Customer satisfaction flows right through a company’s bottom line, influencing capital equity costs and even institutional investors.
Happy customers can mean repeat business and great online reviews for a company, but new research from Monash Business School shows customer satisfaction can also have a significant impact on the cost of raising new capital.
The research by Monash Business School’s Professor Cameron Truong from the Department of Accounting, with colleagues Dr Hannah Nguyen and Dr Thanh Huynh from the Department of Banking and Finance, is the first to demonstrate how high customer satisfaction lowers a firm’s risk and significantly reduces its costs of financing.
The cost of capital is important for companies as it plays a significant role in corporate financing, budgeting and valuation.
“Customers possess direct information about the quality and value of products and services of firms, which not only have implications for demand, sales and profitability but also signal information about firm quality that is useful for investors in the capital market,” says Professor Truong.
“The research shows that when firms are successful in keeping their customers pleased and when customers communicate such success to the market, firms enjoy a significantly lower cost of capital.”
Allocation of resources
The findings have significant implications for management.
“It means management should allocate more resources within a company to focus on higher customer experience and satisfaction. A firm’s risk is reduced when customer satisfaction is high,” Professor Truong says.
The research is based on a sample of United States firms over a 25-year period from 1995 to 2015, using customer satisfaction scores from the American Customer Satisfaction Index (ACSI).
The ACSI uses customer assessments of the quality of goods and services produced by major companies to US consumers, complied from over 70,000 customer interviews.
The national ACSI score is produced based on customer satisfaction scores of individual companies, customer satisfaction scores for 43 industries within ten economic sectors.
Industry customer satisfaction scores were measured as the average of customer satisfaction scores of a firm’s industry weighted by their revenues.
Firms that had higher customer satisfaction scores – or more positive information provided about their goods or services – had a lower cost of equity capital.
When new firms were added to the ACSI list, they experienced a significant reduction in their cost of equity capital.
“What we found is that customer satisfaction offered quality information about a firm and was linked to the level of institutional ownership,” says Dr Nguyen.
“When investors face high uncertainty in their assessments of future earnings and firm prospects, customer satisfaction information provides an important signal about the firm’s quality and means that investors are more likely to keep investing in the firm,” she explains.
“Customer satisfaction is like a ‘business moat’ – it effectively shields a firm from external and internal adversities. We found this held true even during the Global Financial Crisis and meant that those firms with high customer satisfaction levels did not see spikes in their cost of equity financing in this period.”
Cost of equity
The cost of equity is measured as the implied discount rate that equates the market value of the firm and its future cash flows discounted to the present value.
To obtain in-depth information about customer satisfaction, the research team also used data from Amazon and its product reviews to control for supply chain discrepancies.
This is because Amazon has a very homogenous process for supplying products.
The study attributed an annual average customer product review star rating to each firm as a proxy for customer satisfaction.
The idea is based on the ‘wisdom of crowds’ where many are smarter than the few and the collective wisdom from large groups often accurately shape business and economies.
Other review sites such as TripAdvisor were also used. But it isn’t just the raw customer satisfaction score that matters to investors, it is also how a firm compares within the industry it operates.
“We found that different industries have significantly different levels of customer satisfaction,” Dr Huynh says.
Customer satisfaction was also found to relate significantly to the number of institutional investors.
“We found that institutional investors look at customer satisfaction and positive media coverage as one of the channels they investigate before investing in a firm,” Dr Thanh Huynh says.
For example, after the negative media coverage and reviews of United Airlines when in 2017 the airline removed a passenger off the plane when the flight was overbooked, the level of institutional shareholdings dropped significantly and many institutional investors sold out their positions completely.
“This research really shows that in order for companies to be successful they need to care about the end-users or their customers and one of the benefits of that is a reduction in the cost of capital,” he says.
The complete study will be published in the Review of Accounting Studies.