NPS - a metric you better not ignore

Let's start with a simple exercise. What do you think companies like Amazon, Apple, Google, Facebook, Costco, Southwest Airline, Ikea etc. have in common that make them super profitable? Give it a minute and write your answer in the comment box. Your answer might be very different than mine but will converge to the same answer - they all have loyal customers. Customers who are not just satisfied with their products, they are in love with the company, they sing their praises, they drag their friends and relative to the stores to buy from them. Loyalty is expensive and you need to earn it, but once you have it, it makes customer acquisition super cheap.

You will see studies from big consulting saying retaining customer is about 5-7X cheaper than acquiring a new one. Everyone knows loyalty is important, but behind high walls of company offices, we quickly tend to forget loyalty and ruthlessly buy new customers at all cost. Why? Its simpler as its transactional. You pay an affiliate and they will get you some customers - simple, while to earn loyalty you have to carefully craft every element of customer experience to delight them at every step - who will do so much hassle! Leaders think short term which influences their bonus, loyalty is a long term game - you only win it if you know you would stay with the company for that long.

Most relational businesses like banking, insurance, telecom, car hailing etc. earn from customers only after significant number of transactions, in some case after 2-3 years. These businesses don't have a choice to not focus on loyalty, still most businesses just don't. Insurance companies would give steep discount at acquisition and then creep in premium hikes to loyal customers. Banks give hefty bonuses on acquisition and then charge minimum balance pointless fee from loyals to compensate. It's like the world is just upside down - loyals pay the cost of their loyalty. Do you think it is sustainable. Absolutely not! Such companies just wait for the market to get disrupted by a new business model, and given they never created customer loyalty, their business gets eroded so fast that they don't have time to pivot. Think of Blockbuster, who charged enormous late rental fee on CDs. Netflix comes and blockbusters looses everything over night.

Measure of Loyalty

So if loyalty is all that we want to increase, retention rate is the perfect KPI to optimize, right? Answer is no. Even though retention rate is what we want to improve, but it is important to understand how you retain customers. Do they stay with you because you locked them with hefty cancellation fee (in fine prints), or you give them a discount again to beg to stay for one more year, or they are just too lazy to cancel etc. If the answer is one of the above, you don't really have customer loyalty but just an unsustainable customer retention, which can again be disrupted quickly. It is hard to measure good loyalty score, and then enters NPS. NPS is not just a loyalty score, it tells you whether customer loves you or not. If they do love you, they would not just retain business with you, they will get more customers like them to you for free. Let's break down NPS a bit to understand what I mean.

What is NPS?

Is NPS same as CSAT? One of the prominent myths in the industry. While CSAT is an estimate of customer satisfaction, NPS is a proxy for customer loyalty. The difference is evident from the question and where you ask it. Questions for CSAT are like - "Were you satisfied with the service/product?" Satisfaction does not guarantee loyalty nor is there conclusive study that links customer satisfaction to business performance. Jefferey Gitomer takes this missing link to another extreme - "Customer satisfaction is worthless customer loyalty is priceless." NPS reflects on overall customer experience through the question - "Would you recommend us to a friend or relative?"

NPS was born as there was no prominent KPI that could establish the obvious link between happy customers and sustainable business. To know more, I recommend reading the book "The ultimate question 2.0" from the inventor of NPS - Fred Reichheld. One of the cleanest study published from Bain shows NPS correlation with organic deposit growth in Midwest.

But what does NPS really mean?

"NPS is nothing but the missing mathematical link between enhanced customer experience and the incremental long term monetary value of that enhancement, which is all you need to make customer centric actions."

Too complex - lets break it down further.

A mental model of customer's decision making process

Humans are super complex creature and we need frameworks/mental models to really understand what drives their decisions. Here is a simple model to understand how we make purchasing decisions.

Quick scenario to elaborate - You recently moved to US. You have heard a lot about high quality of product that Costco stocks. You eventually go to the store, you see the infinite variety of snacks, fresh fruits, many sampling counters and clean layout. Comparing a couple of items to Walmart, you realize Costco is not at all expensive than Walmart next door, even though quality is unmatched. You stop looking at prices and stock up your cart. Finally you reach the counter and the person on the counters says you can pick up a snack bar for free as you purchased 2 already and Costco is running an offer of 2+1. You run down the aisle and pick the Free snack bar. You come out of the store and fall in love with the store. You go home and end up talking about the experience to many of your friends.

So what really happened here? Let's decode. You get input from two sources - your direct experience and what people/social media/TV/flyers says about Costco. You find value for money from few comparison of prices you make with Walmart. Even though you already started trusting the Brand, the counter guy puts the final nail by being honest about the offer while he/she could have saved a few dollars for the store. You were impressed by the product and service quality. All in all you became loyal to the store, started repeat buying behavior, and became a FREE advertisement board for Costco - I bet this is the cheapest and most effective advertising Costco gets. So your purchase decision and your word of mouth became the final output which impacts Costco income statement directly.

Again, what is NPS? NPS is a simple to calculate metric, which has very high correlation with customers purchasing decision and word of mouth. It is more than customer satisfaction score, which is just a reflection of immediate interaction. It is more than customer centricity, which only is one of the drivers of NPS. You will find a lot of companies that may be customer centric but are not very ethical or don't have product which are not mapped to a customer need, they would eventually have low NPS. For high NPS, you need to get all the proportion in the cocktail right - you need to have a product that serves an important need, price it right,you need to be ethical, need to build a strong emotional connection with customer, need to build trust, need to share you care, etc. Obviously, some of these drivers might matter to you more than others dependent on your industry, but it should be combination of these and more.

End Notes

Obviously, understanding what NPS means and what drives NPS is not enough to boost your loyalty. It needs a much more intricate modelling of what interactions move the drivers of NPS. For instance, in the Costco example, having the right price for items easy to compare wins Costco brownie points on value for money and builds trust. Similarly, a company needs to understand what are the pain points in customer journey which decreases customer trust. And if you do know what those pain points are, then you need to work out the math whether incremental loyalty of customer gives you a positive NPV or not. NPS will provide you the missing link between the enhanced customer experience and long term monetary value to evaluate every decision fairly in financial terms.

This article is based on my personal experiences and can differ quite a bit from your understanding. I would love to hear how you look at NPS and how much importance does it get in your company/industry.