On-Base Percentage and the 3 R’s

Baseball is an interesting game. It is our nation’s pastime, the subject to many books and movies, and, at the major league level, a patently unfair game.

What is the source of this unfairness? – In a word, payroll.  This year the Yankees enter the season with a payroll of $149 million compared to the Tampa Bay Devil Rays who enter this season with a payroll of just under $20 million.

Yet, in spite of this inequity, one team with one of the lower payrolls seems to win consistently.  In the last four years, the Oakland A’s have won fifty-nine percent of their games, and finished no worse than second in the American League.   Last season with a payroll of $40 million Oakland won 103 games – as many games as the Yankees with their 2002 payroll of $126 million.  On average, the A’s spent $390,000 for each win compared to the Yankees’ $1.22 million.

How do they do this?  Have they been lucky? – Doubtful, not four years in a row.  Rather the A’s front office did something very unique for tradition bound major league baseball – they hired a Harvard MBA as assistant GM and conducted an objective analysis to determine which performance measures are key drivers of success in baseball.  The result of this analysis has influenced everything from player selection to game strategy.  Historically, player selection has been dominated by major league scouts who subjectively evaluate players based on their potential to run, throw, field, hit and hit with power.  What the A’s did was conduct research to determine the relative value of each of these attributes in order to maximize the return on their payroll.

Among the conclusions they reached, they found that teams like the Yankees overpaid for speed – that on-base percentage (the percent of the time a batter reaches a base either via a hit or a walk) and slugging percentage (the number of bases achieved per at bat) both correlated closer to winning percentage than any other factor, including speed and batting average.  Intuitively this makes sense, the higher the on-base percentage, the lower the probability of being called out.  The result of this research?  The A’s seek players with skills other teams undervalue, players with less speed, but who don’t swing at bad pitches, control the strike zone and force walks – yet also have the ability to hit home runs.  In any given inning, two walks and a home run is their recipe for success.

So, what’s the lesson for business?

There are many.  Among them: the importance of objective research over subjective opinions, the value of seeking and exploiting inefficiencies in the market place, and the competitive advantage that can be gained by challenging conventional wisdom.

Conventional marketing efforts have historically centered around the four P’s of marketing: product, price, promotion and place – with the primary objective of building market share.  In the 70’s a body of research entitled PIMS (Profit Impact of Market Strategy) concluded that market share was determinate of profitability.

Like the A’s, another group of Harvard researchers in the early 90’s started questioning conventional wisdom.  The problem they noticed, was that the PIMS studies focused largely on the manufacturing sector and failed to differentiate between manufacturing and service industries.  In studying service industries they concluded there was no correlation between profitability and market share.  Rather, the attribute with the highest correlation to profitability is customer loyalty.  Depending on the industry, a small increase in customer loyalty (5%) translated into a 25% – 85% increase in profits.  As with baseball’s on-base percentage, this result is intuitive – customer loyalty lowers sales and acquisition cost per customer by amortizing it across a longer lifetime – leading to some extraordinary financial results.

Like baseball, conventional wisdom gives way to a new paradigm.  The importance of the four P’s gives way to the importance of the three R’s: retention, related sales, and referrals.

So the question is – what is the cause of customer loyalty?  Or even what is customer loyalty?  Is customer loyalty delighting customers?  Is customer loyalty dependent on fostering customers who will stick with the firm through thick and thin? – I don’t believe so, any more than I believe the Oakland A’s are lucky.

Customer loyalty is a rational decision each customer makes every time they patronize a firm – be it the first time or the millionth time.  The mental equation behind each customer’s rational decision to buy is the Customer Value Equation, which is the ratio of results and process quality to price and all other costs of acquiring the service (tangible and intangible).

The Customer Value Equation is the rational underpinning behind customer loyalty.  The idea of customer