The greater the loyalty a company engenders among its customers, employees, suppliers, and shareholders, the greater the profits it reaps. Most business people today understand that. But what can an organization do to win and retain the allegiance of all those stakeholders?

My most recent research, building on the work of more than a decade, points to an answer that busy executives may not want to hear. A study of the “loyalty leaders”—the companies with the most impressive credentials in that area—has convinced me that the challenge of engendering loyalty can’t be delegated to a task force or a bright young up-and-comer. It can’t be addressed with a software upgrade or a new wireless strategy. It isn’t simply a matter of having better customer databases, measurement systems, or rewards programs. Outstanding loyalty is the direct result of the words and deeds—the decisions and practices—of committed top executives who have personal integrity. The companies I studied don’t skimp on talent, technology, or strategy. But it’s their top management that separates them from the pack.

The loyalty leader companies are a diverse bunch, ranging from Northwestern Mutual and Vanguard to Chick-fil-A, Enterprise Rent-A-Car, Harley-Davidson, and Intuit. It may seem far-fetched to suggest that they have anything in common, but beneath the surface variations lie relationship strategies that are strikingly similar. The strategies, which can be expressed as six concise principles, originate at the top of the organization and inform all of its relationships, both within and beyond the company walls. These strategies are the starting point for senior executives seeking to place their organizations among the ranks of the loyalty leaders. In the pages that follow, I’ll describe how exemplary corporate leaders have put the six principles into action.

The Six Principles of Loyalty

Loyalty’s Six Principles

High loyalty companies, though extremely diverse, have several things in common: exemplary leaders who are committed to engendering and retaining loyalty, and relationship strategies that are based on the following six principles.

Preach What You Practice.

It’s not enough to have the right values. You must clarify them and hammer them home to customers, employees, suppliers, and shareholders through your words and deeds.

Play to Win-Win.

If you are to build loyalty, not only must your competitors lose. Your partners must win.

Be Picky.

At high loyalty companies, membership is a privilege. Clarify the difference between loyalty and tenure.

Keep it Simple.

In a complex world, people need small teams to simplify responsibility and accountability. They also need simple rules to guide their decision making.

Reward the Right Results.

Save your best deals for your most loyal customers, and save your best opportunities for your most loyal employees and partners.

Listen Hard, Talk Straight.

Visit call centers, Internet chat rooms, and anywhere else customers offer feedback. Make it safe for employees to offer candid criticism. Use the Loyalty Acid Test survey. Explain what you’ve learned and communicate the actions that will be taken.

Preach what you practice.

Many business leaders are vaguely embarrassed by the idea of trumpeting their deepest values. They believe actions speak louder than words. But only by preaching the importance of loyalty in clear, precise, powerful terms can executives and businesses prevail against digital-age dogma that disparages the notion that loyalty remains relevant to success in today’s world.

Scott Cook, chairman of the Executive Committee and founder of Intuit, a leader in personal-finance software, rarely misses an opportunity to remind employees of the company’s commitment to treating customers right. He also preaches that total honesty and openness is a bedrock principle at Intuit. The messages have obviously gotten through. In February 1995, Cook was en route to a speaking engagement when he read a newspaper report that a bug had been discovered in Intuit’s tax preparation software, TurboTax. There was no time to cancel the speech and return to Intuit’s headquarters, so Cook instructed his executive team to handle the crisis in accordance with the company’s core values. Before Cook even began his speech, the crisis-management team had issued a press release describing the bug and explaining how customers could fix it. By the time Cook finished his talk, Intuit had offered to send a new copy of TurboTax to any customer who requested it, even though the bug affected fewer than 1 of Intuit’s 1.65 million customers. The company said it wouldn’t require proof of purchase, which almost certainly meant that Intuit would end up replacing software that hadn’t been paid for. But as Cook said later, “This was our problem, not our customers’.” And in a gesture that left no doubt about Intuit’s priorities, the company immediately pledged that it would pay any penalties that TurboTax users incurred as a result of the flawed software. The pledge could have bankrupted the company—Intuit made the promise before the full extent of the problem was known.

