3 Things to Do and 3 Things Not to Do with GrubHub like Sites

Previously I wrote about the simple rule for determining whether or not a restaurant should add GrubHub like food ordering services as a sales channel. Restaurant owners seem to have indigestion from the 10-14% per order commission these sites charge. Restaurants may be tempted to recoup these charges from customers or may feel threatened by the power of such sites. Here are some Do’s and Don’ts to help your business put these channels to work for your business.

3 Things to Do

1. Consider  Creative Packaging for Price Realization. You can serve well the customers you acquire through GrubHub and get better price realization through portion sizing. This is not same as the first “Don’t” below. This is about recouping some of excess consumer surplus you give away.
2. Consider separate menu with premium priced items. As a simple rule customers who come through such sites have higher willingness to pay, have higher disposable income and value variety and convenience. Offer them premium products at premium prices, let them self select if they wish.
3. Rebalance Rebalance Rebalance – You need to determine what kind of restaurant are you and what is your core customer segment. What percentage of your revenue do you want to come from takeout?  Are there other opportunities you are forgoing because takeout business is dominating? Revisit your customer mix and revenue mix every three months and adjust accordingly.

3 Things Not to Do

1. There is a restaurant in Palo Alto that charges 10% extra on takeouts – all takeouts. Resist the temptation to do that to your GrubHub customers They do not know your cost to acquire them (the 10% you pay to these channels is your cost). Such an addition is passing on costs rather than a share of your value add.
2. Do not sign exclusive contract with any one site. Although it is getting very difficult with their mergers you should not let any one channel partner be the source of your takeout sales.
3. Do not pay any upfront or recurring charges however labeled they are. Just like you can’t pass on your costs to your customers these sites can’t pass on their customer acquisition costs to you.

 

It costs 6-7 times more to acquire new customers over retaining existing ones …

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

1. 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?
2. Let us take it to the extreme. Shall we stop after the first customer?
3. 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?
4. 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?
5. 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?
6. How generally applicable is this to your businesses – small and large, early stage vs. mature? Is the cost the same to all businesses?
7. 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?

Product – Price Promotion Fit

I saw a Groupon promotion from BlockBuster Express that gives away $5 worth kiosk movie rentals for $2. The deal, at the last check,  had sold more than 25,000 Groupons. For more than one reason, many of which I explain in my book, this is a very good use of Groupon by BlockBuster and in general a very good use of price promotion for a product.

Product: This is a basic utilitarian product that competes on price. Regular rentals go for $1.   The rental choice is likely limited, only so many DVDs can be stocked in a kiosk. The rental period is also limited – just one night. This is a convenience product, something people hire when they run out of most options. It is by no means a premium product.

Customer: There is no direct contact between the customer and customer service reps. It is a vending machine – as impersonal as it can get. There is no reason whatsoever to worry about customer experience and delighting customers. The customer mix and whether or not the new customers will fit the brand’s target segment is not a concern. Even without the promotion, customers choose this product for price not anything else.

Costs: The costs are all sunk once BlockBuster decides to place one and stock it with DVDs. If there are DVDs sitting in it, they are not making money. The marginal cost is close to $0, (it is the opportunity cost of not serving a full priced customer).  It makes sense to put these idle DVDs to work by encouraging  rentals.

Capacity: BlockBuster has many such kiosks and the offer is valid at any of them. So they are not risking over crowding in any one location. By the general rules of random distribution, we can assume that all kiosks will be utilized uniformly. This is a great improvement of capacity utilization of kiosks – making sure DVDs do not sit idle. Even if a kiosk runs out there are no downside risks – no customer backlash, customers either come back another day or move to next kiosk.

Bring in new customers: BlockBuster is struggling to hold on to its current store customers, as more and more are switching to Netflix. On the low end they are behind Redbox rentals. They are new to the rental kiosk business. Before this Groupon promotion, many customers did not even know about BlockBuster Express and even if they did they may not stop to try it.  A $2 for $5 deal is great way to bring them to the kiosk and create awareness.

Repeat Customers: This is a convenience product, not a premium product. There is a specific job this product is hired for. So the logic of people falling in love with service etc do not apply here. Even if only very small percentage of these customers come back, it is a better option than any other available customer acquisition option.

Groupon Fees: A brand like BlockBuster  may have negotiated a better fee for Groupon than the usual 50% small businesses pay. Even if they did not, this is a good application of Groupon as a  Marketing and Sales channel.

Overall the price promotion aligns very well with the product and the target customer segment.

What about your business and your product?

 

5% Increase in Loyalty

You most likely have seen it or heard it repeated many times over in the business magazines,blogs and twitter. It is stated as self-evident truth, so simple that we did not think of it  by ourselves. Or you have read the books on it. It is indeed so simple, backed up with math and blindingly obvious. It is the 5% loyalty increase multiplier effect. While there are many forms of it as it went through the social media mill, the core statement goes like this

5% increase in customer retention rate  will deliver 75% increase in profit

After all holding on to customers you already have makes more economic sense than chasing new ones right? But, verifying the obvious  may show it isn’t true.

Let me break down how this multiplier effect comes into play.

