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Don Peppers and Martha Rogers: Customer Trust is the Next Big Thing (Trust Quotes #12)

We are delighted to have with us Martha Rogers and Don Peppers, the dynamic duo of the business guru business. Business 2.0 ranked them as two of top business gurus of all time. They’ve written one of the most influential business books in several decades, The One to One Future, and several others, including Return on Customer.

They’ve always had a healthy respect for the role of trust in marketing, but it’s their latest book that particularly makes them timely for the Trust Quotes series: Rules to Break & Laws to Follow: How Your Business Can Beat the Crisis of Short-Termism.

As they put it, “We believe customer trust is probably the ‘next big thing’ in business competition.” Let’s find out why they believe that.

CHG: Martha and Don, thanks so much for joining the dialogue. We’ve known each other for some years now, and you’ve always had a good sense of the power of trust—but it sounds like you’re increasing the focus more lately. What’s up with trust?

DP/MR: The basic ethos governing all human social interaction contains a very strong requirement for trustability. The simple trustworthiness of your statements and actions, as an individual (or as a company or governmental organization), is a key attribute – probably the key attribute – in how your interactions will be interpreted, understood, and acted on by others.   The social bond that connects us with others – the fuel that generates our collective intelligence and powers all our cultural and technological development – is based on trustability.  As a result, probably the biggest single driver of the increased demand for trustability is today’s rapid increase in the capability of interactive technology, leading to a more and more connected and interactive human race.

CHG: One of the four Trust Principles that I developed in my work (medium-to-long term perspective, relationships not transactions)  is built right into your title: “the crisis of short-termism.”  First of all, what’s wrong with short-termism?

DP/MR: When we talk about short-termism as a crisis issue, what we are talking about is the business world’s self-destructive, almost maniacal focus on short-term financial results. Obviously, a profit-making business should be cognizant of the short-term results of its actions, but this should not come at the expense of completely ignoring the long-term results. The long term counts, also – the interests of shareholders and other stakeholders are clearly harmed by obsessively short-term thinking. 

CHG: Is short-termism on the increase these days? And what does that say about trust?

DP/MR: Unfortunately yes, our verdict would be that short-termism is on the rise. It definitely undermines trust, because one of the central essences of trustability, as you’ve stated so well in your own work on the subject, is self-orientation. That is, the more selfish you think I am, the less willing you will be to trust me. And short-termism is a big flag for most people of self-orientation. 

CHG: What is driving all that toxic short-termism? What can be done about it, and who in particular can do it?

DP/MR: Do you know what “IBGYBG” means? 

CHG: The Wall Street euphemism?

DP/MR: Yes. It perfectly illustrates what we’re talking about here. Interestingly, during the financial frenzy that constituted the run-up to the mortgage meltdown and panic of 2008, traders and investment bankers were being paid bigger and bigger commissions and bonuses for doing bigger and bigger deals. Cash commissions and bonuses were the short-term compensation banks were paying their people for doing these deals – deals that had significant long-term implications. Many of the bankers and traders themselves knew that some of these deals posed significant long-term risks. But they had immense short-term motivations for doing them anyway. 

IBGYBG is a text message, a kind of short-hand like LOL or OMG. If a trader expressed doubt about the long-term consequences of a deal, he might get a message back from one of his colleagues to the effect that he shouldn’t worry about the long term, because in the long term IBGYBG – I’ll be gone you’ll be gone.

CHG: And what’s to be done?

Two things: First, tie compensation more closely to long-term consequences. We have no problem with paying people a piece of the action to do a deal – a business transaction can be immensely complex, and creativity and innovation should definitely be rewarded. But make it a true “piece of the action” rather than an upfront bonus in cash. 

And second, with respect to compensation in general, recognize that people work much more enthusiastically for the intrinsic benefits involved – recognition, credibility, self-reliance, accomplishment. No business should treat its people as if they are solely interested in money – unless they want them to be.

