Which is More Profitable: to Hold Customers or Attract Customers

The Law of Double Jeopardy asserts that as brands increase their market share, their consumer base also grows. This rise in consumers is not only linked to effective acquisition but also results from a decrease in customer attrition.

Companies lose customers annually - an undisputed fact. There's a prevalent belief in business circles that enhancing customer satisfaction can lead to better customer retention rates. This premise forms the bedrock of the marketing concept, encouraging heavy investment into customer retention programs.

Justifying the need to retain current buyers, it is often claimed that the cost of acquiring a new customer is five times higher than preventing an existing one from departing. But is this really the case? What return does the brand get in this scenario? Should we put more emphasis on customer retention versus attracting new ones?

In his book "How Brands Grow: What Marketers Don't Know", Byron Sharp, the Director of the Ehrenberg-Bass Institute for Marketing Science at the University of South Australia, presents arguments, backed by empirical data, explaining why attracting new buyers is significantly more beneficial than retaining the existing ones. His conclusions draw from extensive research into actual buyer behavior.

Let's delve into the author's argumentation, and we can draw our own conclusions.

In their article "Zero Defections: Quality Comes to Services," published in the Harvard Business Review, Reichheld and Sasser claimed that customer churn can deal an "extraordinarily potent blow to the bottom line...companies can increase profits by nearly 100% if they can retain just 5% more customers."

This dramatic statement, lacking supportive evidence, was constructed on a thought experiment. They hypothesized that a credit card issuing company loses 10% of its customers each year. Consequently, the average "lifetime" of a customer equates to 10 years. Now, let's say the company managed to reduce its customer churn to 5% annually. This would mean that the duration a customer uses the credit cards would double, reaching 20 years. Considering that a customer brings some profit annually and remains loyal to the company for a more extended period, they should generate more profit for it.

However, this theoretical "conclusion," advocating for investing resources in customer loyalty, is misleading. In essence, their primary "discovery" suggests that if a customer remains for a longer time, they bring more money to the company during that period. But, they committed several significant errors. For instance, in their rationale, reducing customer churn by half didn't cost the company anything. Also, they assert that such a reduction in customer attrition in practice is entirely achievable.

Can companies drastically change their customer churn rate or at least halve it without making significant investments? Calculations suggest this is merely wishful thinking.

In reality, continually reducing the level of customer churn is challenging and costly because its metrics are subject to the Law of Double Jeopardy. This means that the rate at which customers defect from a brand is a function of that brand's market share and the product category to which it belongs.

Competing brands have only marginal differences in their customer churn levels. The number of customers a brand loses each year largely depends on how many customers it had to begin with. It's obvious that a brand can't lose a million customers if it didn't have them in the first place. Therefore, larger brands lose more consumers in absolute terms each year, but they also gain a significant amount.

Moreover, in proportion to their customer base, larger brands lose and acquire fewer customers than smaller ones, meaning their customer churn rate is lower.

Let's imagine a market where only two brands are present. One is small with a 20% market share and only 200 customers. The other is larger, holding an 80% market share with a customer base of 800 people.

Assuming the consumer shares remain constant, one brand's attrition should match the other's gain. Let's suppose the larger brand loses and acquires a hundred customers each year. Then, in this simplified two-brand market scenario, the smaller brand should also lose and gain 100 customers. In this case, the smaller brand's churn rate is 50% (100/200), while the larger brand's rate is only 12.5% (100/800).

Here, we see a clear demonstration of the Law of Double Jeopardy. Real markets host more than two brands, so the situation is more complex.

Here, we see a clear demonstration of the Law of Double Jeopardy. Real markets host more than two brands, so the situation is more complex.

The Law of Double Jeopardy:
Brands with significant market shares experience a slightly lower level of customer churn, implying higher loyalty.

Meanwhile, brands with smaller market shares have far fewer customers, and these customers are somewhat less loyal.

The double jeopardy of customer retention: all brands lose some of their customers, and this loss is proportional to their market share—meaning larger brands lose more customers in absolute numbers, but as a percentage, they constitute a smaller share.

