Using the Net Promotor Score as a measure of Goodwill
The Net Promoter Score (NPS) is a survey tool used by many businesses – large and small – to measure customer satisfaction levels. In this edition of the Vantage Performance Podcast Michael Fingland explain to Phil Dobbie how the tool can also be used to value a business. It provides a useful snapshot of how valuable a customer base is – essential for companies looing to buy or sell a business.
Phil Dobbie: Welcome to the “Vantage Performance” podcast, I’m Phil Dobbie and Vantage Performance CEO and founder Michael Fingland is with me to look at the net promoter score. Now, you may be well familiar with the NPS as a means of measuring customer experience. You know, how satisfied are your customers with your company? For marketers, it lets you know whether you’re doing a good job or not, but Michael reckons it’s also important as a means of measuring the value of your customers. So let’s have a look at that on the podcast today.
First of all, a quick history lesson. Where does the net promoter score come from? It’s been around for a while, maybe a decade. It seems like it came out of nowhere, didn’t it? From where nobody was using it to, all of a sudden, everyone was using it in one way or another.
Michael Fingland: Actually, one decade. That’s when two gents from Bain consulting created the tool. One of the main reasons why they did it, which every business or consultant has ever used survey tools will attest to this is, you never get a consistent base because every time you do a customer survey, you always tweak the questions, and so you never get a really good base upon which to measure how you’re improving. And what they came up with, they simplified it and they worked out what the most important question that matters in business when it comes to sales and that is, would your customers refer you.
We all know that referrals are the easiest form of sales and so they designed this very short three question survey around that one most important question and so it also applies for the employee version as well which is, would you recommend others to work here? Then the following question two is, why did he give us that score and the third question is how can we improve? That first score, that first question and the net promoter score that you get, that question never ever changes. So you can benchmark the business every quarter or real-time as Apple does now and most major banks now do in Australia. And it’s becoming very, very widely used because it’s consistent and it’s the best way to calculate the strength of your customer relationships.
Q: Their relationship is only strong if you’re getting like a 9 or 10. I mean, companies that think, “Oh, 5 out of 10, that’s good enough.” It’s not good enough, is it?
A: No, it’s not.
Q: You’ve got to basically be in the top 20%.
A: You end up with three buckets. Those that read you between zero and six, they’re what’s called your detractors. They’re customers who actually go out of their way to badmouth you on social media and with their friends. Sevens and eights are passives. So they’re content but they’re not going to go out of their way to recommend you and then nines and tens, as you would imagine, are active promoters of you. They are your ambassadors, whether they be customers or employees and obviously, it’s all about moving those buckets along from left to right and trying to get as many promoters as possible.
Q: So Marketing Gap, people use it as sales departments use it. Operational and customer support areas use it. Can be used right across the business. I’ve used it because I work in marketing for an internet company. It’s actually a good forecasting tool because it tells you how loyal your customers are likely to be.
A: Exactly. So we’ve seen the power of this tool. We’ve been using it for at least three years now and one of the really, really secret tools in the turnaround situation is trying to get as much intel from the workers on the floor or employees across the business in general and not just the senior management team. So it acts as a fantastic tool and question two and three, why did you score us this way and why and how can we improve? We get a lot of rapid intel from the entire workforce which complements all the management interviews that you do. So you get a lot of really good identification of issues but also lots of really good solutions.
We’ve talked about this issue before, if you can go back to the workforce when you’re communicating the turnaround plan and what it means for them, as soon as they see some of their initiatives in the mix, that gives them a huge boost and they realize that actually what we say does matter and management is now listening and it actually just helps you fast track and solve some of those cultural issues that were evident such as poor communication or management’s not listening or any of those things. So it just acts as a great galvanizer, a great information source, and you get some fantastic initiatives quicker than you otherwise would.
So we’ve seen the power of this tool and we’ve realized this tool if only being used in a very, very narrow bend to do customer and employee surveys. What we’ve realized, when you think about how businesses are valued and NS is what this, obviously, topic is all about, is using the NPS survey now in mergers and acquisitions because up until now, the typical way you value goodwill as an accountant, we use a financial formula and we’ve done them plenty of times as well. You multiply earnings by a multiple. That gives you an enterprise value and then you subtract from that the net assets of the business and that difference is goodwill. So it’s the value that someone is prepared to pay over and above the net assets of the business.
Q: That doesn’t tell you how satisfied the customers are.
A: It doesn’t tell you. It’s a measure of goodwill. It’s a financial calculation, a derivative of goodwill, but it actually doesn’t measure goodwill. It measures the financial impact of the strength of the business at a point in time and it’s always, typically, retrospective. What you really want to try and tap into is the strength, as you said, the real strength of the customer relationships because that’s what’s going to drive your revenue going forward, not historic sales. Also, your ability to keep productivity high and keep growing the business and keep innovating. That the strength of your employee goodwill is what’s really most important there. So what we’ve realized is actually using the NPS score in a valuation sense is actually one step ahead of the financial metric, and it is more important in working out the underlying value and the stability, more importantly, of the business.
