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The Financial Cost of Poor Customer Retention
By Barry R. Schimel CPA, Gary R. Kravitz
Copyright, The Profit Advisors, Inc.
Businesses will use a number of variables to gauge their success between periods. Among the most popular key indicators are total sales and the number of items sold. It is possible that gains made in both of these categories are masking severe problems. From one year to the next, most firms will gain and lose a number of customers. Also, there will be changes in individual customer activity. More potent measures are customer retention percentages and changes in individual customer performance.
A 5% swing in customer retention can have a profound impact on your firm’s profitability. Consider these two scenarios.
Company A has a base of 100 customers. Their average volume per customer is $5,000 per year with sales equaling $500,000. Annually, they retain 95% of their existing customers, and they are able to gain 10% new ones. For planning purposes, they are assuming a 3% yearly price increase. After 14 years, their total number of customers will have doubled and their sales will have grown by 291%.
Company B also has a base of 100 customers. Their average volume per customer and sales are the same as above. Annually, they retain 90% of their existing customers, and they have the same 10% growth of new accounts. They are also forecasting a 3% annual price increase. After 14 years, their total number of customers will remain at 100 and their sales will have grown by 47%. A 5% difference in customer retention will cause a significant variance in the financial performance of both firms. As long as there is a 5% difference in retention levels, these numbers will remain constant for any customer retention percentage. The accompanying chart illustrates this phenomenon.
As you analyze your business, the key question is, “Why do customers leave?”
If they still have a need and are buying from someone else a product that you provide, the value of purchasing from your firm has been lost. It is easy to place blame on your competition. We commonly hear that a customer was lost because someone else was cheaper. Sometimes this is true, but in many cases, the money paid was not equal to their expectations.
To understand the cause of loss of value, imagine this simplistic example. You have been going into the “Corner Hot Dog Shop” once a month for years, because the food and the service have been at a consistently high level and the price is competitive. Two years ago, the “Downtown Hot Dog Shop” opened up nearby, but you were a totally satisfied customer and did not see any reason to go elsewhere.
Over the last six month, things began to change, and your satisfaction with your present hot dog purveyor gradually declined. Here is a list of occurrences:
- The parking lot was littered
- You waited too long in line
- The cashier couldn’t make the right change
- The condiment stand was not fully supplied
- They were out of strawberry milkshakes
- The counter person’s uniform was really dirty
These events did not happen all at once. During each monthly visit, you experienced one of them. The hot dog always tasted great, but the overall satisfaction was no longer there.
It is now hot dog purchasing day in the seventh month. That morning, you happen to see a coupon in the newspaper from the “Downtown Hot Dog Shop” offering a 10% lunch discount. You decide to try them out and discover that the food is OK, the service is comparable and overall their prices are cheaper than the original shop. Next month, you change your hot dog shop allegiance.
The “Corner Hot Dog Shop” is seeing a downturn in their business. Which is the major cause, cheaper competition or the loss of value? Just by them having the best product does not guarantee success. To evaluate the value-creating portion of your business, you must focus on all activities that touch a customer. Each one of these exchanges has the capacity to build or destroy a long-term relationship.
The financial ramifications of retaining an additional 5% of lost customers are enormous. Being able to identify and initiate fixes to aspects of your business that lessen total customer satisfaction is a central part of The Profit Enhancement Process. Our diagnostic tools and process of heightening employee awareness of customer retention can help you to increase your bottom line.
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