The “Magic Number” in Measuring Retention

Most direct marketing and database marketing programs are designed to accomplish one or more of only three basic business objectives; acquiring new customers, retaining existing customers, or cross-selling.

Measuring return on investment for customer acquisition is a fairly straightforward exercise.  Most businesses have a reasonably good idea what kind of revenue a new customer will generate in a year, and they know how much profit that revenue will create. Comparing that margin to the cost of promotion yields a customer acquisition cost.  If the margin is greater than the cost, the effort was profitable. Quite often it isn’t profitable, because the cost of acquiring the customer is a lot higher than the expected first-year revenue, which makes retention and cross-selling a critically important objective. Some companies actually don’t expect a customer relationship return a profit until the customer has been on the books for several years.

Measuring ROI on existing customer programs is somewhat more complex:

First, retention and cross-selling efforts are complementary, especially in multi-contact or continuity programs. In order to determine the effect of one, the calculation really needs to include both.  Cross-selling programs that increase the number of purchases or relationships that a customer has will always have a positive effect on retention. Conversely, retention efforts will always create opportunities to increase the depth of the relationship through cross-selling.

The retention calculation should recognize the fact that lost customers have to be replaced. For some reason, no one ever seems to include the cost of replacing lost customers in the ROI calculation for retention programs, but unless your objective is to have fewer customers at the end of this year than you had at the end of last year, you should include it.

Customer replacement cost is the “magic number” that makes retention ROI calculations work. It’s a real cost, and it almost always has a significant impact on the metrics. 

Written by Richard N. Tooker, VP - Solutions Architect at KnowledgeBase Marketing