Customer Retention and Customer Lifetime Value

The national unemployment rate is 8.5% and in places like North Carolina, where I live even higher, 10.8%. (source: www.cnn.com/SPECIALS/2009/map.economy/index.html).

The new jobless claims rose to 640,000 and unemployment benefits topped 6.1 million. (source: www.necn.com/Boston/Business/2009/04/23/New-jobless-claims-top-640000/1240490384.html).

The new jobless faces are the young and old, rich and poor, educated and uneducated. The recession is throwing millions out of work, it could be your neighbor, it could be you.

In today's challenging economy and competitive business world, retaining your customers is critical to your success. You must give customers reasons to stay, otherwise your competitor with give them a reason to leave. Customer retention and satisfaction drive profits.

Though it is important to gain new customers, it is much less expensive to hold on to your existing customer base and up-sell more services/products to them.

A 2% increase in customer retention has the same effect on profits as cutting costs by 10%. The average company loses 10% of its customers each year. A 5% reduction in customer defection rate can increase profits by 25-125%, depending on the industry. (source: http://www.1000ventures.com/business_guide/crosscuttings/customer_retention.html).

Let’s say you have 1000 customers and you average $1000 per sale per year for each of those customers. That’s a total of $1,000,000 per year. Let’s assume your costs are 34% of sales. Studies have shown that across a random selection of industries, businesses lose on average 10% of their customers each year for an assortment of reasons, you are down to $900,000 per year instead of $1,000,000, since you've lost 100 customers.

Those 100 customers either (1% ) die, (3% ) move away, (5% ) leave because of a recommendation from a friend or relative, (9% ) leave because they perceive that another company has better products, services, or prices, and ( 14%) leave because they are dissatisfied with your product or service. That's 32% of the reasons they leave your business. The other 68% of the customers go somewhere else for some other reason, perhaps indifference or they feel taken for granted.

Let's assume your costs are 34% of sales. A 2% gain in retained customers or retained sales is $20,000 at 66% profit or 34% cost, which means a $13,200 profit increase of $660,000 to $673,200. Over 5 years that's a total of $100,000 gross revenue increase and $66,000 net profit increase. That's a net profit change over 5 years from $500,000 to $566,0000. These calculations only consider maintaining the 1000 customer level. So, a 2% gain in customer retention produces a profit increase of 13.2%.

Customer lifetime value is a way of measuring how much your customers are worth over the time they buy your products and services.

As marketing groups strive to gain a competitive advantage, more advanced quantitative and financial techniques are being implemented. One such technique, customer lifetime value (CLV), can provide marketers a multi-faceted view of the effects of marketing campaigns on customer revenue streams.

The future value of a contractual customer depends on the remaining lifetime of their products and the path of their future cash flows. Predicting customer value involves modeling the churn hazard as a function of tenure and other customer attributes. The mean, restricted mean, and median lifetime value are computed by scoring future time intervals with the hazard model.

By first building a churn model, the average lifetime estimate can easily be calculated and then applied to your financial data to calculate customer lifetime value (CLV).

Only trained statisticians should be used to develop customer retention models, customer satisfaction models, cross-sell and up-sell models, and customer lifetime value.

Statistical & Analytical Research Associates, LLC.