All companies have customers. Yet some organisations are more dependent on customer good will than others. Recent research showed that for certain industries, for example telecommunications, customer satisfaction is a powerful indicator of future financial results.
If good customer service is crucial for a business, it makes sense that management incentives reflect this. Yet an examination of incentive plans for consumer-facing organisations such as banks, supermarkets, hotels and consumer discretionary retailers indicates that customer service performance generally only comprises a maximum of 20% of the short-term incentive (more often around 10%), with long term incentives predominately TSR-, EPS- or ROE-based.
There are three major issues that make it difficult for companies to place a heavy focus on customer service in their incentive plans.
Problem 1: Shareholder focus on the bottom line. Understandably, shareholders want the company to do well and only want executives to be rewarded if they too will be rewarded via dividends or a rise in share price. Therefore, a large proportion of incentives must always be based on financial fundamentals. There is significant pressure in particular against long term incentives that are not strongly linked to shareholder value.
Possible solution: Currently, it is customary for bonuses to be split, with a percentage of the total annual bonus relying on financial incentives and the remainder relying on non-financial incentives. Instead of doing this, the non-financial incentives could be used as a multiplier for the financial incentive result. For example, an executive might be entitled to a bonus of $100,000 if they meet financial objectives. The company might then specify that if customer satisfaction objectives are above target, the bonus awarded will be 1.5 times the result achieved from meeting financial objectives. If at target, 1 times the result and if below target 0.5 times the result.
The disadvantage of this solution is that the financial performance becomes a gateway. Even if an executive makes progress on strategic initiatives such as the implementation of a crucial IT system, they will not receive a payout. This will likely be welcomed by financially focussed shareholders but could cause problems with retention when business conditions are challenging.
Problem 2: Variety of possible performance measures. There is pressure on Boards to reward executives for employing or promoting more women; increasing safety in the workplace; improving employee engagement; enabling whistleblowing; encouraging an appropriate corporate culture, among other priorities. How is it possible to create an incentive plan that takes all these issues into account without reducing the value of each performance metric?
Utilise the LTI – Currently most companies only use the STI to focus on non-financial incentives despite the fact that many non-financial incentives may require a long term focus to make comprehensive changes. Using the long term incentive would enable companies to provide more weight to an important objective.
The Commonwealth Bank’s failure to achieve sign off from shareholders on a LTI grant to its CEO because of its “people and community” performance hurdle would seem to show that non-financial incentives are not acceptable in the LTI. Yet the Commonwealth Bank was a special case. First, the bank already had 25% of its long term incentive based on a non-financial incentive – customer satisfaction. Adding the people and community incentive raised the proportion of the LTI dependent on non-financial incentives to 50%. Secondly, and more importantly, the culture incentive was poorly defined and disclosed and it was not clear exactly what would need to happen for the CEO to receive a payment – the exact measures and targets were not intended to be disclosed until the end of the performance period. If clear (ideally quantitative and/or externally measured) performance conditions and targets had been outlined, the shareholder response may have been quite different.
Prioritise – Instead of providing a small payment for multiple performance outcomes in the annual bonus, a company could focus on the highest priority non-financial hurdle, with this focus periodically changing as required. For example, one year the company might decide customer satisfaction is the key focus, while in the next year it might be employee diversity. To maintain performance levels in off-focus years, the intention would be to implement processes or procedures that will enforce behavioural changes. To ensure critical areas are not neglected, gateways can also be implemented. For example, in the case of safety, no bonus is paid in a year where a company experiences a fatality.
Intensify – Maintain the usual scorecard, but if a $0 payout is recorded for one of the elements in any given year, the weighting of that element could be doubled in the next year. For example, if customer service was below an acceptable standard and it was worth 20% in that year, in the next year, the scorecard would be rearranged so customer service was worth 40% of the incentive.
Problem 3: Scepticism about the consistency and truth of non-financial measures. Some shareholders are wary of measures such as customer satisfaction. They believe these measures are “flaky”, poorly disclosed and easily manipulated so that executives always receive awards.
