by Gary North
The economist W. H. Hutt coined a phrase in the mid-1930s: "consumer sovereignty." I prefer "consumer authority," but why quibble? The reason why the consumer is sovereign in a free market is because he possesses the most marketable commodity, which was how Ludwig von Mises defined money.
Specialists who sell narrowly marketed items want money. The customer is the boss because everyone wants what he has. Hardly anyone wants what the specialist has. That's why he has to advertise.
When I walk into a store, I don't have to wear a sign: "Does anyone here want my money?" My advertising costs to get rid of my money are close to zero.
Back in the 1970s, United Air Lines had an advertising slogan: "You're the boss!" It was a very good slogan. It was an open admission that the company understood that customers are sovereign. It is the correct attitude for every businessman.
It never hurts to translate economic theory into profitable human action. So, let's apply a little economic theory to business.
Two Rules of Successful Marketing
My friend Jay Abraham is a marketing genius. He'll tell you that if you ask him, but he is not alone. So does the market. I have seen Jay fill a room of 200 or more people for three days — people who have paid $5,000 each to be there. He has done this many times. I wish I had his genius. I'd be willing to let 200 people in for only $4,500.
In his seminars, tapes, reports, and everything else he produces, he offers simple but profound rules of the game of business. He knows what works, and he tells you, over and over, in many ways.
Here are two of the big ones: (1) the lifetime value of the customer; (2) risk-reversal.
1. The Lifetime Value of the Customer
It costs a lot of money to bring a customer to your door or your Post Office box or your Web site. Once he is there, do your best not to let him get away without buying something.
His initial purchase may not pay you for persuading him to spend his money. If the profit you receive from the typical customer's first transaction pays for the advertising expense of bringing him to you, you're in fat city. You have got yourself a winning deal. This assumes:
(a)you have other things to sell him later on, and (b) you don't chase him away by blowing the first transaction by being a jerk or by selling junk.
What is a new customer worth? Jay tells every attendee that a business that doesn't know the lifetime value of its typical customer is flying blind. The owner will not know how much to spend on advertising and marketing.
Consider a dentist's practice. If the typical patient comes in four times a year to have his teeth cleaned, and has one cavity filled per year, the income generated by this patient can be calculated. The dentist should have his accountant figure this out per customer: fixed overhead, wages and services paid for, materials used, and net profit.
What if the patient also sends his wife and several children to the same office? The income multiplies. Usually, the family's health-care decision-maker chooses one health-care practitioner in each field to treat all of the members of the family. This is why every new customer who walks in the door should be regarded as carrying a large wad of money in his pocket.
Early in any business, the owner must begin to estimate the lifetime value of the customer. Yes, this stream of income must be discounted by a rate of interest. An accountant can calculate this. (If he can't, find a new accountant. He does not understand his own business, let alone his clients' businesses.) This net revenue figure, discounted by the rate of interest available to the business owner, should shape every marketing plan, including the cost of generating repeat business.
The largest chunk of overall profit is in repeat business, at least in most retail businesses and service businesses. As we direct-mail marketers put it, "the money is in the back end."
To paraphrase Rodgers and Hammerstein, "once you have found him, never let him go." Give him reasons every time you sell him something to come back and spend again.
This principle is crucial for generating the initial purchase, but it should be at the heart of every honest business, every time there is a sale.
The seller should do whatever he can afford in order to bear the bulk of the risk of every transaction. He knows his business. He has specialized knowledge about what he sells. The buyer doesn't. The buyer relies on the competence and honesty of the seller to assess risk. If he doesn't get his money's worth, he can go away, and eventually he will. There are lots more sellers out there, and they all want what the buyer has: money. They will court him. He knows that. So should every seller. But lots of them don't.
In direct mail, sellers offer money-back guarantees. They have to, in order to gain the trust of the buyer. Wal-Mart became the nation's leading retailer in part by offering an unconditional, no-questions-asked money-back guarantee. That surely didn't hurt Wal-Mart's famous bottom line!
The seller has greater knowledge of his business, so he ought to bear most of the risk. He knows where the risks are. Any attempt to shift risk onto the buyer is highly risky for the business that does this. It will hurt initial sales, and it will hurt repeat sales.
Maybe I can make this principle of risk-reversal clearer by giving an example of a recent failure to understand it.
How an $8/Hour Secretary Cost a Dentist $1,000
Several years ago, my wife decided to go to a local dentist. Then we moved farther out of town. I have gone to a local dentist, who is at least 20 minutes closer. Those extra 40 minutes, round-trip, are valuable to me.
But my wife still goes to her dentist.
Last January, she suggested that I visit her dentist. I tried. His appointment book was full. I was told that I would have to wait two months. He obviously has a successful practice. So, I skipped. But, like most people who visit dentists, I never scheduled an appointment elsewhere. The receptionist kept my name and business phone. This was smart business.
If I were a dentist or any kind of hourly professional, I would keep half a day open each week to schedule new patients-clients-customers. Then I would advertise to get them to come in for a free check-up or consultation. That's because I understand the lifetime value of a customer.
Every business should be doing one of two things: pulling in new clients or raising fees. Grow the business's income. When it's not worth growing any longer, the owner should sell it and go do something else for a living.
