It is well known that firms in the US use mainly external financing (debt) to finance growth. It actually is believed to account for 80% of financing.
Yet, this external financing puts pressure on the firms and studies have revealed the adverse consequences it represents :
- less investment in advertising and R&D
- less full-time employees, lower wages, more part-time employees
- inferior product and service quality
With so many negative outcomes, how can customer satisfaction evolve when debt increases, i.e. when financial leverage increases? A study carried out by Malshe and Agarwal (2015) brings very interesting insights that should convince firms that long-term perspectives and less debt are key for a bright future.
What is financial leverage
Before going any further we need to define what “financial leverage” means so that the results of the study can be understood.
Financial leverage is the degree to which a company uses fixed-income securities such as debt and preferred equity. The more debt financing a company uses, the higher its financial leverage. A high degree of financial leverage means high interest payments, which negatively affect the company’s bottom-line earnings per share. (source Investopedia)
High financial leverage means you have to pay a lot of interests, which reduces your capacity to invest in other important areas like R&D, marketing, … and leads you to put pressure on your cost structure, hence paying employees less, reducing full-time workforce and the like.
Why is customer satisfaction important
Customer satisfaction has been studied for decades, pioneered by academics like Oliver, and strong correlation with customer loyalty had been shown. Today, complex constructs like customer experience tend to be better predictor of loyalty than satisfaction. It remains however that satisfaction is a key KPI to measure (for instance with Net Promoter Score or NPS) to understand where your firm is heading to and whether it will have success on the long-term. Loyalty and profitability are indeed tightly linked.
The effects of financial leverage, advertising expenditures and industry on customer satisfaction
Three main results to be remembered (turn to the original paper for further information on the methodology and detailed results) are the following :
- financial leverage affects customer satisfaction negatively
- more financial leverage means less money for advertising which leads to less satisfaction
- the impact of leverage on satisfaction is higher in service and more competitive industries
Investors should pay particular attention to the leverage ratio of firms and understand that the long-term perspectives in service and competitive industrues may be impeded by lower satisfaction.
Marketers (especially CMO’s) should use those results to limit decisions that may adversaly affect customer satisfaction (and hence loyalty). The perspective of CMO’s should be on the long-term whereas CFO’s tend to look at short-term outcomes to please shareholders.