CHG: I’ve always felt that short-termism is inherently less profitable than taking a longer-run strategic vision. You’d think it would be obvious to CEOs; you’d also think it’d be obvious to Wall Street analysts. Someone said the real problem is in the compensation structure for mutual fund managers. Where do you think the key lies for fixing it?

DP/MR:  That’s why the opening chapter of our 2005 book Return on Customer: Creating Maximum Value From Your Scarcest Resource, was titled “An Open Letter to Wall Street.” Investors are in fact very interested in understanding a company’s long-term value, but at present there is no better or more reliable indicator of long-term value creation than, well, short-term financial performance. 

The discounted-cash-flow (DCF) method for valuing a business is based on forecasting the firm’s future cash flows, but in the end even the most sophisticated predictions rely mostly on aggregate business trends, projections of market growth, and competitor activity, and in any case all such projections begin with today’s numbers. So, like the butterfly whose wings cause a tornado a continent away, small fluctuations in current earnings or revenues wreak massive changes in projected company valuations and share prices, as their effects are extrapolated and magnified years into a company’s financial future. 

Ironically, the key to fixing this short-term-only perspective probably lies in applying better customer analytics. That’s why we coined the term “return on customer” and created the financial metric itself. Every value-creating activity of a business involves a customer at some point, but customers create value in two ways: they buy things immediately, in the current period, but they also have memories, which means how they are treated today will effect how much they are likely to buy in the future. A business that understands its customers lifetime values, and makes an effort to track how those lifetime values are impacted by current-period activities will be less likely to make self-destructive, short-term decisions.

CHG: What do you think about new social media and trust? Is it making trust harder to create? Or easier?

DP/MR: Trustability will become even more important as a social and economic norm in coming years, largely because of social media technologies, and the increasingly interactive world they are creating for everyone. This will have effects that reverberate throughout not just our business and economic system, but our society and culture as well. 

For one thing, better and more efficient interactive technologies will increase the demand for trustability on the part of people and organizations, including businesses and governments. Organizations, particularly, will need to respond to this demand by implementing policies and taking actions that are more worthy of trust from the beginning – that is, more transparently honest, less self-interested, less controlling, and more responsive to others’ inputs. It won’t be easy because it might be difficult for a business even to understand what kinds of policies improve trustability – from marketing and customer service, to production, distribution and financial reporting. Moreover, the clash between trustability and a company’s own short-term financial interest is real, and will represent a serious and continuing obstacle.

But second, the increase in demand for trustability will inevitably generate an increase in its supply. As a result, we believe that society will benefit from a “virtuous cycle” of increasing trustability, over time, leading to more rapid economic progress, which will lead to even more trustability, and so forth. This will have the effect of “raising the bar” for trustability, meaning that some previously acceptable business and government activities will become less acceptable, as consumer and citizen expectations rise. We can already see this happening with the influence that highly trustable, online businesses are having on the business practices of more traditional, offline businesses. 

And third, the dominant role of trustability in human interaction cannot be explained by applying straightforward economic thinking.   There are many subtle motivations for human behavior other than rational economic self-interest, and as technology reduces the barriers to interacting, these other, non-economic motivations will become more and more important. Rather than the kind of neoclassical economics still taught in business schools, the relatively new field of behavioral economics is more likely to play a dominant role in explaining how the trustability ethos actually works. 

CHG: What are some of the implications for marketing, broadly, of an increasing role of trust in the world?

DP/MR: We don’t trust advertising and marketing messages coming from companies because they epitomize “self interest.” We know these communications are designed with a particular, self-oriented purpose in mind: to improve the bottom line of the companies doing the communicating. Companies are always transmitting their self-interested messages to customers and potential customers, and these messages have bounced off each of us enough by now that we know what to expect. 

