Customer Retention: The Quiet, Potent Driver of Customer Lifetime Value
Smart investors love compound interest–the longer they can hold onto an asset, the more valuable their portfolio becomes. The same is true in business: Smart companies that are able to retain customers will see a similar compounding effect on the lifetime value of their customers.
Customer lifetime value (CLV) is a measure of the present value of all future cash flows attributed to a customer relationship. As I noted in an article late last year, recent research indicates 47 percent of companies find measuring CLV essential to their business strategy. As you’d expect, strategic CLV users significantly outperform nonstrategic users.
To appreciate the impact of customer retention on CLV, it’s important to understand CLV’s four core elements–revenue, support costs, length of customer relationship and customer acquisition cost–and the relationship between them.
Interestingly, that impact can cut both ways, positive and negative. For example, if customers perceive new self-service tools to be cumbersome or they balk at being driven to an offshore contact center where language becomes a barrier to service, your focus on reducing customer acquisition or support costs could backfire by diminishing the customer experience. Any cost savings could be negated as dissatisfied customers move on to another provider.
Now consider the positive, compounding impact of customer retention on CLV:
- As customers stay longer they spend more (revenue)
- Their support requirements decline through familiarity (cost of support)
- Acquisition costs amortize over a longer period of time, reducing their impact (length of customer relationship)
- As longtime customers advocate for you, they can become your greatest marketing asset, actively helping you win new customers (acquisition cost)
Let’s take a look at these dynamics in action:
Widget Universe is a fictitious technology company with 250,000 customers. Last year, their customer retention rate was 68 percent. Average annual revenue per customer is $1,000, and gross margin on revenue is 50 percent. Annual support cost is $100 per customer. Average length of customer relationship is 3.13 years. And acquisition costs average $500 per customer. Using the CLV formula, the average CLV per customer comes to $750, measured on a gross margin basis.
This year, Widget Universe implements a new customer engagement solution that helps raise customer retention from 68 percent to 70 percent. Average annual revenue per customer stays the same, as does support and acquisition costs. However, because of the retention rate increase, the average length of the customer relationship grows to 3.33 years. As a result, average CLV per customer increases to $833, an $83 increase (see nearby figure).
That doesn’t sound like much, does it? Until you apply it across the Widget Universe’s customer base. Just a modest 2 percent increase in customer retention, applied to the customer base of 250,000 people, translates into a nearly $20 million increase in CLV!
Although this CLV increase can’t be banked today (it will occur over several years), Widget Universe did see approximately $5 million in retained revenue increase in the year after the retention increase. That is revenue that would otherwise have been lost to customer defections and attrition.
How much can an increase in customer retention contribute to CLV in your organization? This self-assessment tool on avaya.com can help you explore the potential impact of CLV’s four variables on your organization. I encourage you to take the tool for a spin. And, if you’re interested, we’d be happy to discuss how you can positively impact those components to drive higher CLV. The return on your time could be astounding.