Bad Profits, Good Profits, and the Ultimate Question
Most companies these days are striving to focus more closely on their customers—to become more customer-centric. Little surprise here: we live and work in a Web-savvy world in which customers have near-perfect information. Only companies that put the customer at the very center of their operations can successfully compete in such a world.
Many companies also want to make themselves more mission driven than profit driven. Again, no surprise. Their leaders understand that they can’t win and keep customers without first winning and keeping the best possible employees. And most talented employees want to pursue a mission, a purpose that transcends profits for shareholders.
But despite all the effort companies have put into these twin tasks, focusing on customers and inspiring employees, the vast majority of firms haven’t made much progress. Their cultures remain staunchly profit-centric, ruled by financial budgets and accounting metrics. Managers must make their numbers; business-unit heads, their sales and profit goals. Chief financial officers must report quarterly earnings to Wall Street. Leaders know the catechism of customer centricity, and most can recite it by heart. Question: why do we want loyal customers? Answer: because loyal customers come back more often, buy additional products and services, refer their friends, provide valuable feedback, cost less to serve, and are less price sensitive. But what leaders track, discuss, and manage each day are the financial indicators.
This is a major disconnect. Our accounting systems—both financial and management accounting—don’t have anything to say about feelings of loyalty, enthusiasm, repeat purchases, referrals, and all the other emotions and behaviors that determine the economics of individual customers. Executives and employees know how to meet their immediate financial goals, and they know they will be held accountable for doing so. But customer loyalty and the company’s mission, as objectives, are soft, slippery, seemingly impossible to quantify. In the rush of daily decisions and priorities, of budget pressures and sales quotas and cost accounting, the gravitational pull toward short-term profits is powerful. And so companies, despite the best of intentions, drift into a vortex. They begin making decisions that alienate customers and employees. They spend too much time focusing on the wrong things. They allow themselves to be seduced by the easy lure of what can only be called bad profits.
Consider some examples.
Bad Profits
The year was 1992. Computer users were growing more numerous by the day, and the online services business was booming. A brash young company known as America Online, or AOL, seemed poised for takeoff. Thanks to an initial public offering of stock, AOL had more than $60 million in its coffers.
AOL wanted to spend that money on growth—and the path to growth, its executives decided, was to invest in customer acquisition. So over the next several years, the company carpet-bombed the United States with free software diskettes that allowed computer users to try out the service. It tucked the diskettes into the pages of magazines. It packaged them with the snacks served to airline passengers. It inserted them in cereal boxes and displayed them at the checkout stands of grocery stores. Most of the diskettes wound up in trash containers and then in landfills, and AOL’s marketing campaign became a kind of national joke. Still, enough people signed up that the company could declare its strategy a success. Membership grew from 350,000 in early 1993 to about 4 million by the end of 1995.
Unfortunately, AOL’s management team at the time wasn’t spending commensurate amounts on improving the company’s service capacity. Soon the flood of new users was straining the company’s operating network. AOL earned a new nickname, “America On Hold.” A full-day blackout in the summer of 1996—the longest in a series of service interruptions around this time, as it turned out—made headlines across the country and frustrated millions of members. AOL’s monthly customer churn rate rose to 6 percent, an annual rate of 72 percent. Searching for a way to boost current earnings, AOL began to inundate customers with irritating pop-up ads and sales pitches. Though the company’s membership continued to grow, more and more customers grew frustrated and disillusioned with what AOL was offering.
In January 2000, AOL merged with Time Warner, in a stunning deal that initially valued AOL at more than $190 billion. But it wasn’t long before AOL began to stumble. Broadband was spreading rapidly, and AOL lost many customers to broadband service providers. It even lost some to dial-up competitors MSN and Earthlink. AOL shifted its strategy to become a free content provider, more like Yahoo! and Google, with much of its support provided by advertisers. But it continued to annoy its customers. People who wanted to complain or terminate their contracts, for instance, struggled to find the carefully hidden 800 number. If they did succeed in finding it and actually reached an operator, they got a sales pitch to extend their contract instead of the service they were seeking. “Long ago,” wrote Randall Stross in the New York Times in late 2005, “the company’s culture became accustomed to concentrating energy on trapping customers who wished to leave.”1 In 2006, a disgruntled customer recorded a call with AOL in which he attempted to quit the service and was stonewalled at every turn. The recording went viral on the Internet, and once again AOL was a national joke.
In late 2009, Time Warner finally gave up on the AOL brand, spinning it off to shareholders at a valuation of $3.2 billion—a destruction of roughly $187 billion in shareholder value in just nine years.
Too many companies these days are like AOL back then. They want to make the most of their innovations. They want to build a great brand with world-class loyalty. But they can’t tell the difference between good profits and bad. As a result, they let themselves get hooked on bad profits.
The consequences are disastrous. Bad profits choke off a company’s best opportunities for true growth, the kind of growth that is both profitable and sustainable. They blacken its reputation. The pursuit of bad profits alienates customers and demoralizes employees.
Bad profits also make a business vulnerable to competitors. Companies that are not addicted—yes, there are many—can and do zoom right past the bad-profits junkies. If you ever wondered how Enterprise Rent-A-Car was able to overcome big, well-entrenched companies to become number one in its industry, how Southwest Airlines and JetBlue Airways so easily steal market share from the old-line carriers, or how Vanguard soared to the top of the mutual fund industry, that’s your answer. These companies manage to balance the need for profits with the overarching vision of providing great results for customers and an inspiring mission for employees. They have figured out how to avoid bad profits, and their revenues and reputations have flourished.
The cost of bad profits extends well beyond a company’s boundaries. Bad profits provide a distorted picture of business performance. The distortion misleads investors, yielding poor resource decisions that hurt our economy. Bad profits also tarnish the position of business in society. That tarnished reputation undermines consumer trust and provokes calls for stricter rules and tighter regulations. So long as companies pursue bad profits, all the noisy calls for better business ethics are pretty much meaningless.
By now you’re probably wondering how in heaven’s name profit, that holy grail of the business enterprise, can ever be bad. Short of outright fraud, isn’t one dollar of earnings as good as another? Certainly, accountants can’t tell the difference between good and bad profits. All those dollars look the same on an income statement.
While bad profits don’t show up on the books, they are easy to recognize. They’re profits earned at the expense of customer relationships.
Whenever a customer feels misled, mistreated, ignored, or coerced, profits from that customer are bad. Bad profits come from unfair or misleading pricing. Bad profits arise when companies shortchange customers the way AOL did, by delivering a lousy experience. Bad profits are about extracting value from customers, not creating value. When sales