Takeaway: Negative word of mouth can negatively impact firm cash flows and stock prices, and increase price volatility over both the short and long term. Moreover, these effects can trigger additional negative word of mouth incidents if the financially struggling company reduces its investment in customer relationship efforts. Understanding this cycle can help you plan to prevent cumulative negative cycles.
Suggested Audience: Investor relations, communications executives, corporate citizenship managers
Researchers analyzed the U.S. Department of Transportation database, which contains records of all the complaints levied against airline companies in writing, by telephone, via email, or in person since 1999. They pulled data on nine airline companies between January 1999 and December 2005, using the complaints as a proxy for negative word of mouth information available to the public. Using cash flow information in addition to stock return and volatility measures for each airline in accord with data from the U.S. Department of Transportation, the researchers were able to make the following observations:
On average in the short term (1 month)
Negative word of mouth was destructive to firm cash flows and was associated with poor stock returns as well as price volatility. The authors declared that an incident involving voiced customer dissatisfaction could lead to a drop in cash flow of $1.882 million a month later.
On average in the long term (20 months)
Future cash flows and stock returns were highly related to historical levels of negative word of mouth. The higher negative word of mouth was, the lower each of these was likely to be (and vice versa). Negative word of mouth incidents also increased stock volatility over the long term. According to the author’s calculations, a negative word of mouth incident could lead to a loss of $8.169 million over the subsequent 20 months.
Market reactions when considering competitive landscape
When controlled for the effects of market competition, findings intensified dramatically. Negative word of mouth hurt cash flows and stock prices 35 percent more, and the damaging effects kicked in sooner and lasted longer. This suggests that in a more competitive environment, competitors are more likely to kick a company when it is down and capitalize on its negative word of mouth incident by, for instance, targeting their consumers with new promotions.
Negative word of mouth “wear in” and “wear out”
On average it took three months before the impact of negative word of mouth on cash flows reached its peak, but six months for the impact to pass. Regarding stock return and volatility, it took four months on average before the impact of NWOM on these reached its peak, but seven months for it to pass.
A vicious cycle
Researchers found that the more shortfalls of a firm’s past cash flow existed, the higher the firm’s future negative word of mouth, and vice versa. Since negative word of mouth hurts cash flows, the researchers conclude that this feedback effect can trap a firm in a vicious cycle, where it gets hit by negative word of mouth, which in turn hurts its cash flow, which in turn leads to more negative word of mouth. The researchers think this happens when firms, struggling with cash flow, cut investments in programs that preempt negative word of mouth, such as customer service. By weathering the low-cash-flow storm and maintaining investments in customer-friendly programs, firms might escape this cycle.
If citing please refer to the original article:
"Quantifying the Long-Term Impact of Negative Word of Mouth on Cash Flows and Stock Prices", Marketing Science 28.1 (2008): 148-65, Xueming Luo