One survey showed that a scant 12% of people trust “big companies.” Even within companies themselves, just a third of employees believe “their leaders act with honesty and integrity.” Nor do investors trust the companies whose shares they own. Only 2% of investors believe the CEOs of large companies are “very trustworthy.” And 80% of consumers believe businesses are too concerned about making a profit and don’t care enough about their workers, the environment, or consumers. 

And the news is full of surveys showing that consumers’ mistrust of business is on the rise. But we think what’s really happening is that consumer expectations are increasing, as they experience best practices by some companies, and as they become increasingly interactive among themselves.

CHG: Interesting; declining trust metrics may be masking a rising standard of trustability. So, what must marketers change?

DP/MR: The primary thing marketers need to realize is that they are facing a trustability standard that is constantly on the rise now. The old “command and control” mechanisms don’t apply as easily to a world where customers can talk back, and also talk to other customers. It used to be that the marketing message was in the sole control of the marketer. Today, that’s no longer the case.

CHG: That’s a huge conclusion right there. 

Martha and Don, thank you so much for taking the time to share your thoughts. As always, they are innovative, yet grounded in deep commonsense and an intuitive feel for the customer. 

[If you are looking for earlier installments of the Trust Quotes: Interviews with Experts in Trust series, you can always find them in the dedicated Trust Quotes Index.]

——– 

This is number 12 in the Trust Quotes series.

The entire series can be found in our Trust Quotes section on TrustedAdvisor.com

Recent posts in this series include:

Trust Quotes #11: Jim Peterson
Trust Quotes #10: David Gebler

Trust Quotes #9: Chris Brogan

Review of Rules to Break and Laws to Follow by Peppers and Rogers

Don Peppers and Martha Rogers have a new book out called Rules to Break and Laws to Follow.

Peppers and Rogers are delightful, brisk, witty and solid business thinkers. Best known for their One to One concept (OtO Future, OtO Manager, OtO Fieldbook), they deserve to be equally well known for their recent work in Return on Customer, and this book.

Don and Martha demonstrate their reliably good instincts around themes like trust, collaboration, values-driven management, and culture. They inhabit that slightly rarefied territory where new age management meets—and greets—old world success in the competitive marketplace. Left wing capitalism is the vibe it gives off, without compromising either, and I kind of like that.

Your mileage may vary, but what I find most interesting about their contribution is the stark, precise analysis it gives of just what’s wrong with short-term management, Wall Street financial analysis, and the modern-day obsession with profitability as the ultimate metric.

Their critique is not based on disempowerment, or cronyism, or the corruption of the soul. It’s how those practices manage to destroy shareholder value, pure and simple.

The (grossly) over-simplified logic is this. In a connected, small world, the supply of capital is greater than the supply of customers. Yet companies will fund programs that chew up customers to supply a higher return on capital, even while they reject programs that chew up capital to supply a higher return on customer. If customers are ultimately the scarce resource, then why over-weight return on capital? The shorter the long-run, the sooner the long-term results are going to show up on the short-term income statement.

The more corporations are willing to focus on annual and quarterly profit, the more likely they are to churn customers. Churning customers destroys loyalty, thereby raising customer acquisition and maintenance costs, thereby lowering long-term profitability.

The authors use simple math and real-life corporate examples to highlight the destructive financial results of focusing too much on the short term.

Their analysis is neither facile, nor squishy.

I remember a century or so ago studying in business school the idea of “quality of earnings.” In one case, we saw equivalent earnings (i.e., the bottom line of the income statement as a percent of revenue or of various measures of capital) from GE and from Westinghouse. But in terms of quality of earnings—basically the presence or absence of long-term, sustainable, repeatable, customer-nurturing behaviors—GE’s earnings per share were far superior. And it was reflected in share prices. (Not to mention continued existence: the saga of Westinghouse makes for interesting reading in corporate history).

This is a macro-level example of what I encounter in my seminars at an individual and micro-level: how do you do the “right” thing when all the “powers that be” around you are focused on the short-term?

