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Chapter 3 How to grow your customer base

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These posts are a collection of notes and summaries from the book “How Brands Grow: What marketers don’t know” by professor Byron Sharp. This work is a must read for any marketer. My personal goal when I embarked on this series of posts was to get a deeper understanding of the book and its lessons, and as I have worked through them I have not only gained that understanding, but also an idea of the areas I need to investigate more deeply in the future. Sharp is always very insightful, but I feel the need for more perspectives on many of the topics he covers. You can buy How Brands Grow here.

In the past I was super enthusiastic about the concept of retention, and I will not change my position about its importance, but after some things clicked into place while reading this chapter, I have assumed a more rounded position.

In the past I was super enthusiastic about the concept of retention. 

It is one of the key marketing aspects of digital business, especially digital platforms like Facebook, Instagram, TikTok or Snapchat.

However, after reading the third chapter of “How brands grow”, I have assumed a more rounded position, because the one-size-fit-all metric doesn’t exist.

Literally, I was one of the most zealous about the quote “it costs five times as much to win a new customer as it does to stop one leaving”

Guess what? 

“There is no empirical evidence to support this idea”

This revelation comes from the book.

It was just mind blowing for me. 

So basically, a probable genesis for the “5 times quote” is one of the most cited Harvard Business Review articles by Reichheld and Sasser (1990) (you can find here).

The article states that:

customer retention can have a “surprisingly powerful impact on the bottom line… companies can boost profits by almost 100% by retaining just 5% more of their customers. “

The article is based on a hypothetical situation:

“Suppose a credit card company loses 10% of its customer each year, then the average customer life would be 10 years*. Now if that firm were able to reduce its annual customer defection to 5% then the average customer tenure would double to 20 years. Given that a customer delivers some profits each year, now (when) they stay for more years, they must each give more.”

On this point, I agree with B. Sharp that Reichheld and Sasser ’s position is misleading because:

  • A 5% drop in churn is 5 percentage points reduction, to reduce by 5 percentage points you have to reduce churn by 50% 
  • They didn’t take into account the cost for reducing retention. These activities are not free, this means that they were talking specifically of customer profitability and not on company profitability

I think this was my epiphany: I never scrutinised the cost of churn reduction strategies

And it is true they are not free.

Is the cost worth the game?

I don’t know and I am not sure there is one single answer (that is) suitable for all industries. 

It is worth noting that churn is also affected by the “Double Jeopardy Law”:

“All brands lose some buyers; speaking, this loss is proportional to their market share.

Big brands lose more customers, though these lost customers represent a smaller proportion of their total customer base”

This thesis is confirmed through a simplified example.

We have a market with 1000 customers that has only two brands.

The first with 20% market share (200 customers) and the second with a 80% market share(800 customers).

Each brand maintains the respective share of customers.

It follows that brand’s defections and acquisitions are equal. 

We can suppose that both lose and gain 100 customers, it means for the first one that the defection and acquisition level is 50% (100 divided by 200) while for the second one is just 12.5%  (100 divided by 800).

Well, for me it is natural to pause, dig into the data, and ask why a small brand has such a high churn and also such a good acquisition? And if there is such a high churn what can be the reason? (Maybe there is a discontinuity in distribution? Anything else?).

Saying that that “losses and gains” in absolute value are the same for the two brands it seems to me a very strong hypothesis.

And it is not strange that also the author says things are more complicated.

Back to the book, the author, never says explicitly that retention is not important, but he highlight that: 

  • Customer churn is largely outside of marketer control in particular through “customer service and other initiatives”
  • Growth is driven by extraordinary acquisition, decline is caused by dismal acquisition 

After reading these points I started a very curious exercise. 

I started thinking about each time I had or hadn’t switched a product or a service and why I made that choice. I like to switch FMCG products like toothpaste or deodorant quite often, while for others like my Greek yoghurt I am definitely more a creature of habit.

The previous points defined by the author are supported with data he provides.

The industries the author uses for his thesis are automotive and classical bank services. 

I don’t know how this analysis changes talking about other industries or product like:

  • Travel, here I am thinking of Avios point for example when you chose your flight and how they can improve retention
  • Digital, I am thinking to all the strategies implemented to get back again a user when he stops using a specific App
  • New Products, the book seems focused on mature established products and not on new products. Which also makes sense if there is a need to generalise. 

While on the first point, about what the marketer can and can’t do, for now I don’t have anything to add to the discussion.

I can add something on the second point “Growth is driven by extraordinary acquisition”.

I already talked about retention in this blog here.

In the post I showed through a mathematical demonstration how, given a product or service, fixed retention and acquisition costs, after an initial growth the product would reach a plateau.

So once we reached the plateau (or saturation) if we want to increase our customer base, without changing the marketing budget, we have two paths:

  • We work to reduce acquisition cost
  • We work to reduce churn rate

Both involve resources, efforts and a trade-off should be made. 

Switching the focus from FMCG and physical products to subscription services (gym/credit card) or to digital services in general, it is natural for me to think in terms of Customer Lifetime Value.

The Customer Lifetime Value is an estimate of the net profit contributed to the future relationship with a customer.

Based on that, through specific activities like special coupons or introducing new products or anything else how can a marketer increase Customer Lifetime Value? 

Obviously, I am not supposing that the customer will be forever loyal to my brand, but at least I want to understand how I can increase the revenue from a customer. 

To do that there is a basic equation:

LTV1 > CAC1 

Based on customer retention activities and their cost (CRC = Customer Retention Costs) I would like to update the previous equation adding another variable as follow:

LTV2(LTV1 + Customer Extended Life Through Retention Activities) > CAC + CRC

Commercially the retention strategy will work and makes sense if 

Customer Extended Life Through Retention Activities > CRC1

To wrap up, independently from the specific industry, retention and acquisition are two key marketing metrics. 

In both cases each experiment should be tracked, evaluated and, most importantly, related to sales.

After that, based on the specific product and industry the marketer should be able to identify his north star and align the team consequently.

See you for the next chapter! 

Andrea 

* Recalling the exponential decay properties, the reciprocal of Churn rate is the average Customer Lifetime

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