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Measuring the value of regulars in your business — by JHT, first published in IT@Work, The Sun, Monday, 9 July 2001

Much has been said about the demise of dotcom e-commerce businesses. Poor business model, unchanging consumer behavior, references to huge losses by Amazon.com all seemed like valid reasons.

Perhaps – putting forward my hypothesis – the real failure in most e-commerce businesses is that they spent way too much time and energy trying to build “brand” and getting “lots of customers” and not enough time making sure all these customers come back to buy from them again.

I’m sure there are many more valid reasons, but for today, let’s examine this important factor. I believe the lessons learnt here can be applied even to physical retail business or even the latest hip word “clicks and mortar” retailers. After all, there are a lot of retailers who do spend way too much money attracting new customers rather than keeping existing ones. They spend a lot of money on mass advertising, packaging, store designs, good location among other considerations. Don’t get me wrong, all of those are important, but I have a suspicion that many of these high-flying look good businesses don’t really consider the all-important question of “will they buy again?”

Central to today’s theme is the underlying fact that most businesses will make a loss on its first sale to each new customer. Research has shown that attracting and getting the first sale from a new customer costs 7-8 times more than actually getting repeat business from a customer who had already purchased something from you.

In fact, many businesses depend on “the regulars” for profitability and sustainability. According to consulting firm Bain & Company, repeat customers spend, on average, 67% more than new customers. To understand the long-term impact your customers have on the bottom line, you must evaluate the customer’s lifetime value.

What is this “customer lifetime value”? It is the present value of the net future profit stream from a customer. In other words, how much a customer is worth to you today when taking into account all the future profits that customer will generate for your business over time.

Suppose you run an advertising campaign designed to generate new customers. Say out of a 4-week campaign that costs you RM50,000 and generated 1,000 new customers. You would have spent RM50 for each new customer. If the average order for each new customer were RM50, then you would have gained revenue of RM50 per new customer. You may have broken even on your marketing investment, however in terms of margins, you would have made an initial loss. To make this example simpler, let’s assume there is no variable cost involved.

Out of this 1,000 new customers, imagine 10% buy from you again the following years at an average order of RM50. That would be RM5000 yearly in additional revenue without much of an advertising cost. That 10% represent repeat buyers. At this point, you will begin to see some return on your earlier advertising effort. In calculating your lifetime customer value, these customers would represent an average value of RM55.04, in other words, how much these 10% of your customer is worth to you over a lifetime. For the financial-savvy readers, I have used a net present value of 15%.

Suppose I manage to increase my repeat customers by 10% to a total of 20%. In calculating lifetime value, the average value of the customer increases 11% to RM61.00. The yearly revenues if increased from 10% to 20% retention rate are RM10,000! Considering this, how much would you spend to increase the retention rates from 10% to 20%? You would probably spend up to a maximum of RM11.00. Compare that to the RM50.00 you have to spend on attracting new customers. See the difference?

To make things even more interesting, how much do you think each customer is worth over a lifetime if you could increase both the retention rates AND the average order size? At the 10% retention level, increasing from the average order RM50.00 to RM100.00 would result in RM10,000 in yearly revenues, a 200% increase.

What I have discuss here is key in the success of all types of business, whether it may be fast moving consumer goods or high consideration products such as automobiles, mobile phones, homes. This is the same reason why I believe Amazon would be a hugely profitable online retailer, because it has a huge base of loyal repeat customers. Naturally, the following question would be, “how do I ensure my hard-earned customer become repeat customers?” The answer lies in the following areas:
1. A customer loyalty program
2. Analyzing customer behavior and patterns (especially if you’re an online retailer)
3. Cross-selling and up-selling

If you have any specific question regarding today’s article or any feedback, I gladly welcome it.

[Written by Jui Hong Teoh, Managing Director of BRANDTHINK Malaysia. First published in IT@Work, The Sun, Monday, 9 July 2001]