How to Hold Customers: Why are Companies Monitor the Retention Rate

By Thomas Bennett Financial expert at Priceva
Published on September 25, 2023
Why are many e-commerce companies currently concerned with a metric known as Retention Rate? This metric measures the level of customer retention. It's no secret that we use some products regularly over many years, while others we try once and then quickly forget.
This is the metric you need to keep an eye on to understand how effectively your customer support is working, and predict the growth rate of your business.

Repeat customers are a guaranteed source of revenue. And the Retention Rate is the thermometer that allows a company to measure how successfully these customers are being retained. In this article, we'll discuss in detail how and why to calculate this indicator.

Customer retention is a business's ability to hold onto existing clients over time.

Retention Rate is the metric used to measure Customer Retention. It shows the percentage of users who continue to use your product or service over a specified period.

If the Retention service on day 3 is 20%, it means that if you consider the whole group of new users who came to you on day 0 as 100%, then only 20% of them will use the service on day 3.

How to Calculate Customer Retention Rate

The Customer Retention Rate is calculated using the following formula:
1. Determine the time period you are calculating: year, quarter, month.

2. Calculate how many customers your company/service had at the beginning of the measurable period and how many at the end.

3. Subtract new customers from the number of customers at the end of the period—to prevent distortion of the metric due to recently arrived buyers who were not present at the start.

4. Divide the number of customers at the end of the period by the number of customers at the beginning and multiply by 100%.

A high retention rate means that your current customers value your product and provide a stable source of income. A low retention rate suggests that you have a "leaky bucket." Regardless of how many users you attract, they will leave you after a short time, and you will continue to lose money.

Of course, everyone understands that a certain amount of churn is inevitable. Existing customers may stop using the product for reasons beyond your control. But you should know the percentage of churn that exceeds the norm and becomes critical for the company's well-being. Calculating the Retention Rate of your product is the first step to understanding the reasons for customer attrition.

What can the Retention Rate Reveal about the Business Situation?

The Retention Rate is used to predict a company's profits and growth. If the retention coefficient exceeds the customer acquisition rate, your product over time gains enough users to provide the projected income. If the retention coefficient is lower than the customer acquisition rate, this leads to a reduction in the customer base with all the ensuing consequences.

Retention is important not only from a net income perspective. Companies also use this indicator to determine:

● how satisfied customers are with the product;
● how loyal they are;
● what value users get from the company's product;
● how well the company is doing in building a successful customer experience;
● whether it has a stable customer base to maintain business sustainability.

As an alternative, some companies track the exact opposite of the retention rate, calculating the Churn Rate - the customer attrition coefficient. It allows you to determine the share of customers who have stopped using the company's services over a certain period.

The formula for the basic calculation, which shows the customer attrition for the entire time, looks like this:
These two indicators are closely tied to each other. While the Retention Rate should ideally tend to 100%, the Churn Rate should strive to 0%.
For obvious reasons, companies should strive for high retention rates and low attrition rates.

Why a Good Retention Rate is So Crucial for Business

Most often, companies are motivated to calculate the retention rate for one reason: to earn more money. The more customers, the more revenue. But at the very least, a business needs to offset its costs of acquiring these customers before they leave.

Qualtrics discovered that loyal customers are five times more likely to make a repeat purchase and seven times more likely to try a new product.

Companies might think they have time to unfold the true value of their product to customers. But statistics are harsh, for example, the average mobile app loses 90% of its users within 30 days of download. There is no business that would want to replenish the majority of its users every month. The first step towards improving the situation may be to decide to track the Retention Rate.

Methods of Calculating Retention Rate

There are two aspects of a product that you need to define to monitor a company's Retention Rate.

1. Critical Action for the Product

This is the user's action that determines whether they will be retained for the company. It's an event that indicates value, both for your customer and your business. It should be tied to the activity that generates revenue for you and provides the customer with what they need from your product. For example, a critical event for Airbnb is a booking, for Netflix it's registration on the service or renewal of a subscription, for World of Tanks it's a completed game level.

2. Product Usage Interval

This is how often you expect a customer or user to perform the company-critical action. You need to determine the time period for this action that is most optimal for your product. For instance, Airbnb customers may be considered retained after they make a second booking within 18 months of the first booking. For Netflix, this interval would be one month, as its users renew their subscription monthly. Online game players may be considered retained if they play the game daily.

There are several ways to calculate the Retention Rate formula, depending on how you define "active users" and what time interval you take for the calculation.

User-Based Retention Rate Calculation

The customer retention rate measures what percentage of your paying subscribers or users you manage to retain. Focusing on this segment puts the needs of users who pay for your product at the forefront, and their retention has a direct impact on your results.

The user retention rate measures retention across your entire user base, regardless of whether they are free or paying users. Focusing on this type of retention can help learn how to achieve high customer satisfaction, but misses the aspect of profitability.

Measuring the user retention rate makes sense if your business relies on advertising revenue rather than a subscription model.

The cohort retention rate measures retention according to specific user segments or groups that share common characteristics. This method helps to find out how certain user segments behave and what helps to retain them.

Time-Based Retention Rate Calculation

The N-day retention rate shows how many users were retained on a specific day after registration, such as the 5th or 30th day. You can determine each day according to strict calendar rates or sliding 24-hour windows. N-day retention rate is valuable if you expect people to use your product every day, such as a mobile game.

The unbounded retention rate measures how many users returned on a given day or the following day. This retention indicator makes sense if you don't expect people to use your product every day. This number is inversely proportional to your churn rate.

The period-based retention rate measures retention over user periods specific to the frequency of use of your product, such as: Day 1, Day 3, Day 7, Day 14, Day 31.

You can use different retention metrics at different times, but if you are going to compare metrics, make sure you only compare those retention metrics that are measured in the same way. Comparing your unbounded customer retention rate with your N-day user retention rate is like comparing apples with oranges, which will not give you meaningful information when measuring user retention.

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