Possible solution: Credit Suisse Director of Equities Research Sandra McCullagh recently wrote a recent research note on non-financial incentives to improve culture. The gist of the note was that such incentives are necessary, but must be properly designed and disclosed. This means a) choosing specific outcome-based measures and b) providing adequate disclosure as to how the company has performed against stated measures.
What measures should companies use?
Credit Suisse’s McCullagh points to safety incentives within the mining sector as an example of good practice. She stated that there were often lagging indicators (lost time injury rates), leading indicators (number of near misses, number of observable incidents) and gateway measures such (no fatalities or major environmental incidents).
In the wake of the Commonwealth Bank’s failed LTI performance measure, she recommended that banks consider adopting a mixture of leading and lagging indicators, where leading indicators predict changes in culture and lagging indicators measure what has already gone wrong (or right).
For customer service, McCullagh notes that the most often used indicator Net Promoter Score (which measures customer advocacy, classing customers as promoters, passives or detractors and summing the result to get a score between -100 and 100) is a lagging indicator. Although this measure is quantitative and externally calculated, McCullagh notes that of the four banks, three use different versions of the measure, ranking themselves number one in their chosen measure. She also comments that with relative performance hurdles, the peer group is very important. For example, smaller banks may have better Net Promoter Scores than bigger banks, but might not be included in the bigger bank’s peer group, making the company’s customer advocacy look better than it really is.
It’s also important to make sure the Net Promoter Score captures the whole picture. A case study of a pay TV provider published in the Harvard Business Review revealed that while customer surveys concentrating on single interactions with the provider received high scores, the overall customer journey involved too many customer interactions in multiple siloed departments. This led to the overall customer impression being negative. Therefore metrics must consider customer “journeys” rather than just touchpoints.
Given the above, here is a checklist for creating customer service incentives:
- Be certain that a customer satisfaction bonus will be beneficial to the company. Not all industries are heavily dependent on customer satisfaction. In the research mentioned at the beginning of this article, the authors found that for a chemical company, customer satisfaction was negatively correlated with financial results. The reason? An improvement in customer satisfaction did not lead to additional sales, so any money spent to increase satisfaction created extra costs for no return. In another example, the research stated that professional services are often more dependent on trust than customer experience.
- If the decision is to include customer service as an incentive, decide whether to include the performance measure in the long or the short term incentive.
- If including the incentive in the short term incentive, decide whether to dedicate a portion of the incentive to the customer service incentive, or make it a multiplier to results-based measures. If the former, decide how much of the incentive should comprise customer service, potentially considering solution b) and c) to problem 2 above.
- When choosing specific measures, think about customer service in terms of leading, lagging and gateway indicators. For leading indicators, think about what behaviour will lead to a positive experience and what measures might capture the advent of this behaviour. (For example, technology innovation for a smoother customer experience.) Lagging indicators are signs of the current state of customer service. (For example, complaints lodged with an ombudsman or a Net Promoter Score.) Gateway indicators are signs that something has gone terribly wrong in a way that may significantly affect the business. (For example, action undertaken by a regulator.)
- Make sure that measures are consistent, not chosen to play to the company’s strengths, and if relative to peers, that the peer group is not cherry picked.
- Ensure that measures are not indicators of one positive customer interaction, but evidence of an overall customer experience. For companies using contractors or working with partners, the experience across the contractors and partners should be considered.
Some examples of measures used by leading customer-facing companies include:
- Implementation of digital initiatives
- External measures of digital functionality
- Implementation of strategic programs for a stronger service culture
- Data analysis to extract customer insights
- Introduction/improvement of customer loyalty programs
- Upgrade premises/brand choice
- Employee engagement (research shows that employee engagement is strongly correlated to customer satisfaction)
- Net Promoter Score / alternate customer satisfaction ranking
- Complaint numbers, potentially externally collated (for example by an Ombudsman)
- Customer churn percentages
- Internal survey results
- Obeying laws, regulations and codes (for example codes of conduct)
- Prolonged or repeated service outages