"We showed that in industry after industry, the high cost of acquiring customers renders many customer relationships unprofitable during their early years. Only in later years, when the cost of serving loyal customers falls and the volume of their purchases rises, do relationships generate big returns. The bottom line: increasing customer retention rates by 5% increases profits by 25% to 95%."Frederick F. Reichheld · Author, Loyalty Rules! and creator of the Net Promoter System
Customer retention is smart business.
Most business owners and managers are focused on two major things: growth and profitability.
However, it seems like the battle for business growth is largely focused on customer acquisition versus retaining and growing existing customers. Why is that?
Are new customers the proverbial "shiny new object"? Is customer acquisition perceived to be "better" because more new customers equate to a better or growing business? Or is it simply because customer retention is hard to define, and somewhat of an ambiguous black hole?
Customer retention is not a panacea, or a simple thing to address, but it is one thing: necessary.
Unless your business involves a one-time sale to a one-time customer, chances are good that your business needs to retain its customers.
Sometimes, we miss what is right in front of us.
"It costs 6 to 7 times more to acquire a new customer than to retain an existing one."Bain & Company
Less expensive than new customers.
New customers are an important part of growing a business. But what about the customers we already have? Are we doing everything we can to help them help us grow our business?
Do you know your CAC?
Customer Acquisition Cost (CAC) is a commonly overlooked metric in many businesses. In fact, a sale to a new customer is usually considered such a "win" that the costs of getting that sale are often ignored.
Let's say it costs your business $300 to acquire a new customer with sales and marketing costs, and related expenses. Depending on industry, gross margins, etc., that might be an acceptable acquisition cost, but it may not be — the point is that we need to know.
Otherwise, it is hard to determine how long we need to make our investment back, how much business we need from each customer, how much we should spend on sales and marketing — the list goes on and on.
Know your customer acquisition cost.
"Customer profitability increases over the life of a retained customer."Emmet Murphy & Mark Murphy · Leading on the Edge of Chaos
Long-term value of current customers.
Customer Acquisition Cost (CAC) is only half of the equation. The other side of the coin is Customer Lifetime Value (CLV).
Business smarts
Simply put, CLV is the value of a customer over a specific period of time — or their "lifetime" as a customer. For example, if a customer spends $50 per month for one year, their One-Year CLV is $600.
An existing customer was a new customer at one time. But the important thing to consider is how much that customer will contribute to the business over time.
CAC and CLV work together and help determine what you should spend on a new customer. Spending $300 to acquire a new customer makes sense if that customer spends $30 per month for two or three years. But it would take well beyond one year to earn back the CAC plus a profit, which may not make sense at all.
Know both sides of the customer value coin.
"Customer loyalty can be worth 10 times as much as a single purchase."White House Office of Consumer Affairs
Selling to current vs. existing customers.
Sales to existing customers can be significantly more profitable than new customer sales, because there is a cost reduction in each additional sale.
Hello bottom line
Using the Chapter 2 example, let's compare sales to a new vs. existing customer:
$300 = Customer Acquisition Cost for a new customer.
$300 sale to an existing customer = $150 gross profit + $0 CAC = $450 gross profit.
Current customer sales are more profitable because the acquisition cost savings goes to the bottom line on each additional sale. Sure, other costs exist — it's not "free" to sell to existing customers, but it is typically much cheaper.
Profitable sales add up to a valuable business.
"There is a 5%–20% probability of converting a prospect into a new customer, but a 60%–70% probability of selling an existing customer."Marketing Metrics
Existing customers are easier to sell.
Most companies default to customer acquisition versus selling more to existing customers. Why?
Maybe companies simply don't know what to do. Maybe it is assumed current customers won't purchase more, or that new sales might be larger or more profitable. Maybe it's an "ego thing" to say we have a lot of customers versus a few who are really profitable.
Go where the crowd isn't
Many businesses have additional products and services to sell to existing customers. What better way to reinforce a customer's initial purchase decision, or to demonstrate you are "new" again? What better path to growth and profitability?
Your best customer is the one you already have.
"A 5% reduction in the customer defection rate can increase profits up to 95%."Bain & Company
Repeat customers are essential for growth.
Whether you plan to grow your company well into the future or have an exit strategy to sell your business, growth equates to customers.
Repeat purchases are essential, because growth from new business alone is expensive, time-consuming, labor-intensive, and probably unsustainable.
The proverbial bucket
Let's assume our customer churn rate is 20%; we lose 200 customers per year; and customers spend $300 each year with a $150 gross profit on each sale.
Reducing the churn rate by even 10% = $6,000 in revenue (20 × $300), and $3,000 gross profit (20 × $150).
Acquiring 20 new customers at $300 CAC and $150 gross margin = $6,000 CAC and $3,000 gross profit, respectively. But we actually lose money because the $6,000 CAC is an expense — so the math is $3,000 − $6,000 = a $3,000 loss.
Plug the hole and keep more customers.
"80% of your company's future revenue will come from 20% of your existing customers."Gartner Research
Add significant value to your company.
The 80/20 rule dictates that 80% of business comes from 20% of your customer base.
Perry Marshall, noted author and marketer, reveals in 80/20 Sales and Marketing that the 80/20 concept can be magnified even further — literally just a few customers are actually worth exponentially more than ALL other customers combined. These are the customers who can really help grow business value.
Staying even isn't profitable
Let's say in five years, you want to sell your business. A company with active and profitable customers makes a business valuable.
If you gain a new customer for each lost customer, you are not "staying even" — you are actually losing money, because of lower margins due to the expense of acquiring new customers versus selling to existing customers.
Customer retention isn't about more sales. It's about profitability.
"About 4% of dissatisfied customers complain. 96% just go away."Harris Interactive · 2011 Customer Experience Improvement Study
Customer experience is more than a sale.
Without a positive customer experience, it is difficult to successfully retain and grow profitable customers.
Retention requires intention. Experience requires effort.
While there are many benefits to customer retention — most notably profitability, growth, and loyalty — it isn't free. We make substantial investments in acquiring new customers. So why don't we invest in keeping and growing the customers we already have?
Investing in existing customers also means leveraging the acquisition investment already made to build a more profitable and valuable business.
Invest in the customer experience. If we educate, motivate, and inspire existing customers, they will become even better and more profitable customers.
Customer experience begets customer retention.