Customer Satisfaction and The Financial Crisis Claes Fornell Chairman, CFI Group and The Donald C. Cook Professor, University of Michigan Madrid, February 25, 2009

What Caused the Crisis? Bizarre behavior by US consumers Didn’t save in good times Now saving in bad times US government Borrowed in good times (created deficits) US banks/financial institutions Enormous risk taking (until now) Zero risk taking (now)

Bizarre behavior by

US consumers

Didn’t save in good times

Now saving in bad times

US government

Borrowed in good times (created deficits)

US banks/financial institutions

Enormous risk taking (until now)

Zero risk taking (now)

Why Is the Rest of the World Affected? Risky assets were packaged and sold to the rest of the world Collapse of US consumption of imported goods World-wide recession

Risky assets were packaged and sold to the rest of the world

Collapse of US consumption of imported goods

What Is a Recession? GDP = Consumer spending + Government spending + (Exports – Imports) + Investments

The Cure: Monetary Policy (Friedman) Interest rates Print money

The Cure: GDP = Consumer spending + Government Spending Fiscal Policy (Keynes) Household Income Tax cuts New projects

How Customer Satisfaction Is Critical Macro Consumer Spending Credit Availability Consumer Confidence Discretionary Income Customer Satisfaction

How Customer Satisfaction Is Critical Loyal customers are the last to leave and the first to come back. Loyal and satisfied customers are a critical asset, but you will not find this on the balance sheet. Micro

Consider the Following Global forces What to do – What not to do Economic returns/Low risk

Global forces

What to do – What not to do

Economic returns/Low risk

Global Forces and Power Shifting Movement of: Information Capital Work (not labor)

Movement of:

Information

Capital

Work (not labor)

Who Benefits Most? Buyers or sellers? Who is getting more choice? Who is becoming more replaceable?

Buyers or sellers?

How to do Business When Buyers Are Getting More Powerful? Off-balance sheet assets Power attracts capital Customer Asset Management

Off-balance sheet assets

Power attracts capital

ACSI: American Customer Satisfaction Index 1994 – 2008

Investment Returns Where’s the leverage? What’s the return on customer assets? Do customers know something investors don’t?

Where’s the leverage?

What’s the return on customer assets?

Do customers know something investors don’t?

Observations Assets on Balance Sheet Less Predictive Intangible Market-Based Assets (Customer Satisfaction) More Predictive Information Technology Globalization More Buyer Choice More Buyer Information Shift in Balance of Power Between Buyers and Sellers

The Theory + + Capitalizing on the Shift in Balance of Power Between Buyers and Sellers in Product/Service Markets Classical Economic Utility (Satisfaction)Theory Technology for Extracting Value-Relevant Information

How Are Markets Supposed to Work? Seller Product Markets Equity Markets Repeat Buying More Capital The Successful Seller Buyer defection in product markets Capital withdrawal from equity markets The Unsuccessful Seller

Buyer defection in product markets

Capital withdrawal from equity markets

Can You Beat the Market? Only if you know something that others don’t

The Premise Customers (in the aggregate) Have Certain Value-Relevant Information Before Investors Do

Investment Universe: Approx. 200 Large Cap. Consumer Companies Covered by ACSI “ The American Customer Satisfaction Index, the definitive benchmark of how buyers feel about what business is selling them.” - New York Times , August 8, 2004

Annual Returns: ACSI stock portfolio vs. S&P 500 April 2000 (Inception) - 2008 -50% -40% -30% -20% -10% 0% 10% 20% 30% 40% 50% Yearly Performance S&P 500 ACSI Stock Portfolio 2000 2001 2002 2003 2004 2005 2006 2007 2008 -13% 26% 9% 3% 14% 4% -9% 11% -6% 34% 14% 20% -19% -12% -23% -38% 36% 16%

Effects of Customer Satisfaction: Repeat Buying/Loyalty Pricing Power High Reservation Prices Low Cash Flow Volatility Investment Implications Translate Into: Above-Market Returns Low Down-Side Risk Beta Surfing (B < 1 in down markets; B > 1 in up markets)

Effects of Customer Satisfaction:

Repeat Buying/Loyalty

Pricing Power

High Reservation Prices

Low Cash Flow Volatility

Translate Into:

Above-Market Returns

Low Down-Side Risk

Beta Surfing (B < 1 in down markets; B > 1 in up markets)

CSat Market Neutral: Annual Returns After Fees 7.9% 17.6% 14.3% 3.0% 10.7% 8.8% 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 2003 2004 2005 2006 2007 2008 CSat Market Neutral

Implications for Corporate Management What Losers Do Buy customer loyalty with price discounts Cut costs at the expense of weakening customer relationships Get too close to the customer Rely on mass production and mass marketing Try to exceed customer expectations

Buy customer loyalty with price discounts

Cut costs at the expense of weakening customer relationships

Get too close to the customer

Rely on mass production and mass marketing

Try to exceed customer expectations

Implications for Corporate Management What Winners Do Manage customer relationships as true economic assets Cut costs where they have the least impact on customer assets Understand marginal analysis Maximize customer complaints Earn the loyalty of their customers by satisfying them

Manage customer relationships as true economic assets

Cut costs where they have the least impact on customer assets

Understand marginal analysis

Maximize customer complaints

Earn the loyalty of their customers by satisfying them

Marginal Analysis What to Do Personal service Merchandise assortment Facilities Waiting time Performance as judged by our customers Impact on customer satisfaction

Marginal Analysis What to Improve in Good Times Personal service Merchandise assortment Facilities Waiting time Performance as judged by our customers Impact on customer satisfaction

Marginal Analysis What to Cut in Bad Times Personal service Merchandise assortment Facilities Waiting time Performance as judged by our customers Impact on customer satisfaction

The Future: Some element of Non-rival goods + customer asset management Customers + Investors A New Alliance: Rising Cost of Time: Buyers will offload work on sellers Key to Success in:

Typical Rate of Return

Rate of Return: Customer Retention Customer Retention

Rate of Return: Non-Rival Goods Degree of Non-Rival Goods