Definition:

Customer retention is the activity an organization takes to reduce the number of customers it loses over time. Though the strategies for customer retention vary greatly, there are commonalities that successful organizations share. Marketing experts point out a strong correlation between the existing customer experience and its ability to attract new customers.

In today’s marketplace, customer retention is about exceeding expectations in an effort to turn customers into loyal brand advocates. By creating customer loyalty programs, organizations place the long term value ahead of the short term maximization of profits.

One of the key differentiating factors in a competitive market is often a high standard of service among existing customers. Extending that high standard of service to customer facing employees has shown even greater returns. Recent research indicates that engaged customers generate 1.7 times more revenue than normal customers, while having engaged employees and engaged customers returns a revenue gain of 3.4 times the average1.


The Value of a Lost Customer:

Steps to determine the opportunity cost of losing a customer forever -

  1. Forecast remaining customer lifetime in years
  2. Forecast of future net revenues year-by-year, based on estimation of future products purchased and price paid
  3. Calculate the NPV of future amounts


Inputs to Determine Customer Value:

Retention rate is the percentage of customers who continue their relationship with a company in a given period. The retention rate has a tendency to change over the life of the product.

Retention cost is the amount of money a company has to spend in a given period to retain its existing customers. Examples of retention costs include billing, customer support, and promotional programs aimed at brand loyalty.

Customer lifetime value is a multi-period calculation, normally 3–7 years into the future depending on the lifespan of the product and the nature of the industry. In reality, evaluation beyond this point is generally viewed as too speculative to be reliable due to changes in the product lifecycle and the market.


Mathematics:

To determine customer retention value one must first determine customer lifetime value and assume that CLV also represents the opportunity cost of losing the customer permanently:

CLV

Where:

• CLV = Customer Lifetime Value

• GC = Gross contribution per customer

n = Time horizon

r = Yearly retention rate

d = Yearly discount rate

i = Number of periods


Advantages:

• There are zero customer acquisition costs, though this is partially offset by retention costs such as customer support, promotional incentives and so on.

• Core competencies: Unless an organization is in the business of generating sales leads, finding new customers is not its core competency. Retaining existing customers allows firms to focus on what they know best


Disadvantages:

• Traditional customer retention strategy ignores the possibility of new technologies and external shifts in the marketplace.


References:

• [1] John H. Fleming PhD, Jim Asplund, (2007) “Human Sigma: Managing the Employee-Customer Encounter”, Gallup Press

• Stephanie Coyles, Timothy C. Gokey “Customer Retention is not Enough” The McKinsey Quarterly, 2002 Number 2, pp. 80–89