Keeping Customers Is Almost Always Cheaper in the Long Run

"There are some customers," a small business owner once told me, "you just don't want."  He was talking about a rude (and cheap) diner who made his staff miserable, and had just flounced out of his diner--without paying--after he told her to stop harassing the waitress.

Nonetheless, most small businesses will do almost anything to keep a customer.  They rely on word of mouth, and they're often in smaller towns or cities where word really gets around.

Bigger businesses, on the other hand . . . well, how many times have you gotten off an impenetrable voicemail phone tree and wondered, "Do they even want my business?"

Those businesses are often using pretty brutal calculations as to how much it would cost them to keep your business; often, they decide it's not worth it.  But consultant (and my business school classmate) Karl Stark argues that they're not doing the math right:

One of our clients has more than 90 percent of its resources-people, marketing budget, etc.-focused on creating millions of new customers a year. Their business model is based on monthly recurring feeds, much like the cable or wireless industries. Customers come in and they stay...until they don't. An analysis of the client's historical data shows that the average customer stays for an average of 2.5 years. Because their customer acquisition cost is lower than their expected customer lifetime revenue, they reach a break-even point in less than two years. So it's a great business, as long as they keep generating new customers, right?

Wrong. The problem is that as the management team's growth expectations increase, it gets increasingly harder to acquire more customers. As a result, customer acquisition costs go up and the quality of customers, in terms of how long they stick around, goes down.

To solve this growth dilemma, the client needs to ask three key questions:

• What revenue growth will we achieve if we keep our existing customers for just one additional month, on average?
• What will it cost us to do this by, say, improving customer service or adding customer benefits?
• How does this growth compare, both in magnitude and cost, to acquiring new customers?

The answer for our client will be the same as it is in almost all businesses. It's cheaper, easier, and more effective to retain current customers than it is to acquire new ones. In fact, if this business can retain all of its customers by just one additional month on average, they can achieve an additional 3 percent of annual growth.

Maybe nice guys don't always finish last.

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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