Is your company struggling to balance its marketing budget between acquisition and retention? According to Invesp, it costs five times as much to attract a new customer, than to keep an existing one. This resonates with the 80/20 rule of marketing investment which states that, in general, 20 percent of marketing messages should produce 80 percent of campaign results. If we further expand this rule by applying it to the customer pyramid, we can conclude that a typical business earns approximately 80 percent of its profits from the top 20 percent of its customer base. On the customer pyramid, this 20 percent would be the platinum customers at the tip of the pyramid; just below are the gold customers who also contribute to profits and might eventually migrate to the platinum group; the next tier is the silver group which may or may not include profit-generating customers (this is your cost conscious group that seeks basic services at minimal costs); finally, at the base of the pyramid lies the unprofitable customers. These customers demand time, resources and services, but are unwilling to pay for them.
This visualization of customer groupings make it obvious that marketing resources should target efforts that move customers upwards to the platinum level and keep them there for as long as possible. An effective retention strategy emphasizes building long-term, mutually beneficial relationships with the gold and platinum customers to secure the longevity of the business.
Despite monumental evidence supporting the need for retention oriented strategies, only 18 percent of companies focus on retention, whereas 44 percent of companies have greater focus on acquisition.
This gap provides opportunities for businesses to reevaluate their marketing strategy, and to place more emphasize on customer retention. Being able to accurately calculate your customer lifetime value (CLV) is an important step to assessing your budget allocation needs.
First, some definitions:
Annual Customer Attrition Rate – Rate at which customers cease their relationship with the company each year.
Annual Customer Retention Rate – Rate at which customers continue their relationship with the company each year.
Note: Attrition rate and retention rate are complements of each other. If a company has a 30% attrition rate, it will have a 70% retention rate.
Customer Lifetime Value (CLV) – Prediction of the net profit attributed to the entire future relationship with a customer.
Customer Acquisition Cost (CAC) – The cost of acquiring a new customer.
Cost of Attrition – Amount of revenue loss due to customer attrition.
Now, let’s dive into the math:
Annual Customer Attrition Rate = (Number of Customers that Leave Each Year) / (Total Number of Customers)
Annual Customer Retention Rate = (Total Number of Customers – Number of Customers that Leave Each Year) / (Total Number of Customers)
Customer Lifetime Value (CLV) = 52 weeks x (Average customer weekly spend) x (Average customer lifespan)
If you want to customize the CLV calculation by incorporating seasonal traffic and coupons, you may expand on the average customer weekly spend value. In that case,
Customer Lifetime Value (CLV) = 52 weeks(s x c x p) x (Average customer lifespan), where s is the average expenditure per visit, c is the average number of visits per week, and p is the average profit margin per customer.
Note: Depending on the nature of your business, you can use other increments such as 12 months or one year instead of 52 weeks. Just remember to adjust average customer spend accordingly as well.
Customer Acquisition Cost (CAC) = (Total Marketing and Sales Budget Including Salaries) / (Number of Customers Acquired)
Cost of Attrition = (Single Customer Lifetime Value) x (Number of Annual Customers Lost)
Putting it Together
Suppose that you began the year with 100 clients. By the end of the year, 10 clients had cancelled their subscriptions. In this case, your annual customer attrition rate is (10/100) = 10%. Your annual customer retention rate is [(100-10)/100] = 90%. Notice that attrition rate and retention rate are complements.
Now let’s suppose that on average, each customer spends $2 per week on services, and the general customer lifespan for your industry is 10 years. In this case, the total CLV of 100 clients would be [52($2 x 100) x 10] = $104,000. However, since you lost 10 clients this years, the cost of customer attrition would be $104,000/100 x 10 = $10,400. As such, a single CLV is $1,040.
Here’s the fun part:
Let’s say your CAC is $20 per client. To replace the 10 clients lost, you would spend $20 x 10 = $200. That’s a great return on marketing investment, as $200 would bring you potentially $10,400. But what if you increased your retention rate by 1%? That’s just one additional client retained, decreasing attrition rate to 9%. Additionally, you may only need to spend $5 to retain that client. Thus, a retention program that cost as low as $50 to retain those 10 clients may help you obtain the same $10,400 in a shorter amount of time!
The choice is clear. Who wouldn’t want to spend less money and time to achieve the same results? Furthermore, effective retention strategies often focus on building solid customer relationships to increase long-term business potentials.
The next step is to determine the most effective platforms for your retention efforts. According to Invesp, the following are some of the most used channels for retention communications:
The prevailing wisdom is that the cost of acquiring a new customer is far above the cost of retaining an existing customer. Talk to a marketing specialist today to find out how to optimize your retention program for long-term sustainability.
Qinghua Lao & ERC team