In my last entry, I discussed ways that we conduct analysis that links customer loyalty to firm financial performance at a customer/account level. In this entry, I will discuss the linkage between customer loyalty and market performance.
A growing base of research has quantified the linkage between stock price, stock returns and customer loyalty (see, for example, Aksoy, Cooil, Groening, Keiningham & Yalcin (2008) and Fornell, Johnson, Mithas, & Krishnan (2006)). Much of the literature has focused on the connection between customer loyalty and stock price – that is, is there a link between customer sentiment (as measured by traditional customer satisfaction/loyalty metrics) and how much value a share of the company’s stock carries? As it turns out, there is a connection, and it follows intuitive reasoning – the more satisfied a company’s customer base, the more favorable the stock price.
But stock price is only one factor to consider – the other factor to consider is volatility. Volatility refers to the ups and downs a stock price experiences, and it is a measure of risk – the more risk in a stock, the greater the volatility. When we refer to volatility in a stock, we are generally referring to the composite of two broad types of risk – first, there is systematic risk – this is the risk that is associated with the market at large, best characterized by the John F. Kennedy quote that “a rising tide lifts all boats.” The other type of risk is idiosyncratic risk – this is the risk associated with actions of the firm. For example, management decisions regarding products, pricing, customer segments, etc. have an impact on idiosyncratic risk.
To date, the literature on the connection between stock risk and customer loyalty has been pretty sparse. Moreover, the available literature has focused exclusively on the topic of systematic risk – in other words, they have focused on how stock prices move relative to the total market, not the company-based idiosyncratic risk.
In the November, 2009 Journal of Marketing, Kapil Tuli and Sundar Bharadwaj add significantly to the literature in their paper “Customer Satisfaction and Stock Returns Risk” by focusing on both sources of risk – systematic as well as idiosyncratic. They find that customer satisfaction scores “insulate a firm’s stock returns from market movements (overall and downside systematic risk) and lower the volatility of its stock returns (overall and downside idiosyncratic risk).” That is, the greater the satisfaction/loyalty of a customer base, the less volatility that is exhibited by the stock.
So, the bottom line is this - companies with strong customer loyalty enjoy not only better stock returns, but they are also less susceptible to volatility in their stock price. We have independently corroborated these findings with our Walker Index - a composite stock index of Walker clients that has outperformed the broader market indices by a factor of 5 to 6 times since its inception. The Walker Index also has less volatility than the broader market indices, as measured by beta as well as upside and downside capture ratios.
In these first two entries, we have discussed how loyalty metrics and financial performance are linked from an internal/micro perspective (i.e., at the customer/account level) as well as at an external/macro perspective (i.e., at the market performance level). What are the implications of these findings? I’ll address that in the third (and final) entry of this series.
In the meantime, what do you think? How can we leverage this information to more effectively run our businesses?
Sr. Vice President, Consulting Services & Resource Management
 Much of modern portfolio theory is based on the idea of measuring and managing volatility in a given portfolio. This essentially means looking for stocks that have complementary volatility – for example, if we had a portfolio of two stocks, we would like to balance the volatility of one off the other so that they average each other out. Managing risk is perhaps the most compelling aspect of having a diversified portfolio; therefore, any metric that can provide a leading indicator of risk carries with it great strategic value.
 Tuli, Kapil R. and Bharadwaj, Sundar G. “Customer Satisfaction and Stock Returns Risk.” Journal of Marketing, Volume 73 (November 2009). 184 – 197.