Customer retention is the maintenance of continuous trading relationships with customers over the long-term; it’s the mirror image of customer defection or churn.
Customer retention has replaced customer acquisition as the most important marketing KPI, particularly in mature markets, but does that really make sense? I think not. Here are two reasons why you should think twice before joining this bandwagon.
First, the use of aggregates and averages in calculating customer retention rates can mask a true understanding of retention. This is because customers differ in their purchasing and costs-to-serve. It is not unusual for a small number of customers to account for a large proportion of sales revenue. You know it as the Pareto principle, or 80:20 rule. If you have 100 customers and lose 10 in the course of a year, your raw customer retention rate is 90%. But what if those ten churned customers account for 25% of your company’s sales? Is the true retention rate, adjusted for sales 75%? Consideration of profit makes the computation even more complex. If the 10% of customers that churned produce 50% of your company’s profits, is the true profit-adjusted retention rate 50%?
What happens if the 10% lost customers are at the other end of the sales and profit spectrum? In other words what if they buy very little and/or have a high cost-to-serve? It could be that they contribute less than 5% of sales and actually generate a loss, i.e. they cost more to serve than they generate in margin. The defection of some customers might enhance the company’s profit performance. It is not inconceivable that a company could retain 90% of its customers, 95% of its sales and 105% of its profit!
Second, a high raw customer retention rate does not always signal excellent customer retention performance. This is because customer defection rates vary across cohorts of customers. Defection rates tend to be much higher for newer customers than longer tenure customers. Over time, as seller and buyer demonstrate commitment, trust grows and it becomes progressively more difficult to break the relationship. Successful customer acquisition programs could produce the effect of a high customer defection rate, simply because new customers are more likely to defect!
This means that marketers should be thinking not in terms of raw customer retention, but in terms that are directly derived from business objectives. If building sales is your goal, focus on sales retention; if building profit is your goal focus on profit retention.
Francis
I think you have done us all a service by pointing out the fallacy of just adopting (sometimes flawed) thinking because everyone else is doing it. Beacause it has become CRM folklore.
Spending lavishly on retaining customers because it is supposedly cheaper than finding new ones is one such fallacy. The fallacy originated from work by TARP in the 80s and was given further support by Fred Reicheld in his influential The Loyalty Effect book in the 1990s. Unfortunately, as Werner Reinartz showed in 2000, the loyalty effect proposition is simply not true. Not as simplistically as TARP and Reicheld proposed anyway.
As you pointed out in your post, the answer is in understanding where the best return on marketing investments will come from. It may come from spending more to retain loyal customers, but it is more likely to be from spending more to increase the spend of mid-loyalty customers. Or even from spending more to turn low-loyalty customers into medium-loyalty ones. It all depends upon the marketing ROI calculation. And ultimately, it all depends upon value creation.
Graham Hill
Independent CRM Consultant
Interim CRM Manager
I am confused a bit by the implied message of the author’s post . . .I am presuming it’s mostly about focusing on the right metrics, and not an arguement against retention activity itself. Most of the industry’s attention, and likely it’s spending, seems to be focused on acquiring new customers or generating product sales from new customers, with precious little effort given to growing the value and duration of existing customers. My experience in a wide range of industries shows that greater ROI on total marketing spending comes from blending acquisition effort with specific effort on increasing the value of existing customer relationships, and in retaining the value in those relationships over time. I sense in the undercurrents of the two posts above that a focus on customer value, and not just the number or percent of transactions, should be the ultimate metric for marketing returns.
It seems that the delivery of offers, ads and messages aimed at generating sales and value via “cross-sell”, “up-sell” and loyalty programs utilize the same approaches that are broadly used in acquiring new customers: targeting based on observed behaviors or search content. Such approaches make good sense for acquiring customers from an anonymous audience, but there are better methods for targeting messages, ads and offers to existing customers. True “customer-centric” marketing, the real breakthrougy promise of digital technology, has really not yet been the focus of strategic program development in targeting existing customers.
In this vein, I personally find CRM to be a bit of a misnomer. It is not just the “management” of “relationships” that is the focus of this expertise, it should be the explicit “management for growth” of the “value” of customer relationships. This is the key to tieing marketing spending and it’s metrics directly to the company’s financial statements and goals: the sum of the value of all customer relationships is the value of the customer franchise, and customer franchise value is directly linked to shareholder value.
