All right, we're back and now we're going to talk about customer retention.
And I hope you know where I'm going with this.
There's really two themes that we're going to see through all of these
discussions.
I'm going to begin by asking the same exact question that I asked about customer
acquisition which is, what metric do we use to gauge and
guide our retention activities?
And so, once again, there's a very common metric out there.
In fact, it goes by several different names.
Some companies call it a retention rate, some call it a churn rate or
an attrition rate.
Let's just explain what it is real quickly although,
you probably get the idea if you're not familiar with it already.
We look at all the customers we had, say at the beginning of the period.
We ask ourselves, how many of them stayed with us?
So what percent of that original chunk of customers stayed with us?
That's the retention rate.
Of course, we can look at what percent of customers left, and
that goes by different names, as I said.
A churn rate, or an attrition rate.
So either way, whether you look at the glass as half full or
half empty, it's that kind of metric that firms use to say,
how good a job are we doing at keeping our existing customers?
So again, very common metric and here's my view on it.
Unlike CPA, cost-per-acquisition, which I view as a very bad metric,
I see the retention rate, or the churn rate, as a pretty good metric.
But you have to be careful about how you look at it, how you use it, and
how you make decisions based on it.
So I'm going to start with a real world example.
One of the things that I like to do is I like to look at the information that
public companies put out there about their retention rates or their attrition rates.
What do they say about how many of their customers stick around?
And what implications does it have?
How do they manage around the attrition rate instead of viewing it as just a nice
to know number?
Let's understand how we can actually use that information to go all the way to even
coming up with the financial value of the entire customer base.
So here's the example that I'd like to work with.
The example comes from Vodafone, okay?
A big cell phone operator, I'm sure many of you are familiar with.
And they actually put statements out there to their investors to say,
here’s our attrition rate and here’s how it varies over time.
And so you can see the graphic right here.
And from a very kind of quick look, it appears that their attrition rate on
an annualized basis, as we look at it from one quarter to another, is around 20%.
Okay, a little bit lower, but around 20%.
So, let's think for a second about what that means.
Okay, so if we're losing around 20% of our customers at any given time,
how long do we expect those customers to stay with us?
It's a pretty simple math question.
Let me make it even simpler.
Suppose the attrition rate were 50%, okay.
Suppose we're losing half our customers every period, God forbid.
Then how long is a typical customer staying with us?
So if our attrition rate is 50%,
then a typical lifetime would be around two years, right?
So if the attrition rate's around 20%, the typical lifetime is around five years.
If it's a little bit less than 20%, it'll be a little bit greater than five years.
So if we want to come up with kind of a quick and
dirty valuation, not just for a given customer, but
for the entire customer base, if our attrition rate's a little under 20%,
that means the typical customer is with us for a little over five years.
We can multiply that by the amount of revenue per customer,
multiply that by the size of the customer base and boom, that's our customer equity.
That's the value of the firm.
At least, again, as a first pass approximation.
And I don't want to understate that.
There's a lot of companies out there that are doing exactly that kind of calculation
to figure out what their customers are worth.
So here’s my question.
What’s wrong with this picture?
And that sounds like a very nice calculation, right?
It’s great to see their attrition rate.
But what’s wrong with it?
What’s missing?
What is it that we really want to see?
I contend that it’s not enough to see their attrition rate for the customer base
as a whole, but what is it that we celebrate in a customer-centric world?
You got it.
We celebrate heterogeneity, right?
We don't want to just see a single number.
We don't want to say, what does the attrition rate look like for
an average customer?
because there is no average customer.
We want to know how that attrition rate,
how that attrition propensity, varies across the customers.
So here's what I want you to think about.
And this is a very, very important question.
How does the attrition propensity vary across the customers?
Just imagine, if we can reach into the mind of each and every customer and
pull out just how churn-prone or not churn-prone they are.
How likely they are to leave at any given time.
And we look at that, those numbers across the customer base.
What will that distribution look like?
Okay, will we tend to have a lot of very churn-prone customers or
will we have a lot of customers who tend to stick around for awhile?
Will it be kind of a nice bell-shaped normal distribution?
Who knows?
Well, I know, and you know, and I think it's a very important question.
So let me show you what it looks like for Vodafone, but before I do,
I want to emphasize to you that the figure you're about to see is actually very,
very typical.
This is the basic shape that we see for
almost all businesses, not just in telecommunications.
Not just for a phone company that primarily operates in Europe, but
for pretty much any company that operates on some kind of
contractual subscription basis.
And here's what it looks like.
Here is what the celebration of heterogeneity for Vodafone.
So, don't ask me where the numbers come from.
Again, it comes from, these are numbers that Vodafone calculated on their own, and
to their credit shared with their investors.
And they broke their customers base into three groups, and
they found that these three groups vary in terms of their churn or attrition rates.
They found that there's one real small group that has very high attrition rate.
So those are people who are very, very likely to leave at the next possible
opportunity, and then there's this middle sized, middle attrition group, and
then there's this largest group to the left that has a fairly low attrition rate.
So the first thing I want to ask you is is this good news or
bad news for Vodaphone and for most companies?
And the answer is yeah, it's pretty good news.
It suggests that most of the customers tend to stick around for
awhile and don't have a propensity to leave right away.