Intuit’s candor and devotion to its users have produced such intense customer loyalty that even when mighty Microsoft gave away its personal-finance software for free, it couldn’t steal the customer base from Intuit’s Quicken. That product and TurboTax remain far and away the most popular titles in their categories.

Play to win-win.

In building loyalty, it’s not enough that your competitors lose. Your partners must win. That sounds obvious, but many businesses seem to have missed the point. Why do the Big Three auto companies, for example, demand concession after concession from unions and suppliers? For that matter, why do U.S. carmakers tolerate dealers who routinely abuse their customers?

My research demonstrates that there is a clear connection between a company’s treatment of its partners—above all, its employees—and its attitude toward its customers. I have yet to encounter a company that has achieved extremely high customer loyalty without fostering similarly high loyalty among employees.

I am convinced that customer and employee loyalty spring from the same root: principled leadership. Leaders who are dedicated to treating people right drive themselves to deliver superior value to customers, which allows them to attract and retain the best employees. That’s partly because higher profits result from customer retention, but, more important, it’s because providing excellent service and value generates pride and a sense of purpose among employees. Dedicated employees who put customers’ needs ahead of their own short-term interests reinforce the organization’s capacity to generate superior results.

That’s clearly the case at Harley-Davidson, whose customers are so loyal that thousands tattoo the Harley logo on various parts of their bodies. Such loyalty is the result of a series of relationships between Harley and its partners, beginning with its employees. Unlike many of its counterparts in the transportation business, the motor cycle manufacturer enjoys cooperative and mutually respectful dealings with its unions. In fact, the manager of Harley’s Kansas City, Missouri, plant shares his office with the presidents of the plant’s two union locals. As the following story attests, they also share a deep commitment to making the best possible machines for Harley’s customers.

One day a few years back, a Harley plant employee (and union member) noticed a sudden spike in quality problems on the production line and shut the line down. The plant manager and his top lieutenants were out of town, and the union presidents would have been perfectly within their rights to send their people home until management returned and addressed the problem. That’s what would have happened at most union shops. But at Harley, one of the union presidents investigated the problem and discovered that a piece of equipment on the line needed adjustment. He called in the mechanics and had the line up and running in less than an hour. Despite the downtime, the union workers were paid for a full day’s work, and Harley’s dealers and customers were assured of a steady flow of high-quality bikes from the plant.

This could happen only at a plant where the customer is the top priority of both management and labor. That’s one of the key points to remember about win-win arrangements and about partnerships in general. Partnerships are not simply about mutual benefits; partnership does not equal collusion. True partnerships serve the customer’s best interests.

Another point worth raising is that partners don’t kick each other when they’re down. The clout and membership of unions have been in decline since the 1980s, and Harley-Davidson could have taken advantage of labor’s weakness in any number of ways—by siting new plants in right-to-work states, for instance. Instead, when Harley-Davidson was considering where to build a new plant, CEO Jeff Bleustein invited his union heads to join him in the site selection process. That’s the mark of a leader who commands loyalty—he understands his obligation to look out for his partners, even (or especially) those who are out of power. Compare the tone of labor-management relations at Harley with the rancorous tone prevailing in, say, the airline industry. I don’t think it’s a coincidence that under the industry’s pricing structure, most airlines charge the highest possible tariffs based on information from sophisticated systems that gauge how badly customers want each ticket. Fairness is secondary to maximizing price per transaction. As a result, the airlines’ relationships with many of their best customers are adversarial. The loyalty leaders concentrate instead on helping their best customers find the best value. That brings us to the third principle of loyalty:

Be picky.

At first blush, such advice sounds arrogant, summoning up images of a snooty maître d’shooing away unsuitable diners. But real arrogance is thinking your company can be all things to all customers. A truly humble company knows it can satisfy only certain customers, and it goes all out to keep them happy. Thus Enterprise Rent-A-Car has risen to the top of the car-rental industry by generating business from its existing customer base, not by chasing after frequent travelers in every airport terminal.

