Studies have shown that many customers are more likely to change their buying behavior than they are to defect. Because of this, it's important that companies not only manage customer retention, but keep an eye on value retention as well. In this chapter excerpt, learn about value retention and get an overview of the cost of customer retention.
Customer Relationship Management, Second Edition
Chapter 9, Managing the customer lifecycle: Customer retention and development
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
Manage customer retention or value retention?
This discussion indicates that companies should focus on retaining customers that contribute value. Sometimes this will mean that the focus is not on retention of customers, per se, but on retention of share of wallet. In the banking industry, for example, it may be more important for companies to focus on managing the overall downward migration of customer spending than managing customer retention. Many customers simply change their buying behaviour rather than defect. Changes in buying behaviour may be responsible for greater changes in customer value than defection. One bank, for example, lost 3 percent of its total balances when 5 percent of checking account customers defected in a year, but lost 24 percent of its total balances when 35 percent of customers reduced the amounts deposited in their checking accounts. The need to manage migration, rather than defection, is particularly important when customers engage in portfolio purchasing by transacting with more than one supplier.
Improving customer retention is an important objective for many CRM implementations. Its definition and measurement need to be sensitive to the sales, profitability and value issues discussed previously. It is important to remember that the fundamental purpose of focusing CRM efforts on customer retention is to ensure that the company maintains relationships with value-adding customers. It may not be beneficial to maintain relationships with all customers; some may be too costly to serve, others may be strategic switchers constantly in search of a better deal. These can be value-destroyers, not value-adders.
Economics of customer retention
There is a strong economic argument in favour of customer retention, which was first introduced in Chapter 2. The argument goes as follows.
1. Increasing purchases as tenure grows: over time, customers come to know their suppliers. Providing the relationship is satisfactory, trust grows while risk and uncertainty are reduced. Therefore, customers commit more of their spending to those suppliers with whom they have a proven and satisfactory relationship. Also, because suppliers develop deeper customer intimacy over time, they can enjoy better yields from their cross-selling efforts.
2. Lower customer management costs over time: the relationship startup costs that are incurred when a customer is acquired can be quite high. It may take several years for enough profit to be earned from the relationship to recover those acquisition costs. For example, it can take six years to recover the costs of winning a new retail bank customer. In the B2B context in particular, ongoing relationship maintenance costs such as selling and service costs can be low relative to the costs of winning the account. Therefore, there is a high probability that the account will become more profitable on a period-by-period basis as tenure lengthens. These relationship maintenance costs may eventually be significantly reduced or even eliminated as the parties become closer over time. In the B2B context, once automated processes are in place, transaction costs are effectively eliminated. Portals largely transfer account service costs to the customer. In the B2C context, especially in retailing, the assertion that acquisition costs generally exceed retention costs is hard to prove. This is in part because it is very difficult to isolate and measure customer acquisition costs.
3. Customer referrals: customers who willingly commit more of their purchases to a preferred supplier are generally more satisfied than customers who do not. They are therefore more likely to utter positive word-of-mouth and influence the beliefs, feelings and behaviours of others. Research shows that customers who are frequent buyers are heavier referrers. For example, online clothing customers who have bought once refer three other people; after ten purchases they will have referred seven. In consumer electronics, the one-time customer refers four; the ten times customer refers. The referred customers spend about 50 to 75 percent of the referrer's spending over the first three years of their relationship. However, it is also likely that newly acquired customers, freshly enthused by their experience, would be powerful word-of-mouth advocates, perhaps more than longer-term customers who are more habituated.
4. Premium prices: customers who are satisfied in their relationship may reward their suppliers by paying higher prices. This is because they get their sense of value from more than price alone. Customers in an established relationship are also likely to be less responsive to price appeals offered by competitors.
These conditions mean that retained customers are generally more profitable than newly acquired customers. Drawing from their consulting experience, Dawkins and Reichheld report that a 5 percent increase in customer retention rate leads to an increase in the net present value of customers by between 25 and 95 percent across a wide range of industries, including credit cards, insurance brokerage, automobile services and office building management. In short, customer retention drives up customer lifetime value.
Which customers to retain?
Simply, the customers who have greatest strategic value to your company are prime candidates for your retention efforts. These are the customers we defined as having high lifetime value or who are otherwise strategically significant as high volume customers, benchmarks, inspirations or door openers, as described in Chapter 5.
You need to bear in mind that the cost of customer retention may be considerable. Your most valued customers are also likely to be very attractive to your competitors. If the costs of retaining customers become too great then they might lose their status as strategically significant. The level of commitment between your customer and you will figure in the decision about which customers to retain. If the customer is highly committed, they will be impervious to the appeals of competitors, and you will not need to invest so much in their retention. However, if you have highly significant customers who are not committed, you may want to invest considerable sums in their retention.
Some companies prefer to focus their retention efforts on their recently acquired customers. They often have greater future lifetime value potential than longer tenure customers. There is some evidence that retention rates rise over time, so if defections can be prevented in the early stages of a relationship, there will be a pay-off in future revenue streams. A further justification for focusing on recently acquired customers comes from research into service failures. When customers experience service failure, they may be more forgiving if they have a history of good service with the service provider. In other words, customers who have been recently acquired and let down are more likely to defect or reduce their spending than customers who have a satisfactory history with the supplier.
Retention efforts where there is portfolio purchasing can be very difficult. Should effort be directed at retaining the high-share customer with whom you have a profi table relationship, the medium-share customer from whom you might lose additional share to competitors or the low-share customer from whom there is considerable lifetime value potential? The answer will depend on the current value of the customer, the potential for growing that value, and the cost of maintaining and developing the relationship.
Continue to the next section: Creating positive customer retention strategies
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This was first published in November 2008