Right after my article on customer retention vs. acquisition (which was triggered by several live tweets I saw from certain loyalty conference) I saw the story of Sycamore networks,
The fifteen year old company known for its high flying stock from the 2000 bubble days ended the day with the decision to close down and liquidate remaining assets.
What went wrong? According to the WSJ article
analysts say the company’s demise also reflects strategic missteps—sticking with its initial product line as the market declined
It had one product that was relevant only to its original customers and failed to see how the market was evolving or where the new needs are arising.
They never kept pace with market development and never got customers.
In other words Sycamore failed to acquire new markets and in that process lost existing customers as well.
Engineers had figured out how to send much higher quantities of information by routing pulses of light down fiber-optic cables rather than relying on electrical signals sent across copper wires. Sycamore’s niche was to help network operators manage those pulses of light more efficiently.
Sycamore was loyal to its product and happy with its original customers. Even there it seemed to have failed to ask, “what job customers were hiring its product for” (i.e., the real need).
This is one just story and likely suffers from hindsight bias and selective recall. So do all the positive stories you hear about customer retention and loyalty. But one thing you need to care and apply diligently is the need for actionable business strategy rooted in data.
If your strategy is wrong it does not matter what rating your customers say on a 0 to 10 scale.
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?
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.
- The book starts with an example of a business that has 90% customer retention rate.
- That means it has 10% annual churn rate – every year 10% drop out
- So the average lifetime of the customer is 10 years (1 over 10%) – simple and standard math nothing fancy here
- But if you increase the customer retention rate from 90% to 95%, that is increase by just 5% (rounded number, close enough) …
- Then the lifetime of the customer jumps from 10 years to 20 years.
- Not magic, just math. At 95% retention rate, churn is 5% and hence lifetime is 20 (1 over 5%)
- 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.