These are the areas where there is great business need and opportunity for significant contribution from innovative marketing approaches and uses of technology, financial and information systems that have not yet been seen.
Robert Viney
Co-Founder, Partner
Interactive Commerce Solutions
Robert,
Thanks for contributing to this thread. Just to clarify matters, my original post was indeed intended to encourage a focus on retaining valued customers – however that is defined – rather than customers per se.
Francis Buttle
Francis, you make a great point about not blindly attempting to retain all customers. Your examples, though, suggest that customers’ value is just about about financial considerations.
What about the value of “strategic” customers or reference accounts? The value of customers that are influential? The value of those that may become valuable later on in life?
Given the complexity of companies calculating a long-term value and cost-to-serve, I wonder how many companies can even attempt this sort of value management. We’ve all heard stories about the bank customer with a small account, who was rudely treated and even encouraged to leave. After doing so, recommending that his/her friends leave too.
And, of course, we know about the mess Sprint made of firing customers. When we start talking about customers we want to retain, it has to eventually lead to the question of what customers do we want to go.
Maybe this is not the scientific approach, but why can’t we treat all customers well? The “CRM” method of picking and choosing customers seems to have significant challenges–and costs–to implement in the real world. By contrast, a policy of treating all customers well is simple, and may result is some customers not generating enough value with their own purchasing behavior–but perhaps will make up for that by becoming advocates and bringing in more business.
Bob Thompson, CustomerThink Corp.
Blog: Unconventional Wisdom
This is an interesting thread and it is nice to see the diversity of opinion showing up in the discussion. My $0.02 worth follows.
Some of the comments suggest differentiation among customers based on some kind of value metric to add focus to resource allocation decisions. Of course – this was the big lesson learned when Customer Profitability analysis first got legs a decade ago. Can’t see much contest room left there.
Yet Bob raises another point which I think deserves support – in many situations our companies choose to or are obliged to provide service to entire communities not just the customers we might like to select… for example services like basic telephone connectivity and basic banking services, where to shun segments is a potentially dangerous decision politically and economically. This is what I like to think of as the “all customers are good” strategy and it takes some refinement ofunderstanding to perform well in this space. Specificaly it requires an understanding of why lower profit customers are producing lower prifits and choices to change the economics of the relationship. Often this results from under pricing, over servicing, excessive features or poor cost to service structures – all of which are the responsibility of the provider, not the customers. “Firing” customers should probably not be considered without firing some managers first.
I don’t want to diverge too far from the thread base by getting into what loyalty is or is not here (and whether or not it works and how well and to whose benefit etc.). I will suggest, however that loyalty scores, however produced are only indicators of risk of defection, which are useful when combined with value metrics to indicate business at risk, which is pretty useful for resource allocation analysis.
At the end of the day I am inclined to subscribe to the school that says marketing and customer strategies should enable and effect acquisition, retention and extension of profitable customer relationships. I really think it is that simple. Retention, therefore, is certainly something I believe to central to the mission. Unfortunately most metrics measure the wrong things or lack ssufficient detail to discover behaviour causality and the relative costs and benefits of management options. Understanding customer behaviour remains the green field in the CRM space.
David McNab
Retention & Sales metrics
Customer profitability
Francis,
Thanks for your clarification. That definition is one I buy into completely.
Since this thread has attracted great comment thus far, I wanted to clarify some of my own language versus what others might take away.
I was attempting to address the issue of how best to effectively allocate marketing investments to customers, not which customers to serve. As David points out, my main observation was that marketing spending today is too often allocated only to acquisition, and the financial benefits to be realized by investing in growing customer value and in retaining valuable relationships over time through allocating a larger share of the total spending budget is quite significant, in my experience. And I was attempting to make the additional point that the appropriate allocation across acquisition, “cross-sell” or value growth, and retention, should be based on the incremental value to be realized, not on the transactional or delivery cost metrics often used by marketers, consistent with the clarification Francis provided.