Vanguard, the loyalty champion in mutual funds, has always been very selective about its customers. Its ideal account is a substantial investor who is cost conscious and oriented to the long term. Vanguard designs its value propositions to appeal to this investor while discouraging high-turnover, quick-trade accounts. It limits transfers to combat frequent fund-switching, and it reserves its low-cost Admiral shares for high-balance investors and lower-balance investors who have kept their money with the company for at least three years.

Vanguard’s strategy may sound foolish—by discouraging rapid-fire trading, the company is forgoing substantial revenue. But those transactions carry significant attendant costs, which ultimately would be borne by Vanguard’s customers. By keeping account churn to a minimum, Vanguard can hold its average expense ratio to 0.3, compared with an industry average of more than 1.2. Lower expenses translate to higher returns over time, benefiting not only investors but Vanguard’s employees, who share in a bonus pool that’s funded when returns on the company’s funds exceed the competitive average. A virtuous circle takes shape: long-term customers create the platform for above-average performance, from which the company, its employees, and its customers gain.

Vanguard is so picky that it turns away high-balance customers if they don’t appear to be in it for the long haul. One institutional investor who tried to place 40 million in one of the company’s funds was rejected because Vanguard suspected the investor was going to flip the position within a few weeks, leaving behind a trail of higher costs that Vanguard’s more loyal customers would have had to cover. The thwarted investor complained to Vanguard CEO Jack Brennan, who not only declared his full support for the decision but used the incident to remind employees to be selective about the revenue they accept.

Careful selection of employees is just as important as selection of customers. It’s easier to get into Harvard or Princeton than to be hired by Southwest Airlines, which accepts only 4 of its 90,000 applicants each year. For its part, Chick-fil-A refuses to grow faster than it can recruit outstanding store operator candidates. It attracts a highly qualified pool of applicants by offering greater earnings potential than its competitors, and from this pool it picks only those candidates whose values are most closely aligned with those of the company. The result: impressive loyalty. Turnover among Chick-fil-A store operators is less than 5 in an industry where operator turnover of 30 to 40 is common. At high loyalty companies, membership is a privilege.

Keep it simple.

This straightforward statement has multiple applications, the first of which is strategic. To make their organizations as flexible and speedy as they need to be in an increasingly complex world, great leaders understand they must simplify the rules for decision making.

Jim Ericson, Northwestern Mutual’s CEO from 1993 to 2001, steered a straight and steady course through a brutally complex business by keeping his company focused on one simple rule: do whatever is in the customer’s best interest. Strict observance of the rule has produced some decisions that appear at first glance to be bad business. For example, several years ago a Northwestern Mutual customer wanted to buy an insurance policy for his new-born daughter. He completed the application and sent in his first premium payment, but the company couldn’t issue a policy because the baby’s physician had not yet sent in the necessary medical paperwork. When a Northwestern Mutual representative called the baby’s father to explain the delay, the father cut her off, saying it was too late—the little girl had died that morning of sudden infant death syndrome. After conferring with her manager, the Northwestern representative decided that since the child’s parents had done all that had been asked of them, the company should issue a policy if the medical records indicated that the child would have qualified for a policy. The doctor eventually provided the necessary information, and Northwestern issued a policy and paid the claim. Although Ericson didn’t even hear about this remarkable decision until after it was made, he was responsible for it, because he and his leadership team had clarified the simple rule that produced it. There may be costs associated with a company’s loyalty to its customers, but the long-term economic benefits are far greater.

Simplicity has a structural application as well. Organizational complexity impedes the quick, decisive execution that a fast-changing business environment demands. An organization composed of many small teams, however, can respond with entrepreneurial creativity as conditions change. What’s more, loyalty comes naturally in a small team. In teams of five or six people, the lines of accountability are clear, and team members don’t want to let one another down. In large teams, it’s difficult to measure each member’s contribution. In the face of this lack of recognition and accountability, high achievers can lose motivation and slackers can get away with not pulling their weight.

Another reason small teams are so effective is that customers don’t get lost within an anonymous bureaucracy. That’s why Dave Illingworth, the first general manager of Lexus U.S., used the small-town car dealership as the model for the Lexus retail system. He understood that small-town dealers can’t afford to abuse or deceive customers—everyone in town would hear about it. Consequently, small-town dealers make a point of cultivating personal relationships and providing superior service. And so do Lexus dealers, who have translated their small-town style into enormous success for Lexus. In only a few years, the company’s sales volumes have grown to levels that match or exceed those of luxury brands that have been around for decades.

