Can caring companies beat the cold-blooded cost-cutters?

INDUSTRY VIEW

The slash-and-burn corporate leadership of the 1980s, with its concentration on cost-cutting and sackings, is out of date. Long live the caring corporation of the 1990s, whose priority is to develop loyalty among employees, customers and shareholders.

Such companies do much better for everyone in the long run - including their shareholders - than firms focused narrowly on financial measures of short-term profit.

This may sound like a preview of the introduction to Tony Blair's next speech on the stakeholder society, a policy statement that is eagerly awaited in British boardrooms, because little detail has yet been offered to flesh out the Labour Party's ideas.

Indeed, it could almost be an extract from The State We Are In, the best selling polemic by Will Hutton against the British business and financial system.

Wrong on both counts. These ideas are a central theme of a new book, The Loyalty Effect, by Frederick F Reichheld, a director of Bain & Co, one of the best-known US management consultancies.

What makes the book unusual is that Bain is one of the firms most closely identified with the cold-bloodedly analytical cost-cutting culture of corporate America and Britain in the 1980s. Mr Reichheld has not only developed his alternative concept of "loyalty management" over the last 10 years, he has also set up what Bain quaintly calls its worldwide Loyalty Practice, advising companies for a fee on how to implement his ideas. Bain has even copyrighted the term "loyalty-based management".

Management fads sweep the US and the UK with confusing regularity, be they total quality management, business process re-engineering, empowerment, delayering, downsizing or the elevation of shareholder value to the main - and often the only - benchmark of corporate achievement.

Mr Reicheld himself is part of a new wave of management gurus in the US who have found much to worry about in the legacy of the 1980s - the decade of leveraged buyouts, financial engineering and mass redundancies.

They have returned, in spirit at least, to the words of Henry Ford, who said: "Business must be run at a profit ... else it will die. But when anyone tries to run a business solely for profit ... then also the business must die, for it no longer has a reason for existence."

Mr Reichheld's version of this is: "Maybe our profit-centred world is as skewed and counter-productive as the concept of an earth-centred universe."

Profits have proved an unreliable measure of corporate performance, he says, because it is so easy to raise short-term earnings at the expense of long-term results by liquidating human capital - in other words by wholesale sackings of staff and failure to maintain customer loyalty.

Mr Reichheld does not dismiss profit, and indeed puts it near the centre of his own universe. But he says it is a consequence of creating value for the customer, not the starting point.

US firms lose half their customers every five years, half their employees in four years and half their investors in less than a year. He tells them to concentrate on cutting these high turnovers.

If loyalty becomes the basis of management decisions, the beneficial effects cascade downwards, he says. By cutting the rate at which customers, employees - and indeed shareholders - defect, it is possible to find "prodigious growth in profits and cash generation", bringing a virtuous circle of cost advantages over competitors.

The examples Mr Reichheld uses in his claims for the benefits of loyalty management are American companies such as State Farm Insurance, Leo Burnett ,the advertising agency, (whose productivity record and its relation to customer turnover is shown in the chart) and Chick-fil-A, a fast food chain.

If he were to attempt a list of British companies with reputations for loyal customers, employees and shareholders, he might well start with Marks & Spencer, which this week won the annual Quality of Management award.

Naturally, Mr Reichheld overstates his case, as consultants selling their services usually do. Indeed, once the hyperbole and the jargon is stripped away, it is hard to find anything particularly new. His theories amount to a comforting shift of focus, blurred with business school cliches, rather than a revolution in corporate governance.

The importance of satisfied customers, of high quality and motivated employees and of convincing shareholders to stick with a company for the long term are a statement of the obvious. The successful companies that make up many business school case studies - think of 3M, Hewlett Packard and Levi Strauss as well as M&S - have probably never lost touch with the issues highlighted by Mr Reichheld.

But whereas in the US, this is the stuff of learned management theory, in the UK the issues Mr Reichheld raises have moved to the centre of the pre-election political debate.

Last week an extraordinary correspondence in the Financial Times demonstrated the extent to which opinion polarises once politics and theories of corporate governance are mixed together.

John Kay, a visiting professor at London Business School and chairman of London Economics, suggested a number of principles Mr Blair could use if he decided that the responsibilities of company directors must be reworked as part of the stakeholder policy.

Two of them were: the development of the skills and capabilities of employees and suppliers, and the provision of goods and services of good quality to the company's customers at fair prices. They read remarkably like extracts from Mr Reichheld's recipes for loyalty management.

But Sir Stanley Kalms, chairman of Dixons and longstanding critic of the corporate governance bandwagon, wrote furiously to the Financial Times, claiming these two apparently innocuous proposals were "a move towards introducing pure socialist policies" and a "glorious utopian socialist concept". Industrialists, he said, must learn to read and understand the "small print of the emissaries of socialism".

It is not hard to find the reason for an over-the-top reaction. It is the possibility that Mr Blair will move the debate out of management theory into legislation, perhaps through a Stakeholder Act that shifts the ground rules of corporate governance.

There is nothing wrong or dangerous about the concepts Mr Reichheld and Professor Kay are proposing. They are so much like motherhood that many companies must surely have incorporated them in one form or another in their mission statements.

But legislating in the hope that a few paragraphs in an Act of Parliament would achieve a wholesale change of company behaviour is another matter altogether. It would be gesture politics and it would not have a chance of working.

`The Loyalty Effect,' Harvard Business School Press pounds 21.95