Repeat customers are the most valuable resource for your business in the long run.
Many businesses looking at how to spend their marketing budget ask themselves whether acquisition or customer retention marketing makes more sense as an investment. For long term success, this is not a difficult decision. Here’s how to think about the value of customer retention marketing and how it drives long-term business success.
Economics of customer retention marketing
Companies obsess over attracting new customers. Makes sense, as new businesses can’t make money until their first customer walks in the door. That’s why we have everything from pay-per-click to TV ads, free samples, neon signs, and 50%-off incentives. They’re all tactics used to draw in new consumers who otherwise would not have made a purchase.
But is newer always better? (In short, “No.”) Regardless of industry, a minority of customers drive the majority of revenue. There are no exceptions. While customer acquisition gets a business off the ground, customer retention ensures long-term success. That’s why Bain & Company and Harvard Business School state that a 5% increase in customer retention can increase a business’s profits by as much as 95%.
Why does retention have such a dramatic impact? Three main reasons:
- Higher spend: according to Small Business Trends, customers spend less on their first purchase because they see new brands as “risky.” After building a relationship, customer spend grows alongside trust.
- Better value: customer retention marketing is more cost effective than customer acquisition.
- Better word-of-mouth: retained customers are more powerful sources of referral business. A Bain & Company strategy brief reported that, on average, a first-time apparel shopper refers three people. After 10 purchases, that same shopper refers seven customers.
Economics of coupon marketing
A good way to understand customer acquisition versus retention marketing is walking through a business case for coupons. Let’s start with the basic calculus: merchants offer a discounted product/service to acquire a customer who would not have otherwise entered their store. After accounting for cost of goods sold, the merchant makes a small profit on each purchase. Let’s assume an average check size of $20 with a 50%-off coupon and 30% COGS:
Sweet – start printing those coupons, right? Well, don’t forget about margin. Even the most profitable businesses boast only 25% margins, which paints a different picture (and also factored in to the troubling daily deal economics, as provider revenues ate in to already slim merchant profits):
Clearly, in order to make money with this form of customer acquisition marketing, merchants have to rely on other factors. Fortunately, customers who come in with a coupon may see a complimentary item they want to buy. Moreover, customers who have a good experience refer others. Keeping our assumptions consistent, businesses with the best referral programs in the world (50%) and 45% overspend essentially break even:
However, businesses still have two more costs to consider: marketing the coupons (not all coupons are redeemed) and the risk of cannibalization (i.e. where customers who would have paid full price use a coupon):
To recap, a company with the best profit margin and referral rate in the world still has trouble seeing a positive ROI. Why? We’ve only considered customer acquisition. As described, businesses rely on customer retention to see a positive return. Let’s assume that half our coupon and referral customers come back once (fair considering some will return multiple times), in addition to all eight cannibals.
Now we’re getting somewhere. If you’ve been tracking our decision metrics, you’ll notice a healthy-looking customer lifetime value and positive ROI once we this business started driving repeat customers. And that’s the goal of all of this marketing stuff, right?
Revenue Is Revenue
Some marketers can get stuck evaluating what investments to make. Here’s what I would recommend: focus on increasing revenue as much as possible. Given that repeat and new customers both spend money, determine whether you can increase revenue more dramatically (and more cost effectively) by allocating budget to retention or acquisition inititiaves. For my money, with less investment required, marketers will see dramatically higher returns when they focus on making sure those who visit come back and those who come back have as rewarding an experience as possible. A one-time customer, no matter how profitable, will never be more valuable than those who continue showing up.
Just for the Kleptones, let’s see what a 5% increase in retenton for our (admitedly crude) example would yield:
Hmm, an 80% increase in profit. Maybe those Bain guys really do know what they’re talking about.