You don’t have to look far for examples. Financial services firms, for instance, like to throw around terms like fiduciary and trust in their advertising campaigns, but how many firms deserve these monikers? Mutual funds bury their often exorbitant administrative fees in the fine print, so that customers won’t know what they’re paying. Brokerage firms slant their research to support investment-banking clients, thus bilking their stock-buying clients. Retail banks charge astonishing fees for late payments or bounced checks. The resentment toward financial institutions after the 2008 economic meltdown was so pronounced that it spawned legislation to protect consumers from predatory practices.
Or take health care. No wonder the market doesn’t work and governments have had to step in. Most U.S. hospitals won’t reveal the deals they have cut with insurance companies, so consumers can’t know the real price of any particular procedure. If the regulations established by the 2010 reform law should be postponed or overturned—their fate is uncertain at this writing—most insurers will continue to do their best to exclude people who might actually need coverage; and whatever the outcome, if you do have coverage, they’re sure to drown both you and your doctor in a deluge of complicated paperwork. Many pharmaceutical companies pay doctors to push their drugs, while carefully quashing studies suggesting that a potentially lucrative new drug may be ineffective or dangerous. And many health maintenance organizations promise to provide cradle-to-grave coverage, yet balk at paying for many procedures their own physicians recommend.
Travelers face their own set of inhospitable tactics. They must pay most airlines $100 to change a ticket and as much as $100 for an extra piece of checked baggage. If they are so foolish as to use a hotel phone, they may find they have run up charges larger than the room rate. If they return most rental cars with less than a full tank, they will be charged more than triple the market price for the fill-up. Of course, they also have the option of buying a full tank at the beginning of the rental and then trying to manage their mileage so precisely that only fumes remain—they get no credit for unused gas.
At times, customers must conclude that businesspeople lie awake nights thinking up new ways to hustle them. Most airlines change their prices frequently—often by hundreds of dollars—so nobody can know what the “real” fare is. Banks develop algorithms that process the largest checks first each day, so that depositors will be hit with more insufficient-funds penalties. Many mobile-phone operators have created pricing plans that cleverly trap customers into wasting prepaid minutes or incurring outrageous overages. In 2010, one Boston-area family hit the headlines because it had received a monthly bill for $18,000 from its wireless provider—all because the family’s college-age son had unwittingly downloaded a stream of data to his phone after the introductory rate had expired. If only the father had been encouraged to sign up for the $150 unlimited data plan, he could have avoided three years of haggling over that bill.
Ironically, the best customers often get the worst deals. If you are a patient, loyal user of your telephone or cable company, your mobile-phone provider, and your Internet service company, chances are good that you are paying more than disloyal switchers who signed up more recently. In fact, you’re probably paying more than you need to, regardless of when you signed up, just because you didn’t know about some special package the company offers. Customers who discover an extra charge of $20, say, for using text messaging might find that unlimited text messaging is available for $5 per month—if only they had asked for it in advance.
How Bad Profits Undermine Growth
Bad profits work much of their damage through the detractors they create. Detractors are customers who feel badly treated by a company—so badly that they cut back on their purchases, switch to the competition if they can, and warn others to stay away from the company they feel has done them wrong.
Detractors don’t show up on any organization’s balance sheet, but they cost a company far more than most of the liabilities that traditional accounting methods so carefully tally. Customers who feel ignored or mistreated find ways to get even. They drive up service costs by reporting numerous problems. They demoralize frontline employees with their complaints and demands. They gripe to friends, relatives, colleagues, acquaintances—anyone who will listen, sometimes including journalists, regulators, and legislators. Detractors tarnish a firm’s reputation and diminish its ability to recruit the best employees and customers. Today, negative word of mouth goes out over a global PA system. In the past, the accepted maxim was that every unhappy customer told ten friends. Now an unhappy customer can tell ten thousand “friends” through the Internet.
Detractors strangle a company’s growth. If many of your customers are bad-mouthing you, how are you going to get more? If many of your customers feel mistreated, how can you persuade them to buy more from you? In 2002, surveys showed that a whopping 42 percent of AOL customers were detractors. No wonder the company was on a downward spiral. Right now, churn rates in many industries—cellular phones, credit cards, auto insurance, and cable TV—have deteriorated to the point where a company may lose half of its new customers in less than three years. People have to fly whichever airline takes them where they want to go, but many airlines have created so much ill will that customers are itching for alternatives. For a while, US Airways dominated many routes into and out of Baltimore-Washington International Airport (BWI). By 1993, its market share at BWI had reached 41 percent. With this market power, the airline was able to charge high fares while delivering mediocre service. Customer resentment grew, but there were few options: if you wanted a nonstop flight, you often had to take what US Airways offered. Then Southwest Airlines entered the market with lower fares, superior service, and none of those irritating bad-profit tactics. Travelers flocked to the new carrier, and even when US Airways dropped prices to match Southwest, the customer exodus continued. By 2010, Southwest had corralled a 53 percent share of the market at BWI, while US Airways’ share had diminished to only 6 percent.
True growth is hard to find these days. How hard? A recent study by Bain & Company found that only 9 percent of the world’s major firms achieved real, sustainable profit and revenue growth of even 5.5 percent a year over the ten-year period from 1999 to 2009.2 It seems like no coincidence that so many companies are having trouble growing and so many companies are addicted to bad profits. To change metaphors, business leaders have become master mechanics in siphoning out current earnings, but they fumble for the right wrench when it comes to gearing up for growth.
Granted, companies can always buy growth, just as AOL did. They can encourage the hard sell and pay fat commissions to the salespeople who master it. They can discount heavily, offering temporary rebates, sales, or “free” financing. They can launch heavy advertising and promotional campaigns. And of course, they can make acquisitions. All such techniques may boost revenues, but only for a while. It’s also true that many factors usually contribute to a troubled company’s downfall: AOL was hurt, for instance, by the increasing popularity of broadband as well as by its seeming disregard of the customer experience. But technologies and strategies are always changing, and companies that listen to their accountants more closely than to their customers are likely to find it hard to make a transition to a new business model.
Consider the experience of Blockbuster. Once a thriving, successful company, it had a leading market share in the video rental business. As video rentals gave way to online rentals and video on demand, it might have morphed into an equally successful company in an adjacent market—as a competitor to Netflix, for instance, or even as an owner of movie theaters. But Blockbuster was addicted to bad profits and thus had more than its share of detractors. Rent a movie for a long weekend for only $5.99! But if you return it even an hour late, the fee is doubled. And if you forget to return it for a week, you might owe more than $40. In our town, the Blockbuster store had no serious competition, so customers had to put up with this nasty practice. But they often took out their frustration on the store’s clerks, which made it harder to attract good employees. Soon the store was understaffed and the checkout lines long. The aisles were cluttered with DVDs that were never properly sorted. More and more customers were accused of failing to return videos. More and