The best brands and businesses are skilled at not only acquiring customers, but retaining them as well. Retention in particular is very significant - businesses want to keep customers around as long as they can, increase their customer lifetime value and, hopefully, get that customer to speak positively of the brand or product, which helps recruit other customers in. The train keeps rolling along.
It’s also a common refrain that retaining customers is more important than acquiring them. The common refrain around this is cost: in theory, once you have a customer, it costs less to keep them happy - and buying - than it does to go out and find a new customer. That takes advertising dollars, hours of time trying to determine the right channels and messages within those channels and adds up to much more effort than simply keeping your existing customers from churning. As we know, advertising can get pricey, particularly on social media.
But is that really the case? Which one should established businesses focus more on: acquisition or retention? Below is some evidence to help answer that question.
Which One Leads to More Profit: Acquisition or Retention?
The common refrain is that acquiring customers is far more expensive than retaining them. According to invesp, acquiring a new customer is five times more expensive than retaining an existing one. Based on just this alone, one could conclude that retention is much more important than acquisition, right?
Not so fast.
First, that 5X figure is a common refrain, but there really is no evidence to support it (that I have come across). The best I can tell, there was a survey done and the 5X figure came from that, but I have not seen the underlying data.
Even if we accept that figure though, there are still some flaws. If we think a little deeper into this, it’s important to retain the right type of customers. This is where the concept of customer lifetime value (CLV) comes in. Roughly defined, CLV is the total amount of value a customer provides over the course of their relationship with your brand. Practically, the formula is:
Note: The purely mathematical version of the formula includes the discount rate and annual margin, but for simplicity’s sake I used this infographic. For those wanting to dig into the math a little bit, this website does a good job of walking you through that.
Think about this scenario: You run a pay-for-television provider, such as Comcast. You could spend $10 each year to keep customer A, or $70 to acquire customer B. Customer A has been with your company for a year and will stay an additional three; Customer B would stay for a total of three years if you acquired them (for sake of argument, you did not spend money to acquire Customer A). If you acquire customer B, you then have to spend the $10 to retain them. So, you would spend $30 on customer A and $90 on customer B. Ignore other costs associated with these customers for this example.
Both customers stay with you for three years. Customer A has basic services with your company and the total money they spend with you is $500 over the course of the three years. Customer B has the same basic service, but they get some add-ons beyond it - maybe they add on high-speed internet, or sign up for HBO. Over the course of the three year relationship, Customer B spends $1000 with your brand.
To total it up, under this example you would make $470 over the course of the relationship with Customer A, and $910 with Customer B, despite paying significantly more to acquire customer B.
As a business owner, which customer would you rather have?
That’s why it’s important to consider the type of customer you are retaining or acquiring. Depending on the product, businesses want to deepen the relationship between brand and customer, whereby the customer not only repeats their purchases but expands their relationship with the company, perhaps through service add-ons in our example, or by purchasing different products from the same brand (for example, SC Johnson would be thrilled if people who bought Windex also bought Pledge).
What you don’t want as a brand are too many of the ‘cheapskate’ customers. These are the ones that you spend money to retain, but that basically purchase the minimum from your brand. Of course there will be a healthy portion of your customer base that fall under this bucket, but you really want the customers who are willing to deepen their relationship with your brand - even if you have to spend more to acquire them.
What About Churn and Loyalty?
Churn is an important consideration when it comes to how aggressive businesses should be in acquiring customers. No business retains 100% of its customers, but how many do they lose? According to Byron Sharp in his book How Brands Grow, brands lose customers in proportion to their market share. Essentially, larger brands will lose more customers than smaller ones - which makes sense, because they have more to lose in the first place. That makes replacing those customers critical for brands. They are out there, as this law applies to all brands (not just big ones).
In addition, Sharp raises another point in his book: when you examining brands of varying sizes, it is observed that while penetration rates will vary greatly depending on brand size, but the average purchase rates do not (he uses metrics gathered from market research agencies, such as Nielsen and TNS, to prove this out). While larger brands will have more customers than smaller brands, Sharp’s research shows that people will not buy more often from those brands than they do from smaller brands.
To show this, Sharp took a look at sales of shampoo brands in the United Kingdom. The largest brand, Head & Shoulders, had an 11% market share and an average purchase frequency of 2.3. The smallest brand, Vosene, had a 2% market share and an average purchase frequency of 1.7. So despite the differences in size, people were buying almost the same amount of shampoo.
The takeaway: loyalty does not vary much between brands. Sure, you may have some customers who buy from your brand consistently, but in terms of how much they purchase, studies show that it does not fluctuate greatly between brands of differing sizes. The products sold and the business model (transactional vs. contractual) do matter, of course, but generally speaking people do not purchase more frequently from larger brands than they do smaller ones.
Think about this point in conjunction with the earlier point about churn. We know that customer purchasing frequency is not going to be impacted, so even if a customer has bought from my brand for a long time, the frequency with which they purchase won’t change relative to other brands in my category. We also know that brands will lose customers in proportion with the size of their market share.
So knowing this, the question now becomes: will I increase my profits more if I focus on acquisition or retention?
Why Acquisition Matter More Than Retention
The very simple answer: there is more potential to grow profits through acquisition. An example helps make this clear: in your industry, brands gain half their yearly sales through existing customers; the other half through new customers. Your brand has a penetration rate of 2% of the market.
If you focus your efforts solely on retention, the lowest your churn rate can go is 0%. If you get it down that far, your brand would gain 50% of sales (because those customers otherwise would churn), which translates to growth of 1%. This does not take into account the actions you would have to take to retain these customers, or the costs associated with doing so. For example, you could offer discounts for customers to stay with your brand, which eats into CLV.
By contrast, putting all your energy into acquisition can yield much more fertile results. In this example, because half of the customers churn each year, 50 points of market share are available each year. While it’s possible for your brand to scoop up all 50 points of that, it’s very unlikely. In a more realistic scenario, let’s say your brand is emerging and gains 3 points of market share through acquisition. That’s 3 times more revenue your brand would bring in annually as compared to the best case scenario of retention.
In reality, businesses need to focus on both acquisition and retention. Retention is not meaningless, as happy customers can have an influence on prospective future customers, and there are plenty of good customers with the potential to deepen their relationship with your brand that you do want to work to retain. But based on the evidence, it’s a misnomer that brands should focus more of their efforts on retention - all the evidence points to acquisition being more vital for brands.
Oak Moon is a consulting agency based out of Columbus, OH that helps companies market their brands, define value propositions and uncover customer insights, among other services. If you are interested in hearing more or have questions or comments about this blog, feel free to reach out to me at firstname.lastname@example.org.