The Law of Double Jeopardy seriously undermines Reichheld and Sasser's idea of easily and costlessly halving customer churn. According to the above law, it's impossible to radically change customer churn rates without significantly increasing market share.

Consider a table showing the levels of customer churn among car brands. The data were taken from a survey of 10,000 new car buyers in the US from 1989 to 1991. The study recorded the brands of the cars purchased and the cars the consumers previously owned.

Churn rates here are considerably higher than in most other industries. However, they are surprisingly low considering that consumers could choose any other car brand instead of remaining loyal to the previous one. Every major car brand in the U.S. suffered from a customer churn of 60-70%, i.e., they lost about 2/3 of their customers.

No brand managed to achieve a churn rate significantly different from the average. Naturally, except for those who had a larger market share. Perhaps only Chevrolet breaks this pattern.

In Table #2, we see similar churn rate figures. But these data come from interviews with 25,000 new car buyers in the UK and France from 1986 to 1989. The British and French car markets are not as fragmented as the American one, and the market share of the brands shown in the table is higher, so according to the law of double jeopardy, customer churn levels are lower.

Every brand loses customers, with a churn rate of approximately 50%, so the customer retention rate is also around 50%. And here too, the Law of Double Jeopardy is evident: smaller brands have lower customer loyalty and higher churn rates. So, Ford, being the largest, has the lowest consumer churn rate, but it's not much lower than competitors.

We remember that Reichheld and Sasser assumed that the level of customer churn could be halved without any investment. It is hard to imagine how to achieve cheaply what no one in the market has ever achieved.

Notice: No brand under consideration can boast a churn rate around 25%, not even Ford, whose market share is twice that of the nearest competitor. To suggest a brand like Honda cut its churn rate in half is equivalent to suggesting they increase their consumer base by more than 30 times!

It is unlikely that any company could easily and without cost do what no car brand has managed to do, despite substantial investments in PR, marketing, and customer satisfaction.

The implications of the Law of Double Jeopardy have tremendous significance for growth potential, and these can be demonstrated with elementary mathematical calculations.

Based on automotive industry statistics, each year any of the car brands presented there secure about half of their sales volume from new customers and about half from repeat buyers.

If a brand like Toyota reduced its customer churn rate to zero, it would achieve an additional 50% of sales, which is one percentage point of market share. This one percentage point is the most a brand can gain if it learns to retain consumers better.

However, every year about half of new car buyers switch to other brands, so annually 50 percentage points of market share are "on a silver platter" handed to the brand that finds a way to the customer's heart and wallet. This is the maximum that Toyota can win by perfecting the attraction of new customers, that is, we get 50 times more sales potential against customer retention!

In most service industries, customer churn levels are significantly lower than in the examples given. Churn rates of 3-5% are quite normal, so even if a company manages to reduce the customer churn rate to zero, the gain in terms of sales volume will be just a few percentage points.

No matter what market you take, everywhere the potential benefits from attracting new buyers only underline the trivial benefits from efforts to reduce their churn.

It is not easy and cheap to halve the loss of customers, and constantly reducing churn to zero is outright wishful thinking. Moreover, the potential for growth due to attracting new buyers is many times higher.

The Law of Double Jeopardy describes the state of already established markets where brands generally do not experience significant growth or decline.

● So how are young developing brands doing?

● What role does customer churn play in the growth process?

● Is there a noticeable reduction in consumer loss during the brand's growth period?

● How significant is the influx of buyers? Or is the growth of a brand a consequence of both?

● Does growth depend on marketing strategy?

As it turns out, the answers to all these questions boil down to one: growth occurs due to significant customer acquisition. And when the brand's customer base shrinks, the cause is a depressing situation with attracting new buyers.

Erika Rebe studied the dynamics of growth and narrowing of the consumer base in her work for a doctoral degree. She studied both growing and fading pharmaceutical brands over a decade. Pharmaceutical panel research data were provided by the healthcare market research company ISIS Research, part of Synovate. This raw data set covered the prescription statistics of antidepressants by British doctors for ten years. Information over such a long period is excellent material for studying sales growth and decline.

Erika calculated the predicted inflow and outflow values for each brand, taking into account the normal level for this market and the size of the brand.

