Lost Customer Cost = Lost Customer's Revenue* + Cost of New Customer Acquisition
Companies that ignore this basic fact have a tendency toward lower profits, overspending on marketing to attract new Customers, and acquire new Customers that have a lower revenue value than lost Customers. The end result is often failure of the business.
The true value of a given Customer is not determined by their most recent purchase or payment, despite the fact that salespeople (and, all too often, their managers) have a tendency to think this way. A Customer's true value is the revenue that they produce over the lifetime of their account, less any costs associated with that account (overhead, discounts, commissions or bonuses, entertainment, etc.).**
The cost of each new Customer acquisition is the total amount that your organization spends on marketing each year divided by the annual response rate (that is, how many Customers purchase from you vs. how many you sent your marketing material to).
New Customer Acquisition Cost = Total Annual Marketing Costs/Annual Response Rate
Let's say that you put out a catalog 4 times a year, and that the cost of each issue (production + mailing) is $2.50. If 2% of the people that you send your catalog to order from you (a reasonable response rate), your cost to acquire a new Customer is $500 per Customer. (This same formula can be applied to radio, TV, Google Adwords, social media campaigns, etc.)
($2.50 x 4)/.02 = $500.00
Now let's say that your average Customer spends $200 per year with you, and that it takes you an average of 6 months (or half a year) to acquire a new Customer. In that case, each lost Customer costs you $600.
($200 x .50) + $500 = $600.00
If you keep your Customer retention rate at 80% or per year - considered a reasonable metric, in many circles - you still have to replace 20% of your Customers each year just to stand still.
Let's say you have 1,000 customers. That's 200 customers at $600 each that you have to replace - $120,000 right off the bottom line - each and every year.
You might as well set your money on fire.
Some organizations respond to this pressure by raising prices for those Customers who remained loyal. This is like taxing your Customers for doing business with you instead of your competitors. Your competitors will love you, of course, but they'll be alone. Unfortunately, so will you.
At this point, you have essentially burned your business to the ground.
Let's consider an alternative: Suppose you took 1/4 of the money that you normally spend on replacing lost Customers and applied it to Customer retention. Spread across your 1,000 customers, that $30,000 could go a long way, and at a cost of just $3 per Customer. And each Customer that it saves also saves you $600. So what do you do with that $30,000?
Here are some ideas (I'm sure you can think of more):
- Give loyal Customers a discount on any orders above their traditional spend.
- Award bonuses to sales and/or support staff who surpass a certain retention rate with their assigned Customers. (Make it a stretch - the money it saves is yours.)
- If you like team-building, create a team-based contest with an overall retention goal. The team that beats the goal by the largest percentage gets a dinner on you, an extra paid day off (everyone loves these, and they cost you virtually nothing), a trip, etc. It all depends on your budget.
- Whoever collects the most Customer referrals or positive quotes that can be used for marketing (such as on your website) receives free tickets to a show or sports event of their choice.
- The employee with the highest retention rate for the year receives formal recognition from the entire company. President's Club, if your organization has such a thing, and the full deal, not some watered-down version (remember, this person likely saved you more money than your best salesperson made for you).
* The figure for your lost Customer's revenue is the revenue they would have generated during the period until you find another Customer to replace them whose annual revenue equals or exceeds the annual revenue produced by the lost Customer.
** Harvard Business School Publishing has an excellent Flash-based tool to calculate this.