Andy Taylor, CEO of Enterprise Rent-A-Car, says small teams are the key to growth: “The reason we have been able to grow so fast for so long is that we aren’t really one big company. We are really a confederation of small businesses, a network of entrepreneurial partnerships.” Taylor has observed that when branches grow large, their customer and employee satisfaction scores tend to suffer. So when an Enterprise branch grows to a specified size (usually between 100 and 200 cars), it is split in two and a new manager is put in charge of the new location. The manager responsible for the growth of the branch is compensated for the loss of potential revenue by being given favorable consideration for the next promotion—a strong incentive to keep growing and subdividing.

It’s also important to keep an organization’s score-keeping simple and consistent. When Truett Cathy opened his first Chick-fil-A store in 1967, he offered Doris Williams, his first store operator, the same basic deal he offers store operators today. Cathy gave Williams a guaranteed base draw plus half the store’s profit. Operators today get essentially the same deal, except that the base has increased to keep pace with inflation. Operators don’t waste their time dickering over numbers, lobbying for a pay system that better suits their specific needs, or worrying that management will cut back on their profit participation because their incomes have grown dramatically. They simply dig in and concentrate on building their stores’ profit pools by providing customers with the best possible value and service.

There’s nothing magical about the 50-50 profit split, according to Jimmy Collins, who retired in May 2001 after a long tenure as Chick-fil-A’s president. “There’s lots of different deal structures that could have worked just as well for us,” he says. “The secret of our success is not the deal; it’s that we have never changed the deal.”

Reward the right results.

The fifth principle is an easy one to get wrong. Many companies reward the wrong customers. Cellular carriers, for instance, often inadvertently punish loyalty: existing customers who want new handsets are charged prices much higher than those offered to customers who switch from rival carriers. In a similar vein, companies often reward employees who grab short-term profits and shortchange those who build long-term value and customer loyalty.

Andy Taylor devised a pay system at Enterprise Rent-A-Car that balanced pure profit incentives with inducements to build long-term assets such as employee and customer loyalty. Taylor’s first step was to develop a reliable gauge for customer service. This gauge eventually evolved into the Enterprise Service Quality Index (ESQI). Each month, the company conducts phone surveys of sample customers from every branch, asking them to rate their rental experiences and inquiring whether they intend to use Enterprise again (keeping the questionnaire simple ensures a high response rate). Among other things, the survey data demonstrate how service excellence begets loyalty: 85 of customers who rate themselves completely satisfied say they’re likely to rent from Enterprise again.

But Taylor and Enterprise’s other senior leaders did more than conduct the surveys and analyze the data. They trumpeted the value of loyalty and customer satisfaction. They highlighted the ESQI at management meetings and business reviews. They redesigned branch financial statements so that each office’s ESQI scores appeared next to its profits. And, most important, they instituted a policy that no employee would be promoted if the ESQI scores at his or her branch were below average. All candidates for promotion are now measured by four criteria: branch ESQI score, branch growth, branch profitability, and the number of promotable management candidates developed at the branch.

By incorporating customer loyalty and employee development in the manager development process, Enterprise has improved the alignment of interests across several partner groups. Branch managers eager for promotion to area and regional offices know they must not only run profitable shops, they must deliver a superior experience to their customers and attract talented, high-potential employees.

Note that the effort to align profit incentives more directly with customer and employee interests didn’t bubble up from the bottom of the organization. It wasn’t the product of a compensation consultant or a staff task force. It happened because Taylor and the other senior executives took the lead. Their perspective as owners allowed them to look beyond immediate profits to the long-term benefits of a loyal customer base and a stable, motivated work force.

Listen hard, talk straight.

Long-term relationships require honest, two-way communication and learning. True communication promotes trust, which in turn engenders loyalty. Communication also enables businesses to clarify their priorities and coordinate responses to problems and opportunities as they develop. That’s the thinking behind the public “bug database” that Cisco Systems has designed. It enables all customers, employees, and suppliers to post on-line any problem with a Cisco product or service and to chat electronically about possible solutions. Little effort is wasted on spin control in such a transparent relationship; the emphasis is on fixing and avoiding problems.