The answer at the micro-level is to play your own game, live your own life, cultivate your own reputation—don’t let others do it for you. Unless you’re a year away from retirement and don’t care about your reputation, then focus on relationships, reputation, and the nurturing of customer relationships. For an individual, the best short-term results come not from short-term management, but from continuous execution of a long-term program.

The answer at the macro-level is the same. You’ll run a better company, produce better earnings, and be a better investor if you focus on the long term, and watch the short-term results take care of themselves. Warren Buffet would be a good example of this strategy, as is Apple, Starbucks, or a host of companies who know the value of values, not just the cost of capital.

Congrats to Don and Martha for a very refreshing presentation of a very solid concept.

Short-termism, ROI and Green Economics

From BusinessWeek comes the painful story of an idealist butting heads with resistance and inertia. Nominally it’s a story of Green economics — identifying ways to be profitable while reducing environmental impact.

But it’s also about an emphasis on short-term economics that is not only paralyzing environmental activity, but is harming business and society.

Think of it as the triumph of payback time over ROI analysis.

Auden Schendler is a classic young outdoorsman environmentalist, full of hope that his employer, Aspen Skiing Company, will “get it” regarding his recommendations.

He recommended a $100K project to remodel the oldest lodge; it has a 7-year payback.

Too long, said the company.

OK, then, how about fluorescents in guest rooms—a 2-year payback in eco-friendly savings.

Nope, not warm enough light for guests.

OK then, how about $20K to save $10K per year in the underground garage?

No, we’d rather spend it on amenities guests notice.

It took Schendler two years to overcome resistance to the garage-light replacement, and then only after he secured a $5,000 grant from a local nonprofit. He acknowledges the strangeness of a corporation with annual revenue of about $200 million, according to industry veterans (the company declines to provide a figure), seeking charity to reduce its electricity use. With a hint of sarcasm, he notes: "This is the sort of radical action that’s needed to get people over ROI thresholds."

BW is writing about Green economics. But look at the examples.

What kind of capitalistic enterprise is passing up 50% returns on investment? The answer—a whole lot of them.

Our economy is increasingly governed by the belief that a bird in the hand is worth more than two in the bush—because that two-bird bush could blow up at any time, and besides, you just might find a four-bird bush around the corner.

Look at the forces of short-termism at work:

• The average length of ownership of a stock is down by orders of magnitude from a decade ago;
• mortgages used to be resold once or twice; now they are sliced and diced and repackaged into securities that are themselves sold over and over;
• the growth of private equity is, among other things, a shortening of the time period of evaluating a company’s worth;
• the growth in auto leasing represents a shortened ownership period;
• Real estate is increasingly a short-term investment to be “flipped;”
• Outsourcing reduces the time required to make a switch in organizations;
• Divorce rates, clothing style cycle times and TV show lifespans—all becoming shorter.

A shift toward transactions goes hand in hand with a reduced time perspective. These shifts make for more efficient markets, and reduce transactional costs (though increasing their number). But there’s a big downside: if everyone’s looking for fast hits, then no one’s around to play the long game.

Mathematically, there are three reasons payback analysis is supplanting ROI analysis:

1. Investment “owners” are turning over faster; I want mine now, thank you;
2. Uncertainty feeds the “get rich quick” mentality; why tie your money up because,hey, you never know!
3. Uncertainty also feeds perceived risk. In effect, investments are being assessed at increasing hurdle rates for farther-out timeframes (note to self—or kind reader?—check bond markets for evidence of this)

So we get more of this kind of thinking:

• Why should a private equity firm invest in anything beyond what will increase the return when the company is sold in three years?
• Why should any company invest with a longer timeframe than three years, lest it be taken over by a private equity firm?
• Why should a company invest in employees, since after all they might leave?
• Why should a company invest in customers if the payback takes over a few years?
• Why invest in branding? In training? In anything you can outsource? (And make sure the outsource contract shows a payback of at least two years).