1. The book starts with an example of a business that has 90% customer retention rate.
2. That means it has 10% annual churn rate – every year 10% drop out
3. So the average lifetime of the customer is 10 years (1 over 10%) – simple and standard math nothing fancy here
4. But if you increase the customer retention rate from 90% to 95%, that is increase by just 5% (rounded number, close enough) …
5. Then the lifetime of the customer jumps from 10 years to 20 years.
6. Not magic, just math. At 95% retention rate, churn is 5% and hence lifetime is  20 (1 over 5%)
7. Since the customer lifetime is doubled, their lifetime value is doubled too. Adjusting for time value of money you get 75% increase in profit.

First, note that this multiplier effect is simply an artifact of the math and not due to any research from customer level longitudinal analysis. You plug in numbers, you will get the answer in the Excel.

Second and most important, it is not 5% increase in retention, it is 50% decrease in churn. When you really say you are increasing retention from 90% to 95%, you are decreasing customer churn from 10% to 5% – a 50% decrease.

How hard and cost effective is that compared to acquiring new customers?

Customers leave for many reasons, many of which you cannot control,  it is futile to chase 100% retention.

See also Barry Dalton questioning the gurus on data and models that prove retention is better than acquisition.

Say you want 10% increase in customers in your freemium startup

Say you want to increase customers (those who pay for the service as opposed to freeloaders)  by 10% in your freemium business. You have two options:

1. Blue Pill: Increase user base by 10% – if the proportion remains the same, % customers goes up by 10%
2. Red Pill: Convert your freeloaders into customers

Which one would you pick? You pick the option that delivers higher incremental profit, that is new revenue less the marketing costs and operational costs.

Let us use some numbers – because of the ubiquity let us use numbers published by EverNote (otherwise there is no connection to EverNote).

Current number of users:  2.7 Million
% customers:                        2%
Revenue/year/customer:  $45
Fixed Cost/year: .09*2.7M =$243,000
Incremental revenue from 10% more customers = $243,000 (just coincidence)

Incremental profit is $243,000 less cost to acquire and support 270,000 more customers.

Incremental Operational Costs: Let us assume you are at capacity and need to add new capacity to support 10% more customers. A moment’s reflection will convince you that this is not an unreasonable assumption. So adding 10% more customers would incur $24,300 incremental cost for capacity enhancements.

Incremental Customer Acquisition Costs: These are the marketing costs. Despite the claims that “free is free marketing”, there is a cost to acquire 270,000 new users especially after already  acquiring 2.7 million users. This is going to take time and will  cost $5,000- $10,000. But to keep with the freemium model assumptions, let us treat the marketing costs as $0.

For option two, both these costs are zero and you only need to convert .22% of the freeloaders compared to acquiring 270,000 new users.

So  converting even a tiny fraction of your freeloaders delivers you higher incremental profit than growing your total user base by 10%.

Is your choice the  blue pill  or the red pill?

Now my selling point – any solution that enables this conversion will add $24,300 in value to you. The value scales as more of your freeloaders are progressively converted to customers.

The value can grow further,  if a solution can find 10% of freeloaders who will never pay and hence enables you to fire them – that is another $24,300 in value for a total of  at least $48,600.

Would you be interested in sharing a fraction of incremental value-add for that solution?

Futility of Chasing Zero Defections

While working with a private school to address their customer churn issue, I looked for reasons why parents decided to switch schools.  The customer research was done in two steps:

1. A focus group  of parents and a number of one on one in-depth interviews
2. A survey of parents in the city and quantitative analysis

Here are some high frequency reasons parents cited:

1. It was the beginning of the economic downturn, people were worried or lost one of their income streams. Private school was no longer affordable.
2. Their second child was starting day-care and it was not anymore possible to pay fees to two children.
3. Parents moved just a few miles and found it hard to schlep the child to the school and get to their work.
4. Until a the early childhood care or the initial grades the school served the needs well but parents were convinced that it simply was not the right choice for the higher grades.
5. The public school lottery they were waiting for came through.

None of these are related to the product itself and nothing the school could have done to increase the loyalty.  It was clear that chasing zero defection would have been completely futile and the resources were better spent increasing the funnel and attracting new parents. This is the case for a product which naturally encourages loyalty, whose selection is not made that lightly and definitely no parent would switch schools on whim. In some of the cases the parents rated their previous schools very highly and yet they chose to switch – exhibiting a large attitude vs. behavior gap.

Businesses must accept that customers switch for reasons which are simply not under their control:

1. Businesses fail, move, change direction
2. Business got acquired and the acquiring company has a preferred vendor
3. Economic shocks
4. Technology shifts
5. Price issues
6. Changing in their needs as they grow
7. Variety seeking – simply interested in trying new products
8. Availability of alternative that was not an option before

None of these can be controlled by any loyalty program or five star customer experience your business can deliver. In fact blindly focusing on increasing loyalty without understanding the reasons will simply take away the resources that could be used for new business development and customer acquisition efforts.

There are a lot of unsubstantiated theories about increasing customer lifetime value by reducing churn – but these are simply models stating the obvious without taking into account such exogenous factors and the costs required to keep price sensitive customers.

[tweetmeme source=”pricingright”] So why should businesses focus their resources on loyalty when the reasons customers switch are completely out of their control?