Customer Retention

What Is Customer Retention?

Graphics originally by HubSpotOpens in new window 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 churnOpens in new window. High retention is equivalent to low defection.

Conventionally, customer retention is defined as follows:

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 12 months.

And 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 that 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 business-to-business (B2B) context, independent office equipment dealers have formed into cooperative buying groups to purchase at lower prices and experience other economies of scale in marketing.
  
  
  When a dealer stops buying direct from Brother ElectronicsOpens in new window, 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.
  
  Telecoms companies acquire customers through many channels. Consider a customer who buys a 12-month mobile telecoms contract from a Vodafone-owned retail outlet. Part-way through the year VodafoneOpens in new window launches a new pay-as-you-go product with no contractual obligation. The customer allows her current contract to expire, then buys the new pay-as-you-go product not from a Vodafone outlet but from a supermarket. If VodafoneOpens in new window 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 behaviors.

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 10 in the course of a year, your raw defection rate is 10 percent.

But what if these customers account for 25 percent of 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 customers lost 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 the 10 percent contributes less than 5 percent of sales and actually generates a negative profit; that is, they cost more to serve than they generate in margin. The loss of some customers might enhance 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 a 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 commitmentOpens in new window, trustOpens in new window grows and it becomes progressively more difficult to break the relationship.

Successful customer acquisition programs could produce the effect of a high customer defection rate, simply because newly acquired 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 bought 50 computers 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 percent (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 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.

Managing Customer Retention or Value Retention

The discussion above 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 customer retention.

Many customers simply change their buying behavior rather than defect. Changes in buying behavior 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 (or current) 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 true when customers engage in portfolio purchasing by transacting with more than one supplier.

Improving customer retention is an important objective for many CRM strategies. Its definition and measurement need to be sensitive to the sales, profitability and value issues mentioned above.

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-creating 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-creators.