Are Old Customers Really Better Than New Customers For Small Businesses?

Ed note: We asked contributor Robert Woo, who frequently writes about all of the cool stuff you can do with Sunrise, Lendio’s small business bookkeeping software (that’s free to use!) to find out once and for all whether retaining an old customer is really more profitable than going after new ones. Here’s what he found.

Your small business can’t throw money at every problem, right? So when the problem is “business growth” and “customers,” that means it’s time to choose wisely: put your money toward adding new customers or work to get more from your existing customers?

Generally, there are two main levers that your business can pull to affect growth metrics: 1) customer acquisition, meaning bringing new shoppers through the door, and 2) customer retention, meaning keeping your old shoppers from exiting that door. Each is a necessary component of business growth, but with limited resources, which is better for your own business?

Isn’t It Obvious?

Obviously, customer acquisition you say because you’re not new to business. Everyone has seen the stat that it costs 5X more to get a new customer than to keep an existing one.

That’s a great stat! But have you ever tried to find the source? Go ahead, Google it and you’ll be clicking around dozens of articles and infographics that cite each other, but you’ll probably never find the actual report or survey where that 5X stat originated.

I’ll save you some time. The statistic goes back to Lee Resources (yes that’s their actual website), in a 2010 report they ostensibly put out. The report itself, I can’t find online. And Lee Resources’ only social media presence, Twitter, last chirped in 2013. Their Facebook page no longer exists. Their oft-cited stat of customer acquisition being 5X more costly than retention may be absolutely right—but there’s no way of knowing without seeing the actual report.

How about another statistic that everyone likes to cite about customer retention? According to Bain & Company, “a 5% increase in customer retention increases company profits from 25% to 95%.” That’s incredible!

Well, have you tried to find the source of this one as well? I have. Sites usually link back to this short brief by Fred Reichheld. Unfortunately, the “95% increase in profit” is not anywhere in these 3 pages. The “25% increase in profit” is there, but a) there’s no actual study/survey reported, and b) it’s only referring to financial services.

The real source of this statistic is actually a paper by Reichheld and W. Earl Sasser, Jr. titled “Zero Defections: Quality Comes to Services.” But three things you should know about this paper:

1. There really is a statistic fairly close to the “95% profit” cited above: “Reducing defections by just 5% generated 85% more profits in one bank’s branch system…” So to restate, this profit increase was seen in a single bank.
2. The industries they covered are probably not the ones you might be expecting: How many of you run an “industrial laundry” business?
3. And finally, this paper was published in 1990. Over 32 years ago and the same year Tim Berners-Lee invented something called the World Wide Web.

I’m going to go out on a limb and say this stat might not be completely applicable to ecommerce—something that hadn’t been invented yet.

Does Acquisition Really Have A Lower ROI Or Is It A Lie?

So what was the point of this exercise in fact-checking? A subtle point is to always do your research into the stats you see spouted across the internet. But the real point is that it isn’t so obvious that the ROI of customer acquisition is always less than the ROI of customer retention. It varies by industry, by company, and even down to the types of marketing & sales tactics that your business employs.

Think about it logically in context of the timeline of a company’s growth:

Retaining customers at the start of the growth curve may indeed be more cost efficient, but it can’t be better for the success of your nascent company. New customer acquisition is overwhelmingly important at this stage in the life cycle. And on the opposite end, retention is the key when a company has matured and has a large base of customers to keep and nurture.

It also depends on the business itself. Retention is a great idea, but what if your business largely produces products that last a lifetime? Think well-made cast iron skillets and Christmas tree stands; items that the average customer will only need to buy once or twice forever. In this case, customer retention is merely an afterthought, and the entire lifeline of the business depends on bringing in new customers.

Finally, one more thought experiment: say you want to double your business. Would it be easier to get every single one of your customers to double their spend, or expand your customer base instead? Suddenly, the obvious answer may not be so obvious for your business anymore.

That’s why it’s more important to track your own business marketing & sales expenses accurately than to rely on “conventional wisdom” that might not actually be accurate to your own business at all. By understanding your own finances, you can calculate your own ROI on acquisition vs. retention, giving you much better data to work off on moving forward.

What Really Matters Is Knowing Customer Lifetime Value (CLV)

I quite like this Forbes article that touched on the silliness of that 5X statistic much