The cost-cutting strategy that won’t pay dividends

Last month, I needed to buy travel insurance to cover someone who is 28 weeks pregnant. I phoned Direct Line and spoke to a sales rep. Once she realised that she couldn’t sell me a policy and wasn’t going to make any commission, her training session sing-song tone changed and she couldn’t wait to get me off the phone. I asked if she knew anywhere I could get cover and she replied, “You’ll just have to shop around, thank you for calling Direct Line,” and hung up.

Following a recommendation from a colleague I phoned InsureandGo. Its sales rep also told me that her company did not offer cover after 26 weeks – yet she recommended a rival that did, and gave me its phone number.

Last Saturday, The Guardian Jobs & Money editor described how a Kwik-Fit mechanic carried out a minor repair for no charge. He wrote: “In other big companies, the person who fixed my car probably would have been obliged to charge me… yet by forgoing some short-term profit, Kwik-Fit has bought my long-term loyalty.” In the same issue, Marks & Spencer’s new chief executive Stuart Rose announced a six-month clampdown on spending, telling staff they must “treat every penny we spend as if it were our own money. From now on our mantra is ‘Cash is King’.”

This is the religion of cost-cutting, which has crossed the Atlantic and is best represented by Wal-Mart. There is only one ‘P’ in Wal-Mart’s marketing mix: price. Despite its poor labour relations and the poverty-level wages, Wall Street loves Wal-Mart. It is perceived to be a low-cost company – and there are signs that such a model is being imposed on Wal-Mart subsidiary, Asda.

Last month, Wal-Mart chief executive Lee Scott said Asda will, one day, be bigger than Tesco. He admitted that Asda’s management has a great deal to do to get there – the “great deal” was reducing prices by cutting costs. In two years, Asda has slipped from being first to 31st in The Times’ annual best 100 employers survey. A clue to this might be the fact that 46 per cent of employees think they are poorly paid compared to other supermarkets and that Asda was recently revealed as the first supermarket – followed by cost-cutting neophyte Tesco – to impose Dickensian unpaid sick leave.

Wal-Mart may be one of the world’s biggest companies, but price-driven marketing also makes it one of the world’s worst brands. This is no hoary argument about price competition versus ad investment. On the contrary, advertising is all about raising awareness, but the key variable that persuades people to buy is personal recommendation. In this, company staff are essential.

In the service-centric world of the 21st century, the remuneration and motivation of staff will be the most important issue facing brands. Marketing directors have often bleated about financial directors being allowed to cut ad budgets in a recession. They should be much more concerned with preventing damage to the brand’s reputation by corporate cuts in staff salaries and remuneration packages.

Loyalty theorist Fred Reichheld says the number one turn-off for customers isn’t the quality of the advertising, but the treatment of customers by staff. The key indicator of a brand’s success isn’t, “How satisfied are you with X’s overall performance?”, but “How likely is it that you would recommend X to a friend or colleague?”. My treatment by Direct Line was satisfactory, but I wouldn’t recommend it; I would recommend InsureandGo.

Automated calling services, offshore call centres and commission-based selling are actually a cheap and nasty way of claiming that the company is “customer focused”, while appeasing shareholders with cost reductions. According to Reichheld, in our haste to cut costs, we’ve created a generation of disposable employees who are unable to trust the businesses they work for, fickle customers who think only about price, and short-termist managers who care only about quarterly profits.

In the US, Costco compensates its workers generously to motivate and retain them. Whereas it pays $15.97 (&£8.80) an hour to its workers, its rival, Wal-Mart’s Sam’s Club, pays $11.52 (&£6.35). Costco also has 50 per cent more employees in retirement and health plans than Wal-Mart, yet Costco’s staff achieve 50 per cent more sales per square foot. And, in spite of lower labour costs,Wal-Mart’s profits per employee are $11,039 (&£6,080), compared to $13,647 (&£7,517) at Costco. In return for this, Costco has one of the most productive and loyal workforces in US retailing. Only six per cent of employees leave in the first year compared to 21 per cent at Wal-Mart – by the way, Asda has an employee churn rate of 28 per cent.

And what does Wall Street think of Costco’s strategy? In April, Costco reported a 25 per cent profit hike; the market responded by driving the stock down by four per cent. One reason for this was that Costco pays its employees well. Deutsche Bank analyst Bill Dreher complained to Business Week: “At Costco it’s better to be an employee or a customer than a shareholder.” Quite.

Sean Brierley is a former deputy editor of Marketing Week and author of the Advertising Handbook