Increased Customer Satisfaction Increases Stock Price

Research by Sunil Mithas

MOST BUSINESS MANAGERS UNDERSTAND INTUITIVELY THAT SATISFIED CUSTOMERS ARE THE KEY TO A BUSINESS’ LONG TERM SUCCESS. CHANGES IN A COMPANY’S CUSTOMER SATISFACTION SHOULD BE A LEADING INDICATOR OF CHANGES IN THEIR EXPECTED EARNINGS, AND CHANGES IN EXPECTED EARNINGS ARE IMMEDIATELY REFLECTED IN STOCK PRICES. SO IF THE STOCK MARKET WAS EFFICIENT, NEWS ABOUT AN IMPROVEMENT IN A COMPANY’S CUSTOMER SATISFACTION SCORES SHOULD IMMEDIATELY MAKE THAT COMPANY’S STOCK MORE ATTRACTIVE AND INCREASE ITS PRICE.

That is not the case, according to recent findings by a team of researchers led by Claes Fornell, Donald C. Cook Professor of Business Administration at the University of Michigan, that included Sunil Mithas, assistant professor of decision and information technologies at the Smith School. In their paper, “Customer Satisfaction and Stock Prices: High Returns, Low Risk,” the authors show that markets do not react to news related to customer satisfaction, making it is possible for investors to generate high returns with low risk by incorporating customer satisfaction scores in their stock trading strategy.

The paper describes two portfolios: a hypothetical paper portfolio and an actual stock portfolio. The trading strategy employed to manage these portfolios was based on customer satisfaction of companies as measured by the American Customer Satisfaction Index (ACSI). Trading decisions such as long and short positions were made based on ACSI levels and changes. Long positions were taken in companies with high and increasing ACSI scores. Short positions were taken in companies with low and deteriorating ACSI scores. No other type of data or additional information was considered in developing these trading strategies; they relied solely on customer satisfaction information as reported in the ACSI.

Both the paper portfolio and actual stock portfolio outperformed the Dow Jones Industrial Average and the S&P 500 over a period of 4 to 6 years. Customer satisfaction pays off in up-markets and down-markets. When the stock market grew, the stock prices of many firms with very satisfied customers grew even more; when the market dropped, customer satisfaction seemed to provide a certain amount of insulation.

If there is such a strong correlation between customer satisfaction and market equity, and if people intuitively believe this to be so, why don’t more investors make investment choices based on customer satisfaction information? It is possible that investors believe an improvement in customer satisfaction scores may actually be detrimental to their interests, as a company could be giving away too much for the price it is charging its customers.

This research suggests that equity analysts should look at customer satisfaction scores while conducting their research and ask marketing-related questions during investor meetings and conferences. They should also closely study customer satisfaction trends for a company and incorporate that information into their research and recommendation making process.

Apart from the obvious implications for portfolio managers, these findings have significant implications for marketing managers and information officers. In a previously published paper Mithas and his co-authors showed that customer relationship management (CRM) applications increase a company’s knowledge about its customers, and that increased knowledge allows the company to provide better services. This in turn improves customer satisfaction. The current paper has shown that increased customer satisfaction is a leading indicator of higher stock process. Thus, investments in CRM applications have the potential to positively impact a company’s stock price. This is important information for marketing managers and information officers, who are always under pressure to justify investments in CRM applications from a return on investment or bottom line perspective.

“These findings are really valuable because they finally demonstrate that intangible capital such as customer satisfaction matters because it impacts stocks prices,” says Mithas. “It is also interesting that the market is inefficient to some extent because it ignores news related to customer satisfaction.”

This research also suggests that IT investments are valuable from a bottom line perspective, since. He says that his paper provides quantitative and empirical evidence against arguments often made against IT investments such as Nicholas Carr’s Harvard Business Review article “IT doesn’t matter”. Mithas has already started preparations for more follow-up research. He is especially interested in testing the cross-selling effectiveness of CRM applications.

This research offers a practical trading strategy for small retail investors. “When looking at a stock, you should not look at only the publicly-available financial information. You should also pay close attention to intangible capital such as customer satisfaction, employee satisfaction, and innovation,” says Mithas.

The paper, “Customer Satisfaction and Stock Prices: High Returns, Low Risk,” by Claes Fornell, Donald C. Cook Professor of Business Administration, Stephen M. Ross School of Business, University of Michigan; Sunil Mithas, Forrest V. Morgeson III, research scientist, University of Michigan; and M. S. Krishnan, professor of business information technology, University of Michigan, was published in the January 2006 Journal of Marketing. For more information, contact smithas@rhsmith.umd.edu.