Regarding the point of “aren’t all customers valued”, the answer is, I think, “yes, but not equally”… if we’re discussing how to allocate a fixed marketing or promotion budget in a given fiscal year, we need to be focused on where that incremental spending will generate the greatest returns. Of course, a portion of the company’s costs are allocated to serving all customers, even those of little current or incremental potential value, and a portion should be allocated to maintaining relationships with customers who may have future potential value. But those spending allocation decisions need to be tempered by the real returns that can be generated within a reasonable time frame and with reasonable confidence.
Investing in customers with a future potential value is something that would need a pretty solid, long-term study to validate the returns that can actually be realized, I would think. In working in several industries, I’ve found it more helpful to focus on the year-to-year returns of year-to-year spending investments, in the absence of such longer-term validating experience. It’s fairly straight-forward to quantify the potential value of customer behaviors expected in the next 12 months, and to then allocate incremental investment spending designed to change behaviors to acquire a portion of that value with a desired ROI. Similarly, quantifying the value of existing behaviors (or recent past behaviors) and the level of an appropriate investment to encourage repeating those behaviors and retaining that value for the next 12 months is fairly straight forward as well.
Those are the basic customer value management activities and metrics, that would help many marketers deliver greater growth in the value of the customer franchise from year to year, with greater effectiveness and higher efficiency, than the traditional transaction-based customer relationship marketing approach. And this would increase the direct alignnment of marketing spending and activity to the overall company’s financial metrics, which is an oft-stated need in many marketing organizations.
Robert Viney
Interactive Commerce Solutions
I like the theory of customer value management, especially if it’s practiced in a way that doesn’t disenfranchise lower value customers.
But I question how many businesses can really practice CVM. Outside of banks, who seemingly can squeeze blood out of a turnip by layering on fees for everything, what kinds of businesses can calculate customer value, taking into account factors like future revenues and cost-to-serve?
Any examples?
Bob Thompson, CustomerThink Corp.
Blog: Unconventional Wisdom
Thanks everybody for your contributions to the thread. This is a good conversation to be having.
Most of the work I do is with business-to-business organisations where computations of potential customer value are much easier to derive. Here’s an example. Dyno-Nobel is an explosives manufacturer serving the mining and related industries. DN negotiates contracts to supply up to two years, and sometimes more, ahead. Price points are agreed, and service level agreements are established. This means that DN knows revenues, margins and cost-to-serve. Ipso facto, it has a measure of future customer profitability. I agreed with you that the task isn’t so simple in B2C contexts.
Now, to the another matter that has been raised – that of focusing overly on dollar indicators of value. Imagine, if you will, a matrix with the horizontal axis marked ‘gross margin’, ranging from low to high. The vertical axis is marked ‘cost-to-serve’ and also ranges from low to high. Account managers, even if they don’t have enough information in their customer-related databases can often produce good estimates of where their customers sit in this 2D matrix.
Now, here’s the trick. You are going to add a third dimension to the matrix, which will create a cube. The third dimension is marked ‘strategic value’ and again ranges from low to high. This is where you consider reference value, the customer’s network position, and a range of other non-financial strategic considerations.
The end-product is a score that incorporates financial and non-financial measures of customer value. The scores guide resource allocation and relationship management strategies.
I’d be very interested to learn how others reading this blog assess non-financial strategic customer value.
Francis Buttle
Francis: I think you initially wrote this in response to my post http://www.customerthink.com/blog/five_steps_understanding_customer_retention. Thanks for continuing the discussion and a lot of great insight has been added in this thread.
I absolutely agree that incorporating customer value and profitability on an individual level is important. You are essentially making the case for measuring customer lifetime value and working towards retaining customers that have the highest value. And, as Bob points out, it’s important to consider the social value of the customer as well as the financial value of the individual. Absolutely.
I do want to point out, however, that doing this stuff in practice is damn hard. It takes data which many marketers struggle to pull together and frankly it takes an analytical savvy that many marketing teams simply don’t possess. There are still way too many marketers out there just looking for industry benchmarks to compare their business to. I always attempt to convert these marketers to start baselining simplified (and aggregate) measures within their own operation. Once marketers start to turn down this path, they will innevitably see the benefits and start working towards more data, more measures, and more granularity. But, they have to start somewhere.
Thanks for continuing the discussion.