Back to my wife's dentist. Yesterday, a patient canceled. That left a one-hour, zero-income hole in the daily income sheet. The receptionist or someone in the office called me. Would I be willing to come in for an appointment 30 minutes later? I live 30 minutes away. I asked: "What is the charge?" The answer: $25 for the check-up and $45 for cleaning my teeth. I decided to go in. My procrastination ended.
Presto: the office had just converted a $45 (or more) loss into $70. Furthermore, the dentist would have an opportunity to sell me something else.
As it turned out, I had chipped a tooth. I need a crown, the dentist told me. A crown costs at least $700. So, the dentist scheduled a second visit ($45) and told me I should get a crown.
Why another visit? To complete the teeth-cleaning. It turns out that my teeth take an hour to clean. (I knew that before I went in.) The x-rays and check-up had taken 20 minutes.
So, I had been moved up from a $70 visit to a two-part $115 visit, plus an extra hour, round-trip. This was looking not so good.
Still, I was impressed with his demeanor and professionalism. The dental hygienist was the best I had ever had — the least pain in cleaning my calcium-caked teeth. His office was almost on a roll.
At the check-out desk, I handed the scheduling lady my credit card. She ran it through. Then she handed me the bill: $130. I balked. I explained to her, "I asked the price before I agreed to come in. I was told that it would be $25 for the visit and $45 for the cleaning."
She told me that my teeth were harder to clean than most people's. It had taken longer than average. But the dentist had already told me I would have to come back to complete the cleaning. He had increased my teeth-cleaning fee from $45 to $90. Now she was billing me $130, with $45 left to go. Total bill, if I came back: $175.
I can get this service done locally for $65, and save 40 minutes of drive time.
I told her I would pay $70. She told me that I had asked for x-rays. I explained that the hygienist had told me she had to do x-rays.
I almost always refuse to allow this, but this time I accepted. The hygienist did not tell me that I would be charged. All first-time patients get x-rayed in every dentist's office I have ever been in. I thought that this was part of the $25 initial check-up.
"Did you think you were getting free x-rays?" she asked, derisively. "Yes," I told her.
"Well, we're just going to have to deduct any discount from the hygienist's pay." I told her that was not a good policy — docking an employee's income for the office's mistake. But I told her to do whatever she had to. I would pay $70.
She ran the card through again. It came back $113. "Ma'am," I said, "I will pay what we agreed to: $70. I am not going to pay any more."
"When was the last time you had your teeth cleaned?" she huffed. "I don't recall," I said. "Years," she shot back. "Maybe a year," I said. I do have a problem with calculus (actually, both kinds).
She ran the card through again. Then she looked at the chart that the hygienist had prepared. "I see that you're scheduled for a crown. You had better get your crown work done elsewhere," she told me.
"Absolutely," I replied.
When I explained all this to my wife, she said, "I guess I can never go back there again." I agreed. She also needs crown work. That's another $700 or so. I wonder what his net income per crown insertion is.
That $8/hour scheduling lady easily cost her employer a thousand dollars: at least one crown, maybe two; my wife's regular $45 visits; my $45 visits (I need 3-4 cleanings a year); and our children's visits.
How long will it take for her employer to regain the lost income stream that our family represents? How much advertising money will he spend?
No one had ever told her about the number-one rule of the free market: consumer sovereignty. Her employer obviously had never written down rules governing this sort of fee dispute.
They should teach these things in graduate school.
What was the correct answer, one worth a thousand dollars or more over the long run? "You're right. It's our mistake. $70 it is!" Instead, she said as I walked out the door, "Well, I wonder which part of this bill we will have to list as free service."
I did not explain to her, "When you fill a cancellation, it's all a free service. That's called sunk costs."
The lesson should be clear: the consumer is king. He has what it takes to be king: money. But sellers' egos get in the way, and they must pay a price to feed their egos or their employees' egos. That $8/hour lady has a large ego, and her employer paid about $1,000 to feed it this time. I suspect that this was not the only time.
Yes or No
A major difference between the free market and the State is that bureaucrats' egos are paid for by taxpayers and thwarted citizens.
The universal rule of the salesman, when he is asked by a customer if something is available, is to reply, "If I can get it for you, are you ready to sign the contract?" He gets the signature; then he scrambles to deliver. He hopes the item is available.
When a bureaucrat is asked if something can be done, the universal rule is to say no. Washington's longest-tenured retiring bureaucrat told a reporter in 1976 what her number-one rule of survival had been. "Whenever anyone asked me if he could legally do something, I always said no. You can retreat later from no to yes, and the person requesting the action is happy. If you are forced by the rules to retreat from yes to no, he gets angry and may cause trouble. So, my initial answer was automatically no."
I prefer yes to no. I may even be willing to sign the contract in order to secure a yes. That's another reason why I prefer the free market.
In the free market, I'm the boss.
March 15, 2001
Gary North is the author of an eleven-volume series, An Economic Commentary on the Bible. The latest volume is Cooperation and Dominion: An Economic Commentary on Romans. The series can be downloaded free of charge at www.freebooks.com.