No my account was not hacked (not yet, at least). I deliberately let this commonly repeated statement be the title without qualifying it. Of course statements like these, (this particular one made famous by Loyalty Effect) cannot stand by themselves regardless of how popular the Guru who said this is.
Let us look at this closely
- Let us assume this statement is true. So shall we fire our sales team, shut down all marketing spend, stop product innovations and get rid of business development? After all this statement indicates new customers are far more expensive. Then why bother?
- Let us take it to the extreme. Shall we stop after the first customer?
- Extending this even further, say you acquired the first customer at a cost of $1 and second at the cost of $7. Then by this logic does it cost $49, $343 etc to acquire third and fourth customer?
- What if you are essentially in a transactional business where you really need new customers every day because the current ones won’t be there tomorrow?
- How do you know it is 6-7 times or only 6-7 times? What are the data and metrics used? Was it based on experimental study?
- How generally applicable is this to your businesses – small and large, early stage vs. mature? Is the cost the same to all businesses?
- What about profits from new customers, is that 6-7 times as well?
You can see how ridiculous the statement sounds now. Here is a further breakdown of problem with this retention vs. acquisition costs statement.
First it is framed around cost and does not base it on marginal benefit and opportunity cost. I also doubt that the proponents know how cost accounting is done and most likely are allocating all kinds of fixed cost share to new customers. You need to have a costing system that can correctly capture only truly incremental costs for both acquiring and retaining. Simply distributing all costs to all customers won’t cut it.
Second it suffers from sunk cost bias. The fact that you spent some money to acquire a customer in the past does not matter in the decision to do everything to retain them. If you cannot recover the acquisition cost it is sunk. You should only look at future unearned marginal profit from each customer – existing or new. At decision time of spending capital on retention vs. acquisition you need to compute the opportunity cost and truly incremental profit from each path, not encumbered by the money you have already spent on existing customers.
Third, if the cost of acquisition is indeed high don’t you think you have a marketing problem? Is it likely that you are targeting wrong customers in wrong places with wrong product, versions, messaging and prices and hence wrong low value customers are self-selecting themselves to your service? Don’t you want to spend your resources fixing this strategic problem vs. worrying about retention?
Lastly the Innovator’s Dilemma. What if the current customers are NOT the representation of future? By choosing to focus your resources on them instead of new customers do you lose sight of new market opportunities, how the customer needs are evolving and how their choices for the job to be done are impacted by market trends and innovations?
Does the retention vs. acquisition pronouncement sound as profound as it did before? I hope not.
How do you make business decisions?