ELANA ANDERSON
Marketing Strategy Consultant
NxtERA Marketing
[email protected]
http://www.nxteramarketing.com
Bob
I once developed an Excel-based application to manage 60,000+ B2B customers and B2C consumers for Coca Cola Hong Kong.
I used IPAK, which stands for Inactive, Potential, Active, Key, to manage the database. IPAK is one of the many ways to segment the market.
Daryl Choy, the founder of Touchpoint eXperience Management, helps firms make a difference at every touchpoint. Choy can be reached at wisdomboom.blogspot.com.
Elana, Daryl
In my view, it’s better to have a crude but mangerially useful customer classification tool, than not have one at all. Computing cost-to-serve to the last cent generally only makes sense if the data are easy to access, current and accurate. But if you know that, say, selling costs -salary, bonus, commission, expenses – account for a significant proportion of your company’s cost-to-serve you can use that as an indicative measure of overall cost-to-serve. This can still give you a decent insight into customer value. I agree that looking internally at the major cost-drivers is a necessary step to uderstanding customer value, at least in the monetary sense.
Francis Buttle
I would like to point out a truism regarding cable TV in the USA. I was browsing a web site which has nothing to do with crm, yet is full of snippets regarding the subject from a client or potential client perspective, including a reference to the birth/gestation of cable TV in the USA, which started life as a free signal concentrator service, and after successfully defending law suits to shut it down, turned itself into a highly successful pay-per business model.
There is a very relevant quote which I think epitomises the issue of retaining clients, viz. consumers are willing to abandon free services if a new technology can give them more choice, better quality and greater convenience.
Paying customers are the same. More choice, better quality and/or greater conveniance are as important as quality of service experience in detrerming retention/churn. What most business people, from management to consultants, forget is that keeping customers happy is both costly and difficult, but it is a whole lot cheaper as well as much easier and less stressfull than trying to turn around an already disgruntled customer.
The only way any service provider can keep 100% of its customer base over the long term is to be a monopoly. The minute a customer has choice, there is no such thing as guarenteed retention. Even Toyota has this experience. Everybody who has any knowledge of the motor industry is aware no Toyota model is bleeding edge in technology or design, yet this has not prevented it from becomming the No 1 player worldwide. None of their products are the best quality available, not even in the comparative price range. So why/how do they retain customers? Because they manage the customer experience in relation to their Brand. Depsite this, they, too, lose clients to other marques.
Yes, it is important to turn around disgruntled clients, but the chances are better than 50% you will lose that client in the short to medium term anyway, even if turned around. So is the money/effort spent on the turnaround worth spending?
Fact! Word-of-mouth advertising always trumps and outperforms media ad spend, so you don’t need or want negative sentiments out there in the public domain destroying everything you’re spending millions on building.
Fact! The cost of attracting new clients or turning around disgruntled clients is greater than keeping existing clients by a factor of 10.
Fact! All companies are going to lose clients. It is a natural process. Like attrition and erosion. Live with it. Put effort and spend were it will do maximum benefit – your existing client base. I don’t mean that you should not spend on attracting new clients or turning around disgruntled clients. I mean those costs should not exceed the cost of keeping existing clients happy.
Fact! Most CEOs, CRM and BPR consultants are 30-somethings or older. How many of them understand the impact of new/cutting edge technologies on the youth. Whatever your company does, you cannot afford to exclude technology or youth. Cut your traditional ad spend. Put the money into placing your Brand into a Playstation, Computer or cell phone game; sponsor a music download web site, cell phone additional service site, FaceBook or other social networking site. You don’t need to conduct expensive market research, talk to your children and their friends to find out what technology they spend time with, then use it.
Lastly, FOCUS:
Faith – if you don’t believe you will succeed, you won’t
Overview – also called a helicopter view, the ability to rise above what you are doing and see the bigger picture
Customers – self-explanatory
Usage – what position do customers have in your organisation
Staff – are all staff on the same page?
This really was a good article. It married the issue of blindly holding onto existing customers with misreading statistics, and injecting common sense. At the end of the day the human factor still needs to decide if a customer is worth the cost or not in terms of revenue. It may sound cold, but as a business that really is the bottom line measurement. We’ve reviewed this article on our own website at http://retentionofcustomers.com/wordpress/?p=232 . Good stuff, keep it up!