asset that Apple has developed is in stark contrast to that of the American motor manufacturers. Detroit’s inferior product quality for years burned many consumers. Today, Detroit’s product quality is on par with that of its Japanese counterparts, yet the American manufacturers still must offer higher incentives and lower pricing to get sales. Why? The reason again is the customer asset and although Detroit is now producing high quality products, their customer asset value is very low. As you can see through these two examples, the customer asset is a leading indicator of profitability and can be a powerful influencer on buying decisions, to the point that it can be a more compelling influencer than the product itself.

Today, consumer service consumption is twice the size of manufacturing. Sixty years ago, it was the opposite. This transformation has caused the accounting system that we currently use to be obsolete. There’s an example in a book1 that easily illustrates how accounting systems don’t properly account for the customer asset.  The simplified example talks about a company that acquires 5,000 new customers at a marketing/selling cost of $1,000 per customer. The average customer is retained for three years and the company nets $300 in income per customer, per year. Clearly this is not a profitable situation. The acquisition cost per customer exceeds that of the income delivered per customer.

Yet, accounting systems don’t accurately show this. In the first year the results show 5,000 customers acquired at a cost of $1,000 per customer equating to $5 million in acquisition costs. These customers deliver $300 in income per customer equating to total income of $1.5 million which would result in a loss of $3.5 million. The next year another 1,000 customers are acquired at an acquisition cost of another million resulting in a total of 6,000 customers generating net income of $300 each for a total of $1.8 million. Therefore in year two, the profit is $800,000 as the acquisition costs were only 1 million. It would appear that if the company adds another 1,000 customers, it would make even more profit.

But that’s not correct. We know that the average customers lifespan is only three years with an average net income of $300 per customer per year totaling an average lifetime income of $900 per customer. Yet the acquisition cost per customer is $1,000. Therefore, with each new customer added the more unprofitable the company becomes and the more economic value is destroyed. Since customer assets are considered a cost and not an investment, they are not amortized over time. This is what causes the confusion and can deceive companies.

If this company could extend the lifespan of these customers to four years, the company would be more and more profitable with each customer added, not less and less as shown in the example above. A missing piece of the puzzle in the example above was missing information related to customer retention. If the company had this intelligence, they would understand that they only are going to get $900 in net income over the lifespan of each customer, yet spend $1,000 in acquisition/marketing costs. The problem would become very clear.

“Retention Economics” can help golf courses and businesses understand what their customers will do to them in the future. By better understanding the customer asset, companies will not only have a better picture of their current financial health, but they will also more accurately be able to predict the future. Linking customer satisfaction to the customer asset empowers companies with the intelligence necessary to optimize customer satisfaction to yield maximum profitability.

 Source Notes
1Fornell, C. (2007). The Satisfied Customer: Winners and Losers in the Battle For Buyer Preference. New York: Palgrave Macmillan.

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