Paul Cardis, CEO, Avid Ratings Co.

Increasing shareholder value is one of management's main responsibilities. This is often accomplished through a series of cost-cutting measures, from staff reductions to renegotiated vendor contracts. Another technique for increasing shareholder value is to shift certain costs to consumers. Externalizing costs to customers, however, is a shortsighted and ill-fated tactic that usually does more to sacrifice customer delight than boost shareholder value.

To understand the link between customer satisfaction and shareholder value, consider Pulte Homes, one of the top builders in the nation when it comes to customer satisfaction. On Jan. 7, Pulte's stock price was down 27 percent from its three-year high. That might seem like a lot, but not when compared with the 50, 70 or even 90 percent declines experienced by some other publicly traded builders.

Pulte is not the only publicly traded builder whose customer satisfaction has insulated it from deep declines in stock price. Others include Lennar Corp., NVR and Centex Corp. — all top performers in customer satisfaction.

A look at how referrals affect a builder's bottom line highlights the link between customer satisfaction and stock performance.

We surveyed prospective home buyers to determine how many were referred by family members or friends. The average builder has 7.4 percent of its prospects referred by family members or friends. Pulte, however, reports more than 40 percent of its prospects come from referrals. Furthermore, we found in a national study that the conversion rate for referred prospects nationally is double that of marketed prospects over a six-month period. Undoubtedly, a high rate of referrals is one of the most valuable assets a builder can have — especially when business tightens up.

Other industries recognize the close relationship between stock price and customer satisfaction. In late 1990, when IBM Rochester in Minnesota won its Baldrige award, the company initiated a study to develop a methodology for translating customer satisfaction into quantifiable business impacts. The company projected lost revenues based on research that showed each dissatisfied customer tells 10 others about a negative experience and 2 percent of those people act on the information.

The formula for estimating the impact of customer satisfaction on lost revenue can be modified for home builders as follows:

NR × PT × MD × IR + DL × IR = Lost Revenue

NR=Number of customers who would not recommend the builder to another person or who tell someone not to buy from the builder

PT=Number of people whom the NR told

MD=Number of people who acted on the advice of the NR

IR=Initial revenue per sale, based on the projected sales price of the average home

DL=Number of disloyal customers

Plug in numbers based on your own customer satisfaction ratings and you'll see how quickly lost revenue adds up when home buyers are unhappy. And when lost revenues go up, stock prices naturally come down.