In the vanguard of loyalty

The largest mutual fund in the world, the Vanguard 500 Index Fund has just turned quarter-century old, in a year that saw returns drop 13.5%. Logically, Vanguard should postpone the party, and dissatisfied investors would shift money to safer havens.

Instead, there's cause to celebrate: The $85 billion fund is the 12th best-selling fund in the mutual fund industry. And the funds' sponsor, the Valley-Forge based Vanguard Group, has attracted an industry-leading $28 billion in net cash inflows (through August) in a stock market environment that is arguably the worst since the 1973-74 bear market. Meanwhile, many rivals struggle with investor redemptions, shrunk revenues, and layoffs.

Why is Vanguard still growing? It's not advertising - Vanguard's media budget is but a fraction of the competition's spending. And it's not a high-powered sales force or hot new product. Vanguard's staple is market-matching index funds and conservatively managed stock and bond funds.

But Vanguard does have loyal customers and employees. "Superior loyalty fuels our growth and reduces our costs," says Vanguard CEO John J. "Jack" Brennan. Mr. Brennan walks the talk. He regularly pulls duty on Vanguard's front-line telephone service lines, alongside Vanguard's crew and interacts with dozens of his 15 million clients. He once spent 15 minutes cautioning an older investor against growth stocks and discussing the merits of more conservative vehicles. This quarter-hour spent likely engendered a lifetime of loyalty.

Just how loyal are Vanguard's stakeholders? To find out, Mr. Brennan performed a "Loyalty Acid Test" survey on a broad sample of customers and front-line employees. More than 70% of both groups agreed with this statement: "I believe this organization deserves my loyalty"-which places Vanguard among the top tier of American companies. Bain & Company has performed this survey on several thousand customers and employees across the U.S., and in a typical company less than half of employees believe their firm deserves their loyalty. No wonder customer loyalty is eroding and that growth and efficiency are eluding our economy as the bottom-line penalties of disloyalty become widespread. Fortunately, there are many loyalty leaders celebrating continued growth and prosperity despite these difficult economic times.

Enterprise Rent-A-Car, for example, has accelerated past Hertz and Avis to become the number one player in the industry. Andy Taylor, CEO, views loyalty as a cornerstone of the firm's success. "A major difference between Enterprise and our competitors," says Mr. Taylor, "Is that their business is cars, ours is people. They focus on building their fleet; we focus on building our employees' careers." When Enterprise took the Acid Test, we found that 75% of the firm's employees believed that the firm deserved their loyalty.

Harley Davidson provides yet another example of the economic benefits of superior loyalty. For example, 80% of Harley's unionized employees believe the company deserves their loyalty, almost double the typical loyalty of union members across America. And Harley is prospering - adding jobs and profits are at record levels-with a discretionary product that should be very sensitive to economic downturns.

What is it that has enabled these companies to build loyalty, when so many others have given up? After more than a decade of analysis, we have discovered that leaders who build long-term relationships follow the six basic rules.

Preach what you practice

At Harley, shortly after a layoff of 40% of the workforce, the leadership team sat down with employees and hammered out the five principles that would define mutually beneficial relationships. Twenty years later, this credo provides the foundation for all major decisions at the firm. At Vanguard, Jack Brennan felt it was so important to explain the principles that he and his management team would live by that he published a booklet that has become the basis for leadership training and evaluation at Vanguard.

Never profit at the expense of customers or partners

Harley management insists on win/win solutions, not just profitable solutions. For example, when the time came to build a new plant, instead of abandoning their unions for a right-to-work state, Harley invited the presidents of its two main unions to join the search committee. In return, the unions have cooperated with new productivity initiatives. It is this same commitment to win/win solutions that kept Harley from considering the development of a corporate web site to sell popular Harley merchandise since this would mean stealing sales from their dealers.

Be Picky

Vanguard is famous for turning away investors who expect to churn their money. The firm has a very clearly defined set of target customers who appreciate the value of low-cost, long-term investing. Vanguard limits exchange activity to discourage market timers and closes high-performing funds to protect existing shareholders from the impact of performance-chasing speculators. Vanguard's brokerage arm did not chase after the active traders who appeared to be so profitable for Schwab and Merrill Lynch. Instead, they focused only on customers where they saw the potential for a long-term, mutually beneficial relationship.

Keep it Simple

Loyalty leaders organize their companies into small teams that are much smaller than their competitors. Smaller teams keep decision making-simple, they improve responsiveness and accountability, and they are vital for building loyalty. Andy Taylor at Enterprise has an ironclad rule that whenever one of his branches grows to a certain number of cars, it will be split in half. While branch managers are often reluctant to give up half of the customer base that they have built, and half of the employees that they have recruited and trained, they know that Taylor is committed to the small team rule. With over 4500 branches (with average teams of eight employees versus more than double that at Hertz and Avis), he credits this rule with keeping his large organization nimble, flexible, efficient, and loyal.

Reward the Right Results

Vanguard recently introduced Admiral Shares for many of their funds. These shares reward loyal customers with even better value. For employees, Vanguard developed a Partnership bonus plan that offers rewards based on their contributions to the company's operating efficiency and the performance of Vanguard funds relative to competitors. Too many companies today penalize loyal customers with mediocre service and high prices (if you were foolish enough to remain loyal to your cellular phone company or long distance provider over the past few years, you are probably paying far above market rates). Loyal customers are treated like stupid customers across America, but never at Vanguard.

Listen Hard and Talk Straight

When Andy Taylor concluded that he might have to sell the company a few years back, he informed all of his employees and asked for their opinion. Hertz and Avis had been bought by Ford and GM, so there was a legitimate question whether it would be possible to make money in car rentals if these manufacturers started using car rentals for inventory management rather than profits. While his investment bankers and lawyers were flabbergasted by his open, honest approach, Taylor was simply living up to one of the most basic loyalty principles. He knew that any long-term relationship must be an honest relationship.

For companies like Vanguard, Harley-Davidson, and Enterprise, their continued prosperity is proof that loyalty still pays, especially in difficult economic periods. But most companies are abandoning the rules of loyalty. Most leaders will discover that most of their customers and employees are not loyal; they are just biding their time until something better comes along. Instead of lighting candles on a birthday cake, these managers have been lighting the fuse on a bomb that will eventually wreck their prospects for growth and profitability.

*Frederick F. Reichheld is a Bain & Company Fellow and author of Loyalty Rules! How Today's Leaders Build Lasting Relationships, Harvard Business School Press, 2001; and The Loyalty Effect: The Hidden Force Behind Growth, Profits and Lasting Value, Harvard Business School Press, 1996.

Source: Submitted by Bain & Company to the EIU ebusiness forum. Bain & Company is a sponsor of the EIU ebusiness forum.