New Customer Acquisition or Core Growth? Try Dynamic Modeling
Several years ago I reconnected with a friend and peer who was on the management team of a fast-growing company. At the time, from a competitive perspective, it appeared nothing would stop their momentum. I was truly envious of their success but then out of the blue the business was sold. Shortly thereafter he moved on as well. In time I thought it was fair game to ask what happened? Why would a company, on an upward trajectory, cash out? He was quick to offer that when, year after year, 100% of his budget was dedicated to securing new retailers (3rd tier customers) he became increasingly concerned. He saw little investment in the infrastructure to support the now-larger base. Growth appeared to be healthy, or so he thought. Being behind a wholesale data-wall, they weren't looking at the post-opening performance of new retailers or the productivity life of the existing core. Along with that, customer defections went virtually unchecked. In time, and exacerbated by aggressive competition, sales flattened and market share began to drop. He went on to explain that there was a point when no level of new customer acquisition could keep the top line moving upward. He only would add that the acquisition happened at the right time and that the business could have continued to grow had some resources been directed to build the architecture supporting the existing customer base. In contrast, the opposite is also an unsustainable philosophy. The company that focuses all resources on supporting its core and little on building new business is at risk for unfavorable outcomes, especially when combined with business maturity. The common myth is, if more resources are dedicated to the biggest segment of the business, it will grow. That perception is supported by many claiming that the cost to establish one new relationship is equal to or greater than supporting five to seven existing customers. Certainly, the cost of selling to an existing customer is less. With loyalty programs, social media, apps, email subscriptions and so on, communicating with the core customer is much less costly than getting the attention of, and successfully onboarding, a new one. Assuming there are no service or product quality issues, it first needs to be proven that the current base can meet the growth needs of the business. Unless the core is engaged, retained and largely moving in an upward trend, a singular focus on existing business is not the right strategy. It could actually create an unintended void of innovation fueled by the fear of change, consequently diminishing relevance and appeal. The debate and battle around where the strategic capital should be positioned is ongoing. So, what’s the answer? I’m sure it will come as no surprise that, to have sustainable growth, its best to have a dynamic concentration on new and existing business development. Look at it like diversifying your portfolio. Dynamic, because it changes and moves with market influences and results. Independently, each of these revenue streams are vital for a well-balance strategic plan. The truth is that in many organizations identifying the methodology and accountability around new customer acquisition is like nailing Jell-O to the wall. All it takes is the simple question, “Who is responsible to find new business?”, to evoke the sound of crickets in the background. Likewise, gaining clarity around how budgets that support the existing base are allocated can be a Pandora’s box. When determining the best route for this journey, data is king. Understanding how the core business is performing, on both a revenue and defection level, is essential before one can wisely place one’s eggs. The basic health of a business can be seen in typical YOY (Year Over Year) or CAGR (Compound Annual Growth Rate) comparisons. You can slice the data literally a hundred different ways but ultimately the question becomes, “Is the ARV (Annual Revenue Value) increasing or declining?” On the other hand, how do customer defections play a role? Defection is synonymous with attrition or churn. Ultimately, keeping a close watch on the GAR (Gross Attrition Rate) is important. For those who live on the sunny side of the street, you might prefer to watch the retention rate, the opposite of attrition. Either way, levels vary so much by customer type, industry and sector, it’s wise to research what sustainable benchmarks for a specific business look like. Defections can be categorized into one of two types. Voluntary churn is a loss due to a sense of indifference, a better option or a decision to no longer use the product or service. Involuntary churn is a loss due to influences like relocation, illness, death, business closure (in a B2B environment), etc. One could argue that, if you are going to lose a customer, it would be best to be involuntary in nature. Not the case. There is little a business can do to prevent involuntary churn, however, executing some preemptive strategies can reduce the number of voluntary defections. An ongoing cycle to MEASURE (gather data), ANALYZE (SWOT), PLAN (correction) and ACT (strategic execution) is the most effective methodology to reduce customer churn. The reason productivity and defections numbers are wildly important is twofold. First, the core business could have low defection rates but isn’t growing. One reason might be maturity, as mentioned earlier. Another possibility, but harder to anticipate, is product life. We only need to think back to the 35mm camera, publishing or wired phones to see examples of obsolescence. Wireless technology and digital media were disruptors for entire industries. Second, if a business has unexplainably-high defection rates, there could be brand or quality factors that require correction before launching any type of recruitment initiative. Let’s use