Customer Service Delivering This Small-cap Outsized Returns

By Ben Rundle | Portfolio Manager at NAOS Asset Management

“There is an excellent correlation between giving society what it wants and making money, and almost no correlation between the desire to make money and how much money one makes.” Ray Dalio

I have spent a lot of time lately analysing customer service within Australian listed companies. Some of the most successful companies in the world don’t do much different from their competition other than offer higher levels of customer service which can significantly enhance their financial returns. Recently, I had a conversation with one of the original company executives of Home Depot in the USA. Home Depot is one of the most successful companies in US history and their business model was successfully copied by Bunnings in Australia. The former Home Depot executive told me that the company would refund products even if they were not stocked by Home Depot. This was done as they believed the value of one customer referral was worth more than any single product. Ever wondered why a well-funded competitor in Masters couldn’t compete with Bunnings? We believe it was because the Bunnings customer was happy.

Earlier this year we added a company to our portfolio that has a lot of competition and what appear to be low barriers to entry, but this company has one key differentiator – a very high level of customer service. The company is Lifestyle Communities (ASX: LIC). Lifestyle Communities develops, owns and manages affordable living communities for semi-retired or retired people.

They run their business on two key adages;

1. You never get a second chance at a first impression and;
2. A customer will never forget how you made them feel

It is for this reason the business achieves a net promoter score of 98.5% and gets more than half of its customers from referrals. The way the business model works is LIC buys a block of land, they develop say 100 homes on the land offering a range of sizes and layouts then they sell the homes to the customer at around 70% of the median land price of the area. Lifestyle retains ownership of the underlying land and charge a rental fee to the customer which is based on their aged pension.

The benefit to the customer is they get a new home, a huge number of amenities like swimming pools, cinemas, bars, and tennis courts, while at the same time being able to withdraw a significant amount of equity from their home.

One could sceptically look at this arrangement and point out that the resident is required to pay a rental fee as well as repay a portion of their future home sale proceeds to LIC. Whilst this is true, LIC are more capable and better incentivised to maintain its villages than its residents, who have a shorter time horizon and may have deteriorating mental and physical faculties. It is for this reason the re-sale of homes remains at a high level when compared to the median price in the area.

On a recent site tour with the management team we asked if they could improve returns through the offering of bulk electricity or insurance products to the occupants of their villages. The answer was that, yes, they could do this and in doing so they would make a lot of extra money, but they don’t operate this way. The reason they don’t is because it is unlikely that those third-party providers would be able to offer the same level of customer service as LIC does and that could therefore result in an unhappy customer. We believe that if a company takes care of its customers first and foremost, shareholders will receive the benefits from this over the long term.   

As one of the smartest investors in the world Ray Dalio points out, give society what it wants and you will make money. Given the extremely high (and increasing) levels of referral rates that LIC achieves, it is proof to us that LIC is giving society what it wants.

Important Information: This material has been prepared by NAOS Asset Management Limited (ABN 23 107 624 126, AFSL 273529 )and is provided for general information purposes only and must not be construed as investment advice. It does not take into account the investment objectives, financial situation or needs of any particular investor. Before making an investment decision, investors should consider obtaining professional investment advice that is tailored to their specific circumstances.