Hearing loyalty marketing experts tout the value of customer loyalty can often feel like listening to a broken record. We get that customer loyalty is important. We get that high levels of loyalty directly drive company profits, and ultimately, long-term success. We understand that developing long-term relationships with a customer base, much like a constituency, is so very critical to success.
But behind all the heady rhetoric lies a rock solid core question that many business owners don’t really get: How much does it cost to lose a long-term client? After all, you can’t manage what you can’t measure.
Calculating the Ripple Effect
Losing a long-term client, or when a patron goes “inactive”, represents a significant loss – more significant than many proprietor’s may assume. Sure, lost customers and their financial contribution to a firm’s bottom line could, in theory, be made up for with new business and new customers.
But the cost of acquiring new customers, through marketing campaigns, promotions, and other new customer acquisition strategies, requires a significant outlay of money that will eat into what profit can be earned. Long-term patrons don’t require the kind of expensive upkeep required to acquire, retain, and ultimately convert newcomers into regulars.
Regulars are low maintenance, yet according to the “Pareto principle”, otherwise known as the 80/20 rule, they often contribute the most to a company’s total income. Furthermore, when a long-term client takes his or her business elsewhere, the dumped company forfeits more than just a single purchase, they also lose out on that client’s future purchases as well, leading to a ripple effect of loss over time.
In Thriving on Chaos, author Tom Peters suggests calculating the 10-year value of a firm’s clientele. By using this simple device to help quantify a customer’s future buying potential, business owners can begin to understand and appreciate the value of a customer (and why it would be beneficial to keep them coming back). So how does this work for a sub shop restaurant with a customer that dines once a week and spends $10 each visit?
Annual Customer Purchases * 10 Years = Rough Lifetime Value (LVT)
For example: $520 avg yearly spend * 10 years = $5,200 rough LVT
The problem is, most small shop owners would view this customer as a one-off $10 transaction, when in actuality this particular customer is worth $5,200. Interestingly, industries with repeat business like restaurants rarely track lifetime value, which is probably due to the fact they don’t have the data to track frequency and spend and identify high value customers, which is due to the fact that they do not have a loyalty program. The key take away here is that customers have a lifetime value (LTV), composed of many transactions that when viewed in sum, represent a much more significant amount of money than a simple, one-time purchase.
The customer and his or her future buying potential represents a huge appreciating asset for businesses. For example, a sub shop may do 2,000 transactions a month. Per the Pareto Rule, 20% or 400 on average dine there once a week, for a total of 1,600 transactions that month. Some of them dine more and some less, but you get the idea.
For many market sectors, losses resulting from poor customer loyalty don’t simply stop at lost direct sales. A disloyal customer may dissuade their friends and family from making purchases, greatly compounding the accrued losses a firm may suffer. A prospect worth $5,200 dollars over a decade may cost a business many times that depending on what kind of word of mouth business they bring (or turn away).
A dissatisfied customer will tell 8 to 10 others about their experience. 1 in 5 tell another twenty. Most American automakers are still wrestling with the ill effects of a bad PR ripple that has persisted for decades. As you can see, lost customers can, in some circumstances, start a chain-reaction of negative PR that can quickly become unmanageable. However, as we pointed out earlier, “you can’t manage what you can’t measure”.
So What’s Killing Loyalty?
A Rockefeller Foundation study found that the most common reasons formerly loyal customers chose to take their business elsewhere were as follows:
- 14 percent switched to the competition because complaints were not handled.
- 9 percent left simply because the competition offered a better deal.
- 9 percent ceased doing business because of geographical relocation.
However, the vast majority of respondents, 68 percent, claimed to have switched for “no special reason at all.”
What that means, suggests author Jill Griffin, is that most customers leave because of benign neglect. More than half the time, customers will not communicate their dissatisfaction; they will simply take their business elsewhere, leaving many businesses both confused and flustered. As it turns out, maintaining a long-term relationship with individual consumers requires constant attention and investment.
Invest in Good Customers
With the Pareto principle mentioned earlier in mind, it is important to note that sometimes it is actually okay to lose a bad customer. Companies should be worried about acquiring fairweather customers that will bale as soon as a promotion ends, or from a bottom line perspective, customers who become more expensive to retain than they are worth.
Most companies simply cannot afford to buy loyalty – at least not everyone’s loyalty. Nor should they. Rather, firms should focus on acquiring and investing in so-called “good customers”.
Good customers typically exhibit higher CLV’s, and higher levels of loyalty, yet require significantly less resources to retain. Unfortunately, many establishments make the mistake of dumping their entire marketing budgets into enticing new customers to make first-time purchases – a rather expensive strategy with questionable returns. Rather, by identifying and then cultivating long-term relationships, as opposed to short-term transactions, with high-CLV patrons, a business stands a much better chance of succeeding.
If you or your business is spending tons of money with little return in order to acquire new customers, you are probably going about it wrong. The goal isn’t to buy loyal customers, it’s to earn them, then keep them with constant investment and engagement.
One way to retain good customers is to reward them for their patronage. However, implementing an effective loyalty rewards system is challenging.