‘What’s the truth about the profitability of customer retention?’

Q: Some three years ago, our son’s MBA professor told his class that research has shown that if a company is able to raise its customer retention by 5 percent, this will lead to a profitability increase of at least 35 percent and even to at most 95 percent. In a recent seminar conducted by a popular entrepreneur we heard this same proposition.

For three years now since our son told us about this idea of raising profitability by improving customer retention, we have persisted in implementing a customer retention program consisting of periodic customer reminders, discount coupons, surprise gifts, lottery and contests, and similar other promo events and activities.

We’ve done and are doing all these in our chain of four carinderias and another chain of laundry services outlets.

But not even once have we experienced a 35-percent profitability increase from a 5 percent and even a 10 percent to 15 percent improvement in customer retention in our two service chains.

When we mentioned our case at the recent seminar by an entrepreneur speaker, we did not get an explanation.  Instead, the speaker told us to check our retention and profitability “metrics.”  We explained to the speaker that it was our son who developed the needed “metrics” because he’s a CPA and an MBA graduate.  The speaker excused himself to turn to some other seminar attendees.

Will you help us by at least giving us your comments on what we may have done wrong?

A: Let the latest and better truth be told and known!  Our emphasis is on the words “latest” and “better.”

In many Friday columns, when we wrote about the issue of customer loyalty programs, we mentioned this relationship between customer retention and profitability. But we did not elaborate because our concern then was only about customer retention and its role as the stepping stone to customer loyalty.

So now, we tackle your question about what you may have done wrong in your quest for higher profitability via improving customer retention.  May we say outright that we do not believe you’ve done anything really wrong. This is because your basis for raising profitability via improved customer retention is not “the latest and better” truth about the customer retention and profitability relationship.

We start with what’s the “latest truth.”  But what’s the “old truth” in the first place?  What research was this highly seductive 5 percent-retention-improvement-leading-to-the-35 percent-profit-rise proposition based on?

The source is a generation old or to be exact, a 22-year-old Harvard Business Review article.  The title of the article is just as seductive as its proposition, namely,    “Zero Defection: Quality Comes to Service.”  The two authors were the highly respected Bain & Company “emeritus director,” Frederick Reichheld, and the reputable Harvard Business School professor, W. Earl Sasser.

Doubtless, it was because of the authors’ reputation and because it was the very influential Harvard Business Review who was the publisher that the article became an instant hit.  Its prescription found widespread and immediate adoption especially among service company businessmen.  In fact, the Senior MRx-er used the article as his framework in helping Meralco in the ’90s develop and manage its subscriber satisfaction program.

But the article’s research basis was not an original research by Reichheld and Sasser. They borrowed the research on “the Experience Curve” of Bruce Henderson’s Boston Consulting Group (BCG) of the 1960s.  The impressive volume of BCG research on the experience curve across a wide range of manufacturing industries consistently led to the same kind of proposition that Reichheld and Sasser applied in the service sector.  Irrespective of this research-borrowing admission from Reichheld and Sasser, nobody challenged the relevance of the retention-profitability proposition to the service industry.

This was true until 2000 or 10 years after.  In the October 2000 issue of the Journal of Marketing, two INSEAD professors, Werner Reinartz and V. Kumar, published the results of their research under the title, “On the Profitability of Long-Life Customers in a Noncontractual Selling: an Empirical Investigation and Implications for Marketing.”  The Reinartz and Kumar research gave “the better truth.”

Then the final challenge came in 2005 when two Columbia University marketing professors, Sunil Gupta and Donald Lehmann, published their definitive research in the book, Managing Customers as Investments: The Strategic Value of Customers in the Long-Run.  The Columbia University book came out with “the latest and better truth.”  Its reported original and impressive research series found this: “A 1 percent improvement in customer retention will lead to a profit increase of at least 3.5 percent to at most 5.1 percent.”

So there’s your “latest and better” truth about the customer retention and profitability relationship.  This latest and better truth is our basis for saying that we do not believe you’ve done anything really wrong.  Our MRx to you is simple.  Keep up with the latest research on any important marketing issue like this retention and profitability relationship. It may also be good to share this MRx with your son’s MBA professor and the entrepreneur speaker whose seminar you recently attended and who have obviously also not kept up with “the latest and better truth” in marketing.

Keep your questions coming.  Send them to us at [email protected] or [email protected]. God bless!