With this kind of thinking endemic, it’s no wonder we’ve got a hard time figuring out how to reform social security, save the environment, deal with immigration, or rebuild falling bridges. It’s just not fast enough to suit us.

Thank goodness Schendler has the optimism of youth. He doesn’t know what he’s up against.

 

Software Programming and the Economics of Trust vs. Transactions

In a charming blogpost, Paul Duval says that developers should “Fire your best people and reward the lazy ones.”

As he explains, developer shops often consider “troubleshooters” to be among the best employees. They know where all the hard-coded quick fixes are, and they can spot them like lightning. Trouble is—those hard-coded fixes are impenetrable to other programmers.

Troubleshooters perpetuate impenetrable coding—because it’s faster, and perhaps because they are the beneficiaries of continued arcane language.
“Lazy” developers, by contrast, are those who can’t stand repetition. Every time they encounter a hard-coded arcane fix, they take the time to craft a generic solution that any future developer can understand.

One key fact: Duvals says that for every time a method is written, it’s read (and maintained) ten times—a 10:1 ratio. Suddenly, the “lazy” developer is the one reaping relationship-based economics for the employer; and it’s the “troubleshooter” who is perpetuating a repetitive, transaction-based high cost structure.

So it is that the world of software development is a microcosm of the broader world of business relationships—rewarding transactional behaviors in a non-transactional world.

We live in a world of incredible inter-dependence, connections, networks—and it’s moving ever-faster toward more, not less, of those connections. Yet we live by ideologies that focus on and reward transactions, not relationships.

• In software development, it’s a focus on how fast the problem can be solved—rather than on the systemic cost of solving the same problem over and over.

• In sales, it’s the dominance of linear “models” that begin with a lead and end with a close—rather than on lifetime and network-based models of business development in a sustained relationship environment.

• In investment banking, over the years it’s become about how to get the deal, rather than nurture the relationship.

• In commercial banking, it’s about transaction fees (e.g. overdraft charges), rather than about earnings based on assets under management.

• In mortgage banking and credit cards, it’s become about penalties charges (prepayment penalties and late penalties) rather than underlying economics.

• A major aspect of the subprime mortgage debacle has been the “transactionalization” of what used to be a relationship business. Mortgages have been on the ownership dimension—being sold repeatedly; on the risk dimension—stripping principle from interest; and on the time dimension—dealers in mortgage “products” increasingly get paid from transaction fees for moving on to the next step in the chain, rather than on the underlying interest paid.

• Private equity in its entirety is arguably an example of transactionalization of the corporation, though at the outset it introduced a needed jolt to stodgy bureaucracies. Of late, however, PE firms are increasingly finding earnings based on—you guessed it—transaction fees.

In all these arenas of business, we are seeing a structural challenge to trust. If you disrupt the relationship aspect of business in favor of approaches that are one-off, transactional, short-term in nature, you destroy the natural economics of trust.

Ironically, the long-term economics of trust far outweigh those of short-term transactionalism. But an ideology of get-in-get-out-fast has overwhelmed commonsense. The result is not only housing bubbles, but a paucity of social trust in business.
 

The Cancer of Short-term Thinking

Western capitalism is fighting a form of business cancer. And the most virulent form of it is short-termism.

In physical cancer, some cells go haywire and turn viciously against the body. This is also what happens when certain core beliefs are perverted or taken to extremes. Some examples—the beliefs that:

• greed is good (Hollywood simplification)
• individual pursuit of selfish aims yields public good (mis-translated Adam Smith)
• pursuit of short-term corporate goals ends in long-term social success (what’s good for General Motors hasn’t been good for America for some time now).

