Focus on keeping your profitable customers
Written by Shirley Lichti for The Record, October 19, 2005

In his book, The Marketing Imagination, Harvard business professor Theodore Levitt wrote that the purpose of a business is to get and keep a customer. While customer retention is an important aspect of profitability, in truth, not all customers are worth keeping.

Anyone who has ever invested in financial markets knows the value of analysing the holdings in your portfolio to measure their return and determine their future potential. The goal for most people is to hang onto investments that are doing well and get rid of those that are underperforming.

Companies should learn to think of their customers as investments. The challenge is how to objectively assess their overall value to your organization.

Many companies focus on measuring revenues and profits at the product or service level. Unfortunately, this approach does not provide insights into which customers are generating those profits.

Another approach is to measure profitability at the customer level. However, past customer revenue is backward looking and does not paint a picture of future profitability.

Instead, companies need to focus on assessing customer lifetime value, that is, the net present value of all future streams of profit a customer generates over the life of his relationship with the business.

Two key drivers of customer lifetime value are acquisition costs and retention rates.

How much it costs to acquire a customer can vary dramatically across industries. For example, acquisition costs range between $50 to $75 for credit card companies to $100 for long distance phone service providers and between $100 to $250 for mortgage lenders.

For some companies, high acquisition costs can be justified against the length of term a customer stays with the firm. In the case of banks, once clients sign up for a mortgage, high switching costs means they are likely to remain customers for many years, bringing in far more revenue than the original cost of attracting them.

On the other hand, video rental companies operate in an environment where there are no real barriers to switching. When customers can easily move from one company to another, marketing programs with high acquisition costs tend to generate customers who are poor investments.

So it's important to understand how much you spend to attract new customers - the cost factors as well as the impact of the acquisitions.

Wooing new customers with price promotions may result in more business. But be careful to consider the big picture. You may run a cost-effective promotion but attract primarily people who are price sensitive. Retention rates may be low as these same customers flit to the next good deal offered by a competitor, creating high churn and negligible profits.

Studies indicate the average retention rate for U.S. companies is 80 per cent. That might sound pretty good until you look at the flip side. If you lose 20 per cent of your customers every year, your entire customer base turns over every five years. Factor in high customer acquisition costs and the picture becomes grim.

In the life insurance industry companies actually lose money in the first few years after a new policy is written due to high acquisition costs. As a result, there is a huge focus on retention.

In the past, the bulk of commissions were paid to agents in the first year of the policy. However, with a multi-year return on investment, some life insurance companies changed their compensation approach to equalize commissions paid out over a longer period of time.

While it was important to acquire new business, it was even more important to keep customers for the long term.

Customer turnover in the mobile telecommunications industry tends to be high.

According to one customer relationship management study, Bell Canada has done a good job of identifying customers at risk of defection and enticing them to stay. Its monthly churn is only 1.5%, the best in the industry. If the entire U.S. wireless industry could achieve the same results, it would add between $1.5-2 billion in annual operating profit.

Although your organization may not have quite so much at stake, determining customer acquisition costs and retention rates is beneficial. Customer lifetime value analysis gives you insights into which customers to keep and helps you to better manage them as investments.

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