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This article was originally published on Graham Weaver’s blog.
By Graham Weaver, Founder and CEO, Alpine Investors
In my experience serving on over 50 boards, I have observed that management teams expend tremendous time and energy discussing acquiring new customers. Meeting agendas are filled with updates on marketing initiatives, sales hires, new annual recurring revenue (ARR) added, new business development targets, and the like. Little, if any, conversation centers on how the company is working to retain and grow its existing customers.
I have realized that boards and management teams often focus on precisely the wrong side of the revenue equation. Truly great companies are not defined by how many new customers they acquire but rather by how well they serve, delight, and retain their existing customers.
Truly great companies are not defined by how many new customers they acquire but rather by how well they serve, delight, and retain their existing customers.
The Bottom of the Bucket
Consider the following illustration of a bucket. New customers are represented by water flowing into the top of the bucket, with the hose representing all the initiatives we undertake to add those new customers. The holes in the bottom of the bucket represent lost customers (or customer churn). The water level at any time represents the revenue of the company, and the caulk gun at the bottom represents efforts to retain and grow existing customers.
Over my 28 years in private equity, I have learned that while we exhaust ourselves (and sometimes our entire organizations) tinkering with filling the bucket from the top, we often forget to patch the holes, and our customers can quickly seep out of the bottom. It has become clear to me that customer acquisition is actually the second most important part of the revenue picture.
True greatness comes from the bottom of the bucket.
Consider two different companies. One focuses on customer acquisition (AcquireCo) and the other focuses on customer retention (RetainCo).
- AcquireCo adds 20% more new customers per year and retains 85% of its customers (including newly added customers) annually.
- RetainCo adds only 10% more new customers per year but retains 95% of its customers (including newly added customers) annually.
On the surface, it may seem like these companies would grow at similar rates. But let’s look a little deeper:
- RetainCo will have 27% more revenue than AcquireCo after 10 years.
- This is true because even though both are adding a net 5% new customers, RetainCo retains its new customers at a significantly higher rate than AcquireCo.
- RetainCo will be able to pay more for new customers in the long run.
- Since RetainCo has higher customer retention, a customer of a similar size will have twice the lifetime value to RetainCo than the same customer would have at AcquireCo over 20 years. Over time, RetainCo can therefore outspend AcquireCo at the customer acquisition game.
- RetainCo will be significantly more profitable than AcquireCo in the long run.
- Adding new customers is expensive — requiring companies to spend money on marketing, customer onboarding, and sales commissions. In the model above, RetainCo is spending half the money on new customer growth that AcquireCo would need to spend.
- RetainCo will build a better brand and reputation than AcquireCo.
- As evidenced by their higher retention, customers are simply having a better customer experience with RetainCo. This will translate into the company’s brand, word-of-mouth advertising, and ultimately even RetainCo’s employee happiness and satisfaction, as employees often gain fulfillment by serving customers well.
All things considered, RetainCo will ultimately win not just the retention game, but it will eventually win the customer acquisition game as well.
Several years ago, I dug through the one-page plans of each of Alpine’s portfolio companies. Comparing the number of initiatives focused on adding new customers (the hose/top of the bucket) versus those retaining and growing existing customers (the caulk gun/bottom of the bucket), I found the mix was roughly 70% to 30% in favor of initiatives to add customers. That ratio wasn’t surprising, but I would argue it should be inverted.
Here are a few suggestions on how to patch the bottom of the bucket:
Hold people accountable for customer satisfaction.
In the early 1990s, Andy Taylor, then CEO of Enterprise Rent-A-Car (Enterprise), found that 90% of referrals came from people who rated Enterprise a 5 out of 5 on customer reviews. Knowing this, Enterprise created a single-question survey asking customers to rate their likelihood of referring Enterprise to a friend on a scale of 1-5 (the beginning of the Net Promoter Score (NPS)). Then they started publishing this data for all locations and promoting managers based on their scores. Over the coming decade, Enterprise became the fastest growing — and ultimately the largest — car rental company in the world with over 9,500 car rental locations in more than 100 countries.
Increase “stickiness” with your customers.
Invest time and energy in transforming episodic purchases into ongoing relationships with your customers. Airlines use frequent flier programs, car washes give a free wash after five washes, HVAC companies offer routine cleaning and upkeep for an annual fee, and Costco requires an annual membership. Amazon Prime customers spend 230% more than non members.
Solve problems your customers hate.
As Yogi Berra said, “You can observe a lot by watching.” If you regularly survey your customers, they will tell you what they dislike. Netflix famously learned that its customers’ biggest pain point was late fees when renting movies from Blockbuster, so they launched a DVD-delivery service that never charged late fees. Uber solved the customer’s problem of calling, tracking, and waiting for a taxi with an app. Often the needed fixes are much less groundbreaking — a tweak to the customer onboarding process or a slight change in part of the customer journey can be transformative.
Find small ways to inspire customers to say, “Wow!”
I remember visiting a fast-growing plumbing company that spent almost nothing on marketing. As I looked closer, I learned they required each technician to put covers on their boots to avoid tracking mud into customers’ homes. After fixing the repair they had been hired for, the company encouraged the plumber to look for a “wow factor” — something the technician would find and fix for free — like a leaky shower head or a slow-draining sink. These tiny practices cost almost nothing, and yet they caused customers to remember the company and refer it to their friends.
Push down decision rights.
Customers and employees — and people in general — hate red tape. Nordstrom famously gave cashiers individual authority to fix any problem less than $100 with no approvals — just using their discretion. This not only improved customer satisfaction, but also increased employee satisfaction, as employees felt empowered and like they could “win.”
Invest money in customer retention.
Early in its history, Amazon spent significant dollars on customer acquisition. Its leaders then ran an experiment where they reallocated some of the money the company was spending on advertising (customer acquisition) into offering customers free shipping (customer retention). This move eliminated a barrier (that previously held customers back from doing business with Amazon) and reduced customer acquisition costs. The rest is history.
Building Your Own RetainCo
Increasing customer retention is one of the few “silver bullets” in business, but it typically requires top leaders to change their mindsets — and ultimately change practices and compensation systems.
Mapping out the entire customer journey for your business — breaking it down into as many detailed steps as possible — is a simple step that can have a huge payoff. Once you identify the steps in the journey, find ways to hold people accountable for customer satisfaction, increase stickiness, have the customer say “wow,” push down decision rights, and invest in customer retention.
Building RetainCo is not only the formula for a much larger and more profitable business, it is also the formula for building a better, more durable company with a wider moat. Ultimately, RetainCo is a company where employees will enjoy working and customers will come back again and again. So, instead of instinctively reaching for the water hose, consider patching the bottom of the bucket — you might soon find it overflowing.