She hypothesized that growing brands would have an excessively high inflow of new customers and a below-expected outflow of existing ones, meaning both factors contribute to the growth of the brand's consumer base.

She was in for quite a curious discovery: growth was almost entirely provided by extremely high rates of customer influx.

Stagnant brands showed the same pattern, only in a reversed form: customer churn rates were fine, they were at the same level as stable brands with a similar market share, but the rates of customer influx were severely lagging.

Erika Rebe conducted similar studies in France, where she studied companies selling shampoos and chocolate bars. Based on panel data for 12 months, she matched the preferred brands of each survey participant in the first half with their same preferences in the second half. This allowed her to calculate how many "brand-loyal" consumers each brand gained and lost during the study period.

As it turned out, the product category "shampoos" is very stable and the consumer bases of brands in it did not change. But in the category of chocolate products, the same pattern was revealed as in the category of drugs - the consumer base expanded mainly due to superiority in attracting customers.

Later scientific research in this direction was expanded by further analysis, for which Nielsen provided bank data for a period of four and a half years. And again it was confirmed that growth was facilitated by vigorous customer acquisition, and in cases where things were going bad with this, there was a decline.

The simple explanation for the above pattern is that customer churn is largely outside the control of the marketer - at least in terms of the ability to influence it through work with consumers and other initiatives of this kind.

There is strong evidence to support this view. Let's look at the data on annual customer churn rates at banking institutions in Australia. These indicators demonstrate the typical law of double jeopardy: with a reduction in market share, loyalty also falls.

Compared to the huge fluctuations in market shares (the difference between Adelaide Bank and CBA is 30 times in this indicator), customer churn rates vary insignificantly.

The smallest among those presented, Adelaide Bank, is a modest regional bank with branches only in Adelaide. The largest brand, CBA, is the most powerful bank of national scale, with branches in all major cities and regional centers of the country.

If someone moves from Adelaide to Sydney, and annually 20% of Australians change their place of residence, previously used the services of Adelaide Bank, they find that the nearest branch of their familiar Adelaide Bank is not very close at their new place. Therefore, newcomers tend to switch to some other bank, whose branch is located near their new housing.

But if they were served by CBA bank while living in Adelaide, they will likely find that this bank's branches are very conveniently located in Sydney as well. These differences in physical distribution seem to almost completely explain the double jeopardy law in the customer churn rates of banks.

The relatively high level of customer loss at Adelaide Bank (twice as large as at CBA) is probably not at all related to the difference in customer satisfaction or that CBA has a better customer retention program. Simply, Adelaide Bank is smaller in size than CBA and has fewer branches, so the churn rate should be higher.

Therefore, Adelaide Bank does not need to worry that their churn rate is higher. Almost nothing can be done about it, unless the bank increases its market share to an impressive size. At the same time, Adelaide Bank remains a profitable and successfully operating banking institution for a long time. Contrary to the conclusions of Reichheld and Sasser, the churn rate of this bank does not have a detrimental effect on its profits.

It's not surprising that scientific papers dedicated to the study of the reasons for customer churn testify: consumers leave for completely uncontrollable reasons. For example, due to moving to a new place of residence, due to loss of need for this service, on the instructions from the head office, etc.

In addition, any brand faces great competition: rivals are constantly trying to lure away other's customers. It doesn't matter how you retain your consumers - from time to time a certain competitor still manages to make such an offer to your regular customer that they cannot refuse.

Attracting new customers is not a matter of choice. There is nothing fundamentally new in the thesis that attracting customers should play a critically important role in the growth of a brand, and yet there is an impression that this is often forgotten. However, convincing examples from practice leave no doubt: attracting new customers is fundamentally important, if only to maintain the current positions of the brand.

You must understand that we are not disputing the importance of customer retention work in any way. In the following article, we will talk about such important business metrics as Retention and Churn Rate. But we wanted to call on you to critically assess the significance of attracting and retaining customers in your business. Perhaps you are overestimating some part of the work with customers, while not paying enough attention to some.

This is just the point of view of Byron Sharp, but it is worth attention, at least because there is evidence behind it.

And how does the law of double jeopardy affect your business?