Q: So you’re saying, you should be listed as an asset on your balance sheet in effect.
A: Not as an asset but another way for…If you’re looking to buy a business, and certainly we’re now recommending this to any of our clients who are looking at buying businesses or indeed if we’re looking to sell a business…We already use this now. When we’re trying to sell [inaudible 00:06:44] plan to a financier, if they’ve got a really good score, we actually use this in the conversation to demonstrate the underlying strength of their customers and culture to give them extra comfort. So that’s the way this idea came from is, well we can go one step further.
So if you’re looking to buy a business, you don’t just want to look at the valuation based on a financial construct. You actually want to understand the strength of the employee relationships and the customer relationships behind the scenes because that gives you a lot more comfort to the maintainability of those earnings and those sales. So if it’s a high, strong score, then that’s peace of mind. If you are paying a little bit above odds than what you wanted to, that’s okay because I know that there’s a really, really strong customer and employee relationship in the business which has been independently verified by a consultant using the NPS survey tool.
On the flip side, if you’re looking to pay three or four times earnings for business and wanting more for it and as part of your due diligence process, you request that they do an NPS survey and it turns out that they’ve got a negative 10% or whatever, a concerning score, then that is a red flag to either walk away from the deal or use it to negotiate down the price of the deal because historically it might have had great earnings and therefore they’re just using that as a justification to ramp up the multiple that you got to pay. But if you see that the actual customer score is actually low or declining, then it’s an early warning sign that there are issues there that you couldn’t possibly pick up in a typical financial due diligence process. That’s why we’re seeing this could be the next evolution and a fantastic tool to use in M&A, acquisitions and mergers and sales etc. because it is the best marker of where goodwill really sits.
Q: Are they always comparable low? Is one company’s implementation of net promoter score the same as another one? The reason I ask that is because it really does depend on how it’s implemented, doesn’t it? I’ve seen situations, for example, and you’ve probably had this when you found a phone company that might not be particularly good and you’re having a problem with them and they say, “Sure, I’ll solve all of these problems for you.” And at the end of the call, they say, “By the way, based on today’s experience, how likely would you be to recommend us to a friend?” And you go well, “This is great, it’s been a great service. I’ll give you an eight or a nine.” And then two weeks later, they still haven’t done what they said they were gonna do and you go, “God, I wish I could take that eight or nine back now.” So there are different ways that this is used.
A: It’s got to be done after the fact. What we’re talking about here today is more so around a potential buyer of business using this an extra level of due diligence in their process.
Q: So you’re calling people up cold or you’re contacting people cold and asking them this question.
A: I wouldn’t even be doing that. It’s got to be sent via email or via text to your customer base and also to your employee base and by an external consultant. In that way, you can get objective results back. It can’t be done over the phone because people feel pressured in that sort of environment. It’s got to be done independently where they simply receive a link to assess their interaction with the businesses and employee or as a customer.
This is the other secret to it. If you’re wanting to do a customer survey using this tool or an employee survey and the potential of the business that you’re looking to buy, the management team say, no, then that actually could give you the answer already that you are looking for. Unless they’ve recently done a survey and they don’t wanna annoy their customers, fair enough. But a lot of them don’t do it regularly. So use this as a tool to get a deeper insight into the underlying…The real value of the goodwill is what do you customers currently say, what do your employees currently say. This tool is the best window into that to complement, not to replace but to complement the typical financial metric of using [inaudible 00:11:03] and goodwill.
Q: So over that accounting formula that you talked about, how much of a premium if you have a really good, strong net promoter score, what sort of premium over the sort of standard accounting approach would you expect?
A: You could get at least an extra multiple. Rather than get three times, you could get four times or six times, you could get eight times. It’s peace of mind. Most businesses are bought using leverage of some form, whether it’s equity or debt and there’s always a risk. It just takes a lot of the risk out of buying a business or it reduces the risk greatly. If you know that, you’ve got three years of strong earnings, that’s one thing. It doesn’t guarantee you’re gonna have another three years strong ahead. But if you can get an extra level of comfort, which the NPS survey can give you, then you’re willing to pay more.
Q: Yeah, makes perfect sense. Great talk. I won’t ask you if you’ve done the net promoter score on yourselves. Well, maybe I will. Have you?
A: Yeah, we have.
Q: How did you come out?
A: We do it every year. Our customer NPS survey typically ranges between 80% to 85% positive, negative 100 to positive 100. So we measure it with our employees but also with our referral partners.
Q: Well, thank goodness for that. You’ve scored well. Look, I’ll send you the text message so you can tell me how I’m doing. It all makes perfect sense. A great way of valuing a business. Thanks for your time.
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