Customer Relationship Management, Second Edition
Chapter 9, Managing the customer lifecycle: Customer retention and development
Most experts will agree that retaining a customer is easier (and more cost-effective) than aquiring a new one. Because of this, it's important that all companies have established customer retention strategies. In this chapter excerpt, you'll find an explanation of customer retention, tips for creating a customer retention strategy and three ways to measure your customer retention rate.
Customer Relationship Management, Chapter 9
Table of contents:
Customer retention management
Customer retention vs. value retention
Creating positive customer retention strategies
Understanding customer commitment
Customer development and termination strategies
The customer lifecycle is made up of three core customer management processes: customer acquisition, customer retention and customer development. The processes of customer retention and development are the focus of this chapter. Customer acquisition is covered in Chapter 8.
The major strategic purpose of CRM is to manage, for profit, a company's relationships with customers through three stages of the customer lifecycle: customer acquisition, customer retention and customer development.
A customer retention strategy aims to keep a high proportion of valuable customers by reducing customer defections (churn), and a customer development strategy aims to increase the value of those retained customers to the company. Just as customer acquisition is focused on particular prospects, retention and development also focus on particular customers. Focus is necessary because not all customers are worth retaining and not all customers have potential for development. We will deal with the issue of retention first, before turning to development.
A number of important questions have to be answered when a company puts together a customer retention strategy.
- Which customers will be targeted for retention?
- What customer retention strategies will be used?
- How will the customer retention performance be measured?
We believe that these issues need to be carefully considered and programmed into a properly resourced customer retention plan. Many companies, perhaps as many as six out of ten, have no explicit customer retention plan in place. Most companies spend a majority of their time, energy and resources chasing new business, with 75 percent or more of marketing budgets being earmarked for customer acquisition.
What is customer retention?
Customer retention is the maintenance of continuous trading relationships with customers over the long term. Customer retention is the mirror image of customer defection or churn. High retention is equivalent to low defection.
This chapter is excerpted from the book, Customer Relationship Management, Second Edition, authored by Francis Buttle, published by Butterworth-Heinemann.
Customer retention is the number of customers doing business with a firm at the end of a financial year, expressed as percentage of those who were active customers at the beginning of the year.
However, the appropriate interval over which retention rate should be measured is not always one year. Rather, it depends on the customer repurchase cycle. Car insurance and magazine subscriptions are bought on an annual basis. Carpet tiles and hi-fis are not. If the normal hi-fi replacement cycle is four years, then retention rate is more meaningful if it is measured over four years instead of twelve months. Additional complexity is added when companies sell a range of products and services, each with different repurchase cycles. Automobile dealers might sell cars, parts, fuel and service to a single customer. These products have different repurchase cycles which make it very difficult for the dealer to have a whole of customer perspective on retention.
Sometimes companies are not clear about whether an individual customer has defected. This is because of the location of customer related data, which might be retained in product silos, channel silos or functional silos.
- Product silos: consider personal insurance. Insurance companies often have product-based
information systems. Effectively, they regard an insurance policy as a customer. If the policy is
renewed, the customer is regarded as retained. However, take a customer who shops around for a
better price and, after the policy has expired, returns to the original insurer. The insurer may
take the new policy to mean a new customer has been gained, and an old customer has churned. They
would be wrong.
- Channel silos: in the B2B context, independent offi ce equipment dealers have formed
into cooperative buying groups to purchase goods at lower prices and benefi t from other economies
of scale in marketing. When a dealer stops buying direct from Brother Electronics and joins a
buying group, Brother's customer data may report a defection, but all that has happened is that the
dealer has begun to buy through a different channel. 5 Telecommunications companies acquire
customers through many channels. Consider a customer who buys a 12 month mobile phone contract from
a Vodafone-owned retail outlet. Part way through the year Vodafone launches a new pay-as-you-go
product with no contractual obligation. The customer allows her current contract to expire and then
buys the new pay-asyou- go product, not from a Vodafone outlet but from a supermarket. Vodafone
regards her as a lost customer because the contract was not renewed. They would be wrong.
- Functional silos: customer-related data are often kept in functional silos that are not
integrated to provide a whole of customer perspective. A customer might not have made a product
purchase for several years, and is therefore regarded as a churned customer on the sales database.
However, the same customer might have several open queries or issues on the customer service
database, and is therefore regarded as still active.
The use of aggregates and averages in calculating customer retention rates can mask a true understanding of retention and defection. This is because customers differ in their sales, costs-to-serve and buying behaviours. It is not unusual for a small number of customers to account for a large proportion of company revenue. If you have 100 customers and lose ten in the course of a year, your raw defection rate is 10 percent. But what if these customers account for 25 percent your company's sales? Is the true defection rate 25 percent? Consideration of profit makes the computation even more complex. If the 10 percent of customers that defected produce 50 percent of your company's profits, is the true defection rate 50 percent?
What happens if the 10 percent of 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 percent to sales and actually generate a negative profit, i.e. they cost more to serve than they generate in margin. The loss of some customers might improve the company's profit performance. It is not inconceivable that a company could retain 90 percent of its customers, 95 percent of its sales and 105 percent of its profit!
A solution to this problem is to consider three measures of customer retention:
1. Raw customer retention rate: this is the number of customers doing business with a firm at the end of a trading period, expressed as percentage of those who were active customers at the beginning of the period.
2. Sales-adjusted retention rate: this is the value of sales achieved from the retained customers, expressed as a percentage of the sales achieved from all customers who were active at the beginning of the period.
3. Profit-adjusted retention rate: this is the profit earned from the retained customers, expressed as a percentage of the profit earned from all customers who were active at the beginning of the period. 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 programmes could produce the effect of a high customer defection rate, simply because new customers are more likely to defect.
A high sales-adjusted customer retention rate might also need some qualification. Consider a corporate customer purchasing office equipment. The customer's business is expanding fast. It purchased 30 personal computers (PCs) last year, 20 of which were sourced from Apex Office Supplies. This year it bought 50 PCs, of which 30 were from Apex. From Apex's point of view it has grown customer value by 50 percent (from 20 to 30 machines), which it might regard as an excellent achievement. However, in a relative sense, Apex's share of customer has fallen from 67 percent (20/30) to 60 per cent (30/50). How should Apex regard this customer? The customer is clearly a retained customer in a ' raw ' sense, has grown in absolute value, but has fallen in relative value. Consider also a retail bank customer who maintains a savings account, but during the course of a year transfers all but a few dollars of her savings to a different institution in pursuit of a better interest rate. This customer is technically still active, but significantly less valuable to the bank.
Continue to the next section: Customer retention vs. value retention
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This was first published in November 2008