When it comes to the impact of customer retention on profitability, precision can be a tricky thing.
One of the partners in my firm recalls a case in point when he worked with one of the country’s leading consultantcies on customer retention in the 1990s.
Their modeling found that a 5 percent reduction in total customer base attrition translated to an 80 percent increase in profits in recurring revenue business models, but they were afraid to share the data with clients for fear they wouldn’t be believed.
So it was welcome news when other companies had similar findings, such as a 2004 case study from Bain, which showed that a 5 percent increase in targeted customer retention boosted a credit card companies’ value creation by 75 percent.
Today, this type of modeling has been tested many times in many settings and it’s widely accepted that, across most industries, a 5 percent boost in customer retention (measured across the base) can drive an increase of profits from 25 percent to, in extreme cases, more than 100 percent after the referral power of retained customers and other holistic factors are factored in.
Still, discussions with many executives about customer retention’s statistical impact on profitability are likely to lead to glossy stares, yawns and “that look” strategic advisors know all too well: The one that says, “Even if I pretend that what you’re telling me isn’t abstract, I don’t know how to effect it, anyway.”
It’s a fair response, so we’re going to spend the next few weeks giving you some simple tools to improve customer retention that, in the age of Net Promoter, have fallen into obscurity despite their proven potency.
(I’ll have more to say on Net Promoter later in this series).
1. TOP LINE IMPACT
First, let’s take a stab at making the impact of customer retention a little less abstract for your company by focusing first on its impact on revenue growth, which many executives overlook when they consider investments in customer service and retention efforts.
Here’s a simplified example that drives home the impact of retention on growth:
- Let’s say you start the year with 100 customers and have an 85 percent annual customer retention rate, which means you’ll lose 15 percent of your customers. You add 25 new customers by year-end, but lose 15 of your existing customers to attrition since you hold on to 85 percent of them, so you net the year with 110 customers (the 85 you retained, plus the 25 new customers). So, you started the year with 100 customers and ended it with 110. That’s a 10 percent net growth rate.
- However, by increasing your customer retention rate to 90 percent, your net growth rate becomes 15 percent (instead of your 25 gains in new customers being offset by a loss of 15 customers, you only lose 10 customers). By retaining 90 percent of your customers, you close the year with 115 customers – a 50 percent increase in your growth rate.
Over time the tangible impact of this increased growth rate includes more years of growth before the revenue pool matures (and you find yourself “treading water,” as sales simply replace lost customers) and, of course, a much larger pool when it happens.
2. BOTTOM LINE IMPACT
Beneath these top-line benefits, the advantages of faster growth rates and more revenues result in:
- Greater purchasing power in all areas
- Shorter windows to breaking even and profitability
- Significant increases in net profits after fixed costs are covered and the profit margin on added revenues soars
3. VALUATION IMPACT
Finally, if you’ve been paying attention to our series on selling and/or acquiring businesses, there’s a strong relationship between customer retention and valuation as well.
Reduced attrition plays strongly to your benefit when selling your business because it translates directly to greater revenues (and profitability) when potential buyers project ROI on revenue streams they’re purchasing from you.
Simply put, the more revenues (and profits) in the projection window, the more they can afford to pay you for your customer base.
In fact, often when you learn of a company that earned an abnormally high buyout multiple with no obvious cause for the boost (e.g., exclusive distribution deals, patents or other unique intellectual property), it’s because of extraordinary customer retention.
Not only can buyers afford to pay more when customer retention is exceptional, they must pay more because potential sellers are better off holding on to the cash cows they’ve created.
Next week, we’ll wade deeper into the nuts and bolts of customer retention with some dos and don’ts when it comes to measuring customer satisfaction.
Khali Henderson is senior partner with BuzzTheory Strategies, a marketing consulting firm specializing in the channel.