a restaurant for example. If people aren’t coming back due to service, atmosphere or food issues, a new customer acquisition initiative is the worse path. Attracting more people to essentially have a bad experience will perpetuate the old adage that good news travels fast and bad news travels faster. Statistics show that happy customers will tell 9 people about their experience while unhappy customers will tell 22. Social media only increases the audience size and transmission speed. A less alarming exception is when low retention rates are due to market influences like seasonality, transience or high promotional activity. A Net Promoter Score (NPS) would be a better measure of quality and value for these business conditions. It measures more about customer perception/satisfaction and less about whether they coming back or not. While generally positive, some strategies can have unintended consequences. Recently, I received a call from a successful business owner and former client looking for some advice. With customer service ratings well above industry standards, her strategy was to drive more people to the business. A fundamentally sound approach. Up to that point her base was built exclusively on referrals. With the goal to increase her base, she enrolled in an electronic coupon program. The concern she had was new customers didn’t appear to be coming back. Since she already made the investment, I advised her to track the new customers separately through to the end of the program and we’d look at the entire picture. In total, 225 people had redeemed the offer. A big success! After a full customer cycle, sadly only 20 (9%) had returned in the next 90 days. Certainly, not the 60% first-time customer retention they normally saw. A quick look at the existing customer retention rate showed strong numbers and no signs of quality issues. The total cost of the program, including all discounts, staff compensation, fees, expenses and charges was around $18,500, bringing the CAC (Customer Acquisition Cost) in at over $925. There’s a general guideline that suggests the ARV of a new customer should be 4 to 5 x the CAC. This was double and would have taken over 10 customer cycles to offset the cost. Not only was it unsustainable, it lessened the efficiency of the business. After seeing the numbers, she wisely opted out of all future programs. The lesson here was, make sure you are attracting the right customers. CAC is arguably the second leading cause of startup failure, next to market fit. While this was an existing, stable business, if the cost of gaining new customers isn’t properly projected, it can lead to stagnancy and fiscal weakening. My suggestion was to create a referral program linked to her existing loyalty program. It resulted in a CAC of less than $125 that generated just over 40 new guests and met the ARV expectation after just one repeat transaction. The most significant improvement was that 70% of the new customers were retained in 90 days and 85% in 120 days. Distributing resources for growth isn’t like sports or politics. The good news is that you don’t have to put all your eggs in one basket. Neither core nor new business investments have mutually exclusive benefits. There’s a third leg of this stool called marketing. While the majority of everything you do can be charged to one of the two buckets, blended investments like advertising, designed to attract newcomers, will also reaffirm and validate the core customer’s decision to have a relationship with you. On the other hand, an experiential brand tour and store-finder app that allows users to find and explore existing locations, has strong value to a new constituent and would be an attractor. We only have to look as far as our pocket to see this in application. The message Apple communicates about a new product is absolutely created to pull new users but not before it appeals to the core customer. One source reports that typically, 50-60% of users with an iPhone, two or more years old, upgrade in a given year, a behavior also driven by service plan contract periods. The three dynamic models below show graphically how resource investment might look when adjusting for the current business condition.
One would imagine that Apple has an evenly-distributed model with a large allocation to blended strategies. That said, it's balance, not even distribution that is critical for extended growth. Also for clarity, this is investment distribution, not anticipated revenue. You may need 40% of your discretionary spending to drive a successful new customer acquisition initiative that only generates 10% of your top line revenue in that year. Keeping your eyes on the compounded contribution over a wider window of time is best. Dynamic modeling lives in the space between understanding what is happening in the current business and where investments must be made to engineer the vision of the future. As a business changes and evolves, so does the allocation of resources to best match the current condition. In the highly-competitive, fast-changing business world, we can't be pacified into thinking that everything we need is already in our pocket. Remember, 100% of your core base was a new customer and it’s where your growth begins.
Top Ten Takeaways: · Factor productivity trends (ARV) of the core into strategic planning · Know retention rate or GAR and what fuels it · Customer acquisition is only sound without quality issues · Know the new customer target profile (possibly same as best core customer) · Know the CAC and if it supports a sustainable business plan · MAPA (Measure, Analyze, Plan, Act) · Innovation corrects maturity, become a disruptor · Allocate resources for the current business condition · Maximize blended investments to support both new and core · Watch the long-term producivity generated from new customers, not the immediate