How good are you at keeping customers?

Unstable job - Low section of a business person walking on thin red line

Unstable job – Low section of a business person walking on thin red line

When we talk to customers and prospects about the challenges they face when marketing to their current customers, the issue that never fails to surface is customer retention.  Yet when we press for more details, we are confronted by a paucity of analysis, a struggle to even size the problem, and more often than not, a semi-helpless shrug when we ask how they are attacking the problem.

We think the starting point is to first size the problem.

The most common approach is to simply count the size of the active customer file and ask whether it is growing or shrinking. Retention percentage is the comparison between the number of active customers now and the number at some earlier time. However simple and straightforward this seems, retention percentage calculated by simple counting is a flawed methodology. For example, you may have more customers than last month, but you don’t know if last month’s (or last year’s) customers are still with you. The gain or loss might be primarily a function of your customer acquisition efforts and not your efforts to build customer loyalty.

If counting is your methodology of choice, at least you need to count correctly. A better way to count is to find out how many of the customers who were active one year ago are still active today. It’s a little more work than counting the size of your active file, but a whole lot closer to actually measuring retention. We call this the traditional approach.

Another approach

A different approach we use is to look at the risk profile of your customers.  Each customer has a Risk Score that measures the probability that a customer will NOT buy in the next twelve months. A risk profile shows the distribution of Risk Scores — how many customers there are in each bucket of Risk Scores. We use Risk Scores in many ways, most notably in the Behavior Maps that are the basis for our segmentation schemes (see our white paper on Customer Segmentation for examples).

Since Risk Score correlates so closely with buying behavior, it is a precise way to measure your customer retention rate without having to look back to see which customers were active a year ago but are not active today. We look at the median Risk Score of the entire population. Half of the customers will have a higher Risk Score and half will be lower.  A healthy company usually will have a median Risk Score below 0.5. The table below shows some typical values by industry niche and comments based on the company used to illustrate the category.

 

Type of business Median Risk Score Comments
Manufacturer selling direct 0.615 competitive pressures on brand
eCommerce company 0.742 many one-time buyers
Retail services 0.644 too many infrequent customers
Distributor 0.461  selling popular brands to small businesses
Medical supplies 0.218 very stable set of customers

Impact on revenue

Another way to apply Risk Score to retention measurement is to use it to calculate the revenue at risk because of customer defection. Here’s how: for each customer, multiply the customer’s Risk Score by the revenue from that customer in the trailing twelve months. Summing the numbers for each customer will give you an estimate of potential lost revenue in the coming year due to retention losses. Often a dollar amount has more impact and meaning than a percentage.

Just telling you the severity of the problem is not as satisfying as knowing what to do with the information.  One advantage of the risk score approach is that it identifies which customers are at risk, so you can begin marketing to them to keep them buying. Combining the list of at-risk customers with the up-sell and cross-sell opportunities for each one is the start of an effective campaign to prevent defection.

Customer retention deserves its spot in the forefront of any Customer Marketing Management (CMM) discussion, and the first step is to assess the size of the problem. Companies work hard to acquire new customers, but those customers are usually not profitable until they make multiple purchases. It’s much easier to hang onto a customer you have than to acquire a new one. Consequently, as a CMM company, customer retention is a core part of our value proposition at Loyalty Builders: we deliver actionable customer insights and metrics to drive revenue, maximize marketing capacity, and increase customer retention.  In this case the actionable metrics are the risk scores and purchase opportunities.

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