The Acid Test

Leaders who want to build lasting relationships must measure loyalty as carefully as profits. Satisfaction metrics are a good first step, but they are far from sufficient, because satisfaction can be fleeting. Far better than satisfaction scores are measures such as customer and employee retention rates, which track real behaviors with financial consequences. But even retention rates don’t tell the whole story. Sometimes customers stick around simply because they aren’t aware of alternatives or because they are hostage to long-term contracts. Some employees stay put only because they lack ambition or attractive options.

The Loyalty Acid Test, a set of surveys that specifically measure the loyalty of customers, employees, suppliers, and other corporate stakeholders, corrects for these shortcomings. The full text of the surveys can be found atwww.loyaltyrules.com, but in essence, the Loyalty Acid Test examines one simple question: does this organization deserve your loyalty?

Respondents’ answers reveal striking differences between the companies with the highest levels of loyalty in their segments and the rest of the pack. For example, 70 to 75 of the employees at the loyalty leaders agreed with the statement “I believe this organization deserves my loyalty.” By contrast, only 45 of employees drawn from a broad cross section of U.S. businesses agreed with that statement, and 23 strongly disagreed.1

What explains the ability of the loyalty leaders to beat the averages so decisively? When we analyzed the results of the surveys, we found that one fundamental difference set the loyalty leaders apart: the perceived integrity of their top executives. This point comes through loud and clear. Of the 1,057 employees who agreed that the “senior leaders of [their] organization are people of high personal integrity,” 63 also agreed that the organization deserved their loyalty. The negative correlation is just as strong: of the 444 respondents who did not believe their senior leaders were people of high personal integrity, only 19 considered their organization worthy of loyalty.

1. The data on average companies is drawn from Walker Information and Hudson Institute, “National Employee Relationship Report,” Bain & Company, Boston, May 5, 2000.

Even at a technology leader like Cisco, however, lower-tech methods of communication are sometimes more appropriate. Every night, CEO John Chambers receives personal updates on 15 to 20 major accounts via voice mail. “E-mail would be more efficient,” he says, “but I want to hear the emotion, I want to hear the frustration, I want to hear the caller’s level of comfort with the strategy we’re employing. I can’t get that through e-mail.”

Chambers’s comments reflect his bias toward candor, which is typical of leaders at high loyalty companies. Michael Dell, the founder and CEO of Dell Computer, has always been extraordinarily straightforward with employees, customers, and the press, especially when assessing his own mistakes and shortcomings. This was particularly noticeable when the company mishandled the introduction of a line of notebook computers in late 1992, and its stock price fell 68. Rather than deflect inquiries or minimize the problems, the CEO admitted to shareholders, customers, vendors, and the press that he had committed a series of strategic and operational blunders. Some observers, in fact, thought he had gone overboard with the mea culpas, but he doesn’t see it that way. “Because we laid out our plan to correct the problem in a clear, straightforward manner,” he says, “we never lost [customers’] trust.”

Dell Computer is equally plainspoken with customers about more mundane matters. Customers can readily get information about costs, order status, delivery schedules, and technical problems on-line. This transparency is a trust builder. There’s no fudging about costs or missed deliveries when the information is on-line. There are also some less apparent benefits to Dell’s straight talk. Company president and chief operating officer Kevin Rollins points out that by posting all pricing information on the Web, Dell executives can devote the time they formerly spent in price negotiations on developing new solutions and improving product quality.

The principle of straight talk extends to vendors as well. Dell constantly grades each of its vendors on a supplier report card in areas such as quality, efficiency, availability of technology, and integration of the supplier’s Internet operations with Dell’s. Vendors can check on-line at any time to see how their performance measures up against the company’s other suppliers.

Most of the top loyalty companies are equally forthright about telling employees where they stand. Managers at many of these companies submit annually to 360-degree feedback—performance reviews from bosses, peers, and subordinates. But giving feedback is only half the battle. The leaders of the top loyalty companies are just as assiduous about soliciting evaluations of themselves and their companies from employees and customers. Vanguard’s Jack Brennan regularly visits the call center, where he sits alongside the service reps and answers customer questions and addresses complaints. He also holds lunches with groups of employees in the company cafeteria. The price of admission: each employee has to bring a serious question or complaint. Not only does Brennan address each issue raised, he follows up with a handwritten note to each employee who attended the lunch, explaining what actions he has taken.

Intuit’s Scott Cook practices a variation of this approach, holding regular lunches with employees, who are encouraged to ask questions and air gripes. But because he understands that talking to even the most sympathetic boss can be intimidating, he asks attendees to write their questions on unsigned index cards. In addition to clearing the air, the sessions serve an educational purpose. Coaxing out negative feedback teaches the organization how to listen, how to take the right action in response to what’s heard, how to explain the action taken, and how to sustain the flow of constructive criticism. Explains Robert Herres, USAA’s CEO from 1993 through April 2000: “If employees feel like they are throwing pennies down a bottomless well and they never hear a splash, they are going to stop throwing the pennies. We have got to show them that we are listening and we are taking action if we want them to make an effort and keep the communication flowing.”

The High Road

If Herres and the other leaders were thinking only of themselves, would they go out of their way to solicit sometimes painful feedback, share information with customers, or own up to their own failings? Would they go to the effort of devising win-win solutions or crafting compensation schemes that recognize long-term loyalty-building efforts as well as immediate cash returns? Not likely. These are the decisions and actions of leaders who put the welfare of their customers and partners ahead of their own comfort and interests.

Herein lies the essential paradox of business loyalty. If loyalty is about self-sacrifice—about putting ideals and relationships ahead of immediate personal financial gain—what relevance can it possibly hold for business, which is driven in large part by the pursuit of self-interest?

Some would argue that self-sacrifice has no place in a business context. According to this argument, the sole point of business is to maximize shareholder value. But this confuses profits with purpose and leads away from the high road of business practice. A single-minded focus on financial results will not create the conditions for loyalty or long-term success, and it may well lead an organization down a slippery slope to the low road, where money matters more than people. At low-road companies, it’s standard practice to take advantage of customers, employees, vendors, and other business associates whenever they are vulnerable. The goal of strategy at those companies is to create market power; the job of leaders is to use that power to strangle competitors, bully vendors, intimidate employees, and extract maximum value from customers—all to please the shareholders, whoever they happen to be this month. In this Darwinian struggle, only the toughest individuals survive. Trust and loyalty are weaknesses to be exploited.

Low-road strategies can generate impressive financial returns, for a time, and buoyant earnings and stock price provide the necessary bribes to keep followers committed. But eventually the low road leads to trouble. There comes a time when the company is blindsided by a competitor or fails to anticipate a shift in market preferences or discovers that a new technology has made its business model obsolete. That’s when the value of loyalty becomes apparent. As its earnings and stock price plummet, the company can no longer fund the bribes it has been paying, leaving its leaders with no means of persuading customers, employees, dealers, and suppliers to work together toward a solution. Unless leaders have built relationships based on loyalty—loyalty to something more fundamental than today’s earnings or stock price—nothing will keep partners from jumping ship the instant a better opportunity comes along.

This is not to say that profits and stock price don’t matter. Of course they do. A company can’t treat people right unless it can afford to. But high standards of decency and consideration don’t impede profitability, they enable it. Leaders of high-road companies recognize this. They break through the cynicism of the times by showing they believe that business is not a zero-sum game, that an organization thrives when its partners and customers thrive. And implicit in each of the six principles I’ve outlined is the key finding of my research: the center of gravity for business loyalty—whether of customers, employees, investors, suppliers, or dealers—is the personal integrity of the senior leadership team. Through loyalty to ideals, leaders become worthy of loyalty from their partners.

Frederick F. Reichheld (fred.reichheld@bain.com) is a Boston-based director emeritus at Bain & Company, and the author of Loyalty Rules! (Harvard Business School Press, 2001). His next book, The Ultimate Question, is due in early 2006 from Harvard Business School Press.