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Study Shows How Customer Satisfaction Translates into Future Cash Flow

Two University of Iowa business professors have published a study that shows a direct connection between customer satisfaction and long-term shareholder value in a company.

The findings, which appeared in the July 2005 issue of Journal of Marketing, are significant because the authors believe they show for the first time a clear link between customer satisfaction and the two characteristics of future cash flows that are most desirable to shareholders: growth and stability. Until now, most research has focused on the impact of customer satisfaction on the behavior of individual customers.

Common business wisdom holds that a happy customer is a loyal customer, one who's more likely to provide repeat business and who's more receptive to cross-selling efforts and positive word-of-mouth advertising. But even if a company has data showing that its customers are satisfied by the level and quality of its services and goods, how does that relate to shareholder value over the long run? In other words, how does customer happiness translate into the kind of predictable future cash flow that shareholders desire?

Thomas S. Gruca, associate professor, and Lopo L. Rego, assistant professor, both in the University of Iowa's Henry B. Tippie College of Business marketing department, set out to find a clearer chain of events linking satisfaction and two characteristics of future cash flows: growth and stability.

Using American Customer Satisfaction Index (ACSI) and COMPUSTAT data, the authors found that satisfaction creates shareholder value both by increasing future cash flow growth and reducing its variability. Their study, "Customer Satisfaction, Cash Flow, and Shareholder Value," appeared in the July 2005 issue of the Journal of Marketing.

"When customer satisfaction increases, as a consequence of managerial decisions and marketing actions, cash flows grow," Rego said. "We also found that, as satisfaction increases, the variability of these cash flows is smaller. A more stable cash flow results in a lower cost of capital, which increases the net present value of the future stream of cash flows. Together, these two things enhance shareholder value." Gruca reiterated that their study showed that people who are satisfied buy more from the same company and are more loyal and as a result are less sensitive to price promotions by competitors and therefore less likely to be stolen away.

For the study, Gruca and Rego measured customer satisfaction using the ACSI database, the first comprehensive U.S. customer satisfaction database. More than 50,000 customers are surveyed every year, with data dating back to 1994, and the survey includes more than 200 members of the Fortune 500 (both public and private firms) in more than 40 industries and who collectively generate sales volume exceeding 40 percent of the U.S. gross domestic product. They also used COMPUSTAT data from the years 1994 to 2003 to estimate the impact of customer satisfaction on cash flow growth and cash flow variability.

In all, about 115 companies were studied over an eight-year period, ranging from those that sell nondurable goods (apparel, beer and personal care products) and durable goods (automobiles, appliances and personal computers) to those in the service, retail and financial industries.

Overall, the researchers found a positive, significant association between customer satisfaction and cash flow growth. Additionally, they found a negative, significant impact of satisfaction on future cash flow variability. In other words, the happier the customers, the less future cash flow tends to fluctuate.

Accounting for variations in sizes of companies studied, Gruca and Rego found that every one-point increase in customer satisfaction generates an additional $1.01 in net operating cash flows in the following year for every $1,000 in assets. "To put this amount in perspective, consider that the average firm in our data set has $54 billion in assets," the study states. "A one-point increase in customer satisfaction translates into an increase in future cash flows of $55 million, a substantial figure by any measure." Furthermore, the authors concluded that same one-point increase in customer satisfaction results in a reduction in the variance of future cash flows of more than 4 percent, boosting the value of a firm to its shareholders.

The study did turn up some surprises. Gruca and Rego found that the nature of the product being sold by a company can influence the impact of customer satisfaction on future cash flows. Companies that sell nondurable goods that are replenished fairly often (weekly, in the case of groceries, or seasonally, in the case of clothing) have more opportunities to reap the benefits of customer satisfaction than those selling vehicles and washing machines, for example. Since vehicles and appliances have a longer life span, technology and other factors can change significantly before a customer needs to make a repeat purchase.

And while one might expect local and long-distance telephone services, which work to cultivate a relationship with customers, to benefit from customer satisfaction, that doesn't always hold. Because firms have worked so hard to reduce switching costs so that customers can pursue the best combination of price and quality with little effort, they rarely feel a sense of allegiance to a provider, even if they're satisfied with the previous level of service.

According to Gruca, "Overall, the findings imply that customer satisfaction has a significant impact on building shareholder value because of its influence on cash flow growth and stability."


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