Chapter 3

Customer retention rate

• Why: To better understand customer loyalty
• What: To measure the extent to which customers are satisfied and loyal
• When: When repeat customers and positive recommendations matter
• The question this indicator helps you to answer: to what extent are we keeping the customers we have acquired?

Why does this KPI matter?

In order to keep making money, companies need customers who buy their products and services. Keeping the customers we already have is usually better and cheaper than trying to find and win new ones. First, attracting and converting leads to customers is expensive. It is generally cheaper to maintain an existing customer relationship than to create a new one from scratch. Second, once customers have made a decision to buy from you, it is generally easier to re-sell, cross-sell and up-sell to them.

This is why most businesses aim to convert their first-time buyers into long-term profitable customers. In his book The Loyalty Effect, Fred Reichheld makes the point that ‘A 5% improvement in customer retention rates will yield between a 20 to 100% increase in profits across a wide range of industries.’

The customer retention rate is a powerful indicator of current customer performance as it demonstrates loyalty through real behaviours (customers have actually decided to come back or stay), instead of factors that might predict future loyalty, such as the net promoter score and brand equity (customers might be more likely to repurchase in the future but there is no guarantee). On the other hand, of course, current retention rates are no guarantee of future retention either, but as a rule of thumb it can be stated that customers who buy more frequently are more likely to continue to do so.

Customer retention is therefore a metric that allows you to understand what percentage of your existing customers remain customers or make a repeat purchase. If your retention rate is high, you can generally assume high customer satisfaction levels (unless the barriers to leaving are very high or the incentives you give to your customers outweigh the bad service they might receive). If retention is low, you want to know not just the actual numbers but more importantly the reasons for dissatisfaction, especially relative to your competitors.

A final point to remember about retention is that you don’t necessarily want to keep all the customers you have acquired. Reasons for this are that some might not be profitable or some might be more expensive to serve compared to others. This is why the customer retention rate needs to be understood in the context of other measures such as customer profitability and customer lifetime value.

A complementary measure of customer retention is the customer churn rate (or customer attrition), which measures the percentage of customers a business loses over a specified time-frame.

How do I measure it?

How do I collect the data?

If your company has good and accurate customer data, data for your customer retention ratio come from your purchasing information, i.e. your general sales ledger or your CRM (customer relationship management) system. If no customer data are available, a survey could be used to estimate customer retention.

What formula do I use?

Retention rate measures the percentage of customers a company is able to retain over a specified period. The formula that is often provided in textbooks just divides the number of active customers at the end of the time period by the number of active customers at the start of the time period. The problem with this formula is that it not only measures retained customers but includes newly acquired customers and therefore is not really a measure of retention.

A better formula is:

A slight variation on this formula and an even better measure of customer retention would be to divide the number of customers at the beginning of a period who are at risk of leaving by the number of those customers who remained customers at the end of a period.

How often do I measure it?

The frequency of measurement depends on the average lifespan, contract duration or purchasing cycle. Monthly collection of the data usually makes sense in most industries.

Where do I find the data?

These data can in most cases be extracted from the sales ledger or CRM system.

How difficult or costly is it to measure?

The cost and effort involved in measuring retention rates depend very much on the quality and accuracy of your customer data. Banks, for example, which hold accurate data about customers, will find calculating retention very inexpensive. If you have no accurate data about your customers (e.g. in a restaurant chain), a survey might be necessary, which tends to raise the cost significantly and reduce the reliability.

How do I set targets for this KPI?

In a typical company, customers are defecting at the rate of 10–30% per year. However, customer retention rate and churn rate targets need to be set in the context of your industry and against past performance, because retention rates vary widely between industries. While the retention rate in retail banking is still fairly high (but coming down as more young people are willing to switch), the retention rate in the mobile phone or internet service provider sector is generally low, as customers are constantly looking for the best package deals. A recent study by J.D. Power and Associates of retention rates in the car industry found that Toyota (64.6%) leads the customer retention rankings, followed by Lexus (63.0%) and Honda (62.8%). Most commercial organisations will set customer retention targets as a key part of their (annual) marketing strategy development process.

Practical example

One of my clients is a world-leading telecommunications company that wanted to understand customer retention as a key measure for its corporate dashboard. Using its CRM database, it can calculate what percentage of the customers who are at risk are renewing their contracts.

Let’s say that in December of a given year 200,000 mobile phone contracts are coming up for renewal and the company is able to review 130,000 of those. The customer retention ratio is:

This is giving the company a very reliable picture of true retention and loyalty, as opposed to just measuring customer churn, which was hiding information such as customers who were counted as churn because they changed handset, changed phone number, moved from pay-as-you-go to pay-monthly contracts, or were disconnected by the company because they did not pay the bills.

Companies without customer contracts or good customer records that allow them to identify customers might find measuring customer retention rates a little harder. Retailers might find it difficult to track customers (unless they are using a loyalty card) and therefore might tend to track transactions rather than customers. The only way to track retention in that case is by surveying customers about their loyalty to specific retailers. Retail giant Wal-Mart does not identify its customers and therefore tracks only the number of transactions. The UK retailer Boots, on the other hand, now has an estimated 70% of sales revenue linked to its loyalty cards – which allows the company to get an understanding of retention rates based on past purchase history and basket estimations (how often you are predicted to come back and how much you are predicted to spend). Based on this, it can determine whether you are returning or not.

Some tips and traps to consider

There are a number of difficulties in measuring retention. The main one is identifying and counting customers correctly. In order to calculate customer retention rates correctly, you need first to identify your customers and then count them correctly. For example, if you are a telecom company, do you count people with multiple contracts (phone, tablet, mobile, broadband) as one customer or multiple customers? How do you treat family contracts – as one customer or as multiple customers?

Another difficulty is measuring customer retention rates in industries where sales transactions are more sporadic and when they take place in non-defined intervals. A car company like Mercedes-Benz might use research to come to the conclusion that we buy cars in intervals of, let’s say, five years. If the company is able to keep correct customer information, it can then estimate customer retention. The difficulty again is identifying a returning customer (especially if this person has changed address, credit card, etc.).

Finally, remember that looking at customer retention in isolation is no good; you need also to look at measures such as customer profitability and customer satisfaction to get a more complete picture of customers.

Further reading and references

Frederick F. Reichheld and Thomas Teal, The Loyalty Effect: The Hidden Force behind Growth, Profits, and Lasting Value, Boston, MA: Harvard Business Press, 2001.