Those and other beliefs have resulted in rampant short-termism. A few examples, “ripped from the headlines:”

1. The trend in private equity toward front-end deal fees. Gretchen Morgensen’s NYTimes article quotes Michael Jensen, emeritus of Harvard Business School and the “father of private equity:”
“…these fees are going to end up reducing the productivity of the model… People are doing this out of some short-run focus on increasing revenues."
In other words, private equity is good when it subjects bureaucratic managers to the pressure of markets, with say a 3-5 year timeframe. But when the privateers themselves succumb to the lure of instant front-end fees, the greed snake is eating its own tail.

2. The trend in the mortgage industry to convert relationships to transactions—from integrated loan-making and loan-holding, to separating the entire process into various stakeholders—most of whom get their money up front, now. Short term.

3. The IBGYBG mentality in investment banking during several market crashes detailed by Richard Bookstaber in his book A Demon of Our Own Design, that resulted in people making fast deals that would explode on investors down the road, but that paid off nicely up front for the dealmakers, who said not to worry, because—"I’ll be gone, you’ll be gone," it’ll be someone else’s problem then.

4. Young financiers opting out of an MBA because the opportunity exists to make so much more money in the short term:
“With the growth of hedge funds, you’re getting a lot of really smart people who are getting paid a lot very young,” says Arjuna Rajasingham, 29, an analyst and a trader at a hedge fund in London. “I know it’s a bit of a short-term view, but it’s hard to walk away from something that’s going really well.” Yup on both counts.

5. The current residential real estate recession, driven heavily by speculative buyers betting well beyond their means on continued high prices—“I’ll pay off the loan when I flip it.”

6. The longer term trend in business toward “alignment” of processes—which often assumes the only way to long-term profit is to ensure that every short-term measure is itself profitable.

7. Quarterly earnings pressure, which was one of the original drivers of private equity, back when PE was doing some good.

8. Private equity firms selling equity to the public: “a non sequitur in both language and economics,” according to Gretchen Morgensen’s paraphrase of Michael Jensen .
The private equity movement initially shook up stodgy companies that were permanently-funded by stock, where inefficient managers could hang out draining away value for decades. Private equity would buy them and insist on returns in 3-5 years; it left managers no place to hide, and produced real value returns. But when the 3-5 year people themselves start selling permanent stock to investors, they have become what they started out to fight. Which means they’re either stupid or venal. And while I usually opt for stupidity in explaining conspiracy cases, in this one I’d put money on venal.

Is there any relief? Or is this just another case of cheap hustlers exploiting weak human nature that goes with every business cycle?

Three antidotes can work against short-termism. One is pain. Suffering may not be a sufficient condition for social change, but it’s usually a necessary one.

Second is education. Awareness creation can help.

The third is leading thinkers, and there are some hopeful signs. Martha Rogers has begun talking about a lifetime financial perspective on customers:

"Creating maximum value from your customers involves optimization — balancing current-period profits against decreases or increases in customer lifetime values, to maximize your “Return on Customer.”

This isn’t new in finance, accustomed to present-value thinking in pricing financial assets. But it’s new to management thinking, accustomed to quarterly EPS. Robbing future customers robs enterprise value, says Martha. And she’s right.

The aforementioned Michael Jensen announced last month a paper he wrote with Werner Erhard (the controversial founding father of EST training, and more recently of Landmark Forum) on the subject of—get this—integrity.

Here’s a tasty quote from the abstract:

We demonstrate that the application of cost-benefit analysis to one’s integrity guarantees you will not be a trustworthy person (thereby reducing the workability of relationships), and with the exception of some minor qualifications ensures also that you will not be a person of integrity (thereby reducing the workability of your life). Therefore your performance will suffer. The virtually automatic application of cost-benefit analysis to honoring one’s word (an inherent tendency in most of us) lies at the heart of much out-of-integrity and untrustworthy behavior in modern life.

They are right too. You can’t fake trust; trust is a paradox; motives matter. The act of justifying trust by its economic value destroys not only trust, but its economic value. The best economic results come as byproducts, not goals.

Can clearer business thinking beat short-termism? It can’t hurt.