Good Profit vs. Bad Profit

Fred Reichheld has been working on the significance of customer loyalty for decades.  His work has won wide acclaim and is reshaping the business landscape.  Fundamental to Reichheld’s work is the notion that not all profit is good profit.  In fact, bad profit is a thing and according to the research Mr. Reichheld and his colleagues at Bain & Co have conducted for years, it is a drag on the performance of the vast majority of the world’s companies.  The core difference between good profit and bad is the way it affects a relationship. We’ll let Mr. Reichheld explain:

The ultimate goal, of course, is to treat people in a way that encourages them to invest their time, energy, money, and creativity in building better and deeper relationships.  The practical benefits of such loyalty are growth and economic prosperity.  When customers, employees, suppliers and investors invest in creating better, more valuable relationships, [that investment] will fuel profitable growth.

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The problem is that accountants can't distinguish between good profits and bad. (I define bad profits as earnings at the expense of customer relationships--whenever a customer feels misled, mistreated, coerced or abused; profits from that customer are bad).  The average firm today is booking bad profits from more than 30% of its customers.  Some large firms so consistently abuse their customers that more than 50% of their customers would not recommend them to a friend or colleague. 

And here the free market begins to work its magic.  Without good relationships, firms cannot grow. This explains why almost 80% of the world's top-2500 firms couldn't even achieve true growth rates of 5% over the past decade. Over time, bad profits cause firms to shrink as they are displaced by competitors, but not before they inflict enormous damage on customers, employees, suppliers, investors, our economy and our society.  Meanwhile, the reputation of business as an institution is besmirched.  We really must help companies break their addiction to bad profits.1

As Mr. Riechheld hints in the last paragraph, there is an equivalent of bad profits in a company’s interactions with its employees, suppliers, host communities and other stakeholders too. The standard is whether an interaction contributes to or detracts from the relationship between the company and the stakeholder. While Mr. Reichheld does not talk about stakeholder orientation by name, his lessons align perfectly with the topic at hand.  Stakeholder orientation is about building strong, mutually beneficial relationships.  Not just with customers, but between a business and each of its stakeholders. Research from Mr. Reichheld and many others on this topic suggests that doing so is the best way to build a healthy and resilient organization that creates maximum value. 

1Reichheld, F. F. (2006). The Ultimate Question: Driving Good Profits and True Growth.