Editor’s note: Michael Murphy is director of research at Service Management Group, Inc., a Kansas City, Mo., research firm.

The linkage between customer satisfaction and profitability is a cornerstone of service improvement efforts. Measurement of customer satisfaction is irrelevant if this linkage does not exist. Because if variations in customer satisfaction do not connect with variations in profitability, attempts to manipulate satisfaction will have no impact on profitability. Several methodological issues can obscure the relationship, leading companies to erroneously assume that customer satisfaction measurement is not essential to their growth.

The measurement of customer satisfaction has become more common among organizations providing products and services to consumers and businesses. Customer satisfaction measurement is central to operations because it provides valuable feedback to organizations about where their efforts for improvement are most necessary, as well as indicating the degree to which improvements are likely to have the most significant impact on customer behavior and loyalty. In an effort to improve customer satisfaction, companies have spent millions of dollars evaluating customer satisfaction and making improvements, always assuming that their measures are directing them to address the right issues.

Organizations usually invest in customer satisfaction measurement because they assume that satisfied customers will engage in a number of behaviors beneficial to the company and demonstrate a long-term commitment to their brand. These behaviors include, but are not limited to, continuation of the customer relationship, deepening of the customer relationship through cross-selling, and referrals to new customers. Thus, it has been assumed that customer satisfaction should be consistently and positively associated with a company’s profitability.

This assumption of a customer satisfaction-profit link is the heart of the service profit chain (Heskett, Sasser, and Schlesinger, 1997). The model discusses the relationships among several organizational constructs, including employee satisfaction, motivation, and loyalty, customer satisfaction and loyalty, future purchase intentions, and profitability. The model has garnered considerable applied research support since its inception in 1997. The model connects customer satisfaction to several key organizational variables, such as employee satisfaction and tenure, as well as financial performance. Researchers have demonstrated strong support for many of the relationships hypothesized by the model.

The key linkage that must be demonstrated is the linkage connecting customer satisfaction to profitability. Demonstrating this linkage provides the ultimate justification for measuring customer satisfaction. Research has demonstrated that a highly satisfied customer is six times more likely to re-purchase than a customer who is merely satisfied (Jones & Sasser, 1995). In fact, if the linkage cannot be demonstrated for a company, then the measurement of customer satisfaction is irrelevant. However, there are very few cases where this relationship should not be demonstrated.

In most other cases, profitability should be strongly related to customer satisfaction. However, the statistical relationship between profitability and satisfaction will be obscured if research methodologies are not carefully constructed and implemented. Some standard guidelines should be followed when designing studies, while in other cases the unique situation of the organization must be considered when planning to empirically demonstrate a linkage between profitability and customer satisfaction. After discussing some of the situations where a linkage between satisfaction and profitability is not expected, methodological issues will be addressed.

Exceptions to the satisfaction-profitability link

Most commonly, the relationship will not exist if a majority of customers do not have a choice of which company will provide a product or service. These customers are what Heskett, et al (1997) defined as hostages. Hostages are customers who are not satisfied, but still express an intention to purchase from the company. The clearest example of a company whose customers are likely to be hostages are utility companies in communities where the customer has no choice of providers. A relationship between satisfaction and profitability would not be expected as customer satisfaction has little impact on a customer’s choice of service providers.

This relationship would also not be expected to exist in situations where the cost of switching providers is low and there are many companies providing the product or service. Heskett, et al (1997) refer to customers in these markets as mercenaries, as price can be a strong determinant in the product/service choice process. Commodity markets are the clearest examples of this type of market, where customers have ready alternative choices and their selection is likely to be driven by price.

Methodological issues

Level of analysis issues
Typically, customer satisfaction is measured with respect to a specific instance of experience. This decision is supported psychometrically, as respondents can more accurately evaluate their experience at a specific point in time than if asked to cognitively combine their satisfaction with multiple experiences that they might have had with a company’s products or services. These individual measures are commonly aggregated to represent the level of satisfaction typical of any customer interacting with a specific business unit, such as a store location or individual restaurant. Analyses are then conducted examining the relationship of unit-level satisfaction with a unit-level measure of profitability. Matching the level of analysis enhances the ability to identify a significant relationship between profitability and customer satisfaction.

Another alternative is to examine the relationship between loyalty and profitability. Theoretically, loyalty can exist with respect to a specific unit or to the brand, or both, in contrast to customer satisfaction, normally measured with respect to a specific experience. In other words, as a consumer, I may be satisfied or unsatisfied with my meal experience at a restaurant. While that satisfaction may have an impact on my likelihood of returning, other factors may also impact that decision. Further, I may recognize that the brand is a good brand, but a specific store or unit is poor.

When conducting research with companies that might provide several alternative locations within a respondent’s zone of convenience, the relationship between unit loyalty and unit profitability may not exist. Customers may be more strongly driven by brand loyalty and brand equity and operationalizing loyalty and profitability at a unit level may obscure the expected relationship. In this instance, profitability needs to be operationalized at a market level as do loyalty measures.

Customer need cycles
Depending on the product or service, a customer’s need for future products or services may vary. For example, two clients provided our firm with sales data, each calculated on a quarterly basis. We linked the sales data for each individual unit to the satisfaction scores for the same unit. For the first client, analysis of the relationship between customer satisfaction and quarterly sales growth indicated that units with stronger satisfaction scores also had stronger sales growth. The relationship between the proportion of customers who are highly satisfied and subsequent profitability changes for this client are shown in the table. A 6 percent change in the proportion of customers who were highly satisfied was associated with a 5 percent change in profitability. The identical analysis was conducted for a second client with the outcomes indicating no relationship between unit satisfaction and unit sales growth.

Figure 1

The difference between the two client companies was the customer need cycle. The first client was a company with a very short need cycle, while the second client was a retailer with a product cycle of typically more than a year. Customer need cycle has a strong effect in understanding the difference between these results. A customer might reasonably patronize the former client more than once a day, however customer need is most commonly annual for the latter client. As a result, the impact of satisfaction is felt over a much longer and likely less immediate period of time. For the client with the long need cycle, relating customer satisfaction from the current quarter to current quarter sales growth is much less likely to identify a strong relationship than if one related it to sales growth for the same quarter the following year. Thus, study design must take into consideration the timing of the next opportunity for purchase.

Figure 2


Figure 3

Lag between satisfaction measurement and profitability
The time lag between measures of satisfaction and measures of profitability must be appropriate. Given a normal distribution of purchase behavior following experience with a product or service provider, it would be expected that if one measured satisfaction continuously each month the relationship between satisfaction and profitability would rise and fall when related to a single point in time measure of profitability. We have found this relationship with several clients whose products and services have short need cycles, specifically in the restaurant and retail industries. In both industries, the relationship builds up to a two-month lag in measurement, peaks, then falls sharply afterwards. The graphs above demonstrate how the strength of this relationship is moderated by time. Timing in other industries may vary based on seasonal demand, need cycles, or other situational factors.

Satisfaction-profitability effect size
Generally, our research has demonstrated statistically significant relationships between customer satisfaction and profitability, with satisfaction accounting for between 1 percent and 10 percent of the variance in profitability. This is strong evidence in support of the reliance on customer satisfaction measurement. Providing customer satisfaction feedback allows individual units to identify areas for improvement in customer service, which in turn supports a direct impact on profitability.

Profitability is driven by other constructs at several different levels of organizational functioning. At the customer level, decisions to purchase are also driven by factors such as location, product quality, price, etc. Thus, measures of these variables should moderate the relationship between satisfaction and profitability. Analysis of the relationship between satisfaction and profitability should attempt to remove as much variance related to these other factors as possible, in order that the satisfaction-profitability relationship be clearly demonstrated.

Measuring profitability
Profitability can be measured in many different ways. Our research has demonstrated the strongest impact for customer satisfaction on incremental sales growth. Reliance on this measure allows for several intervening variables to be controlled. For example, unit size often has a strong influence on profitability. Measuring profitability through the use of incremental sales growth removes the impact of unit size by comparing sales at a particular unit in the target month to sales at the same unit in a previous month. If seasonal differences are expected in sales, then it is also useful to compare the current month’s sales to sales in the same month in the previous year.

Strong relationship

The service profit chain theorized a strong relationship between customer satisfaction and profitability. Research has continually demonstrated this relationship. However, as with any research, in order to find meaningful results, measures must be carefully constructed and designed. If you do not find a relationship between satisfaction and profitability and have reason to believe this relationship does not exist, the benefits of customer satisfaction measurement must be re-evaluated.

References

Jones, Thomas O. and W. Earl Sasser, Jr. (1995). “Why satisfied customers defect.” Harvard Business Review, November December, pp. 88–99.

Heskett, James L., W. Earl Sasser, Jr. and Leonard A. Schlesinger (1997). The Service Profit Chain: How Leading Companies Link Profit and Growth to Loyalty, Satisfaction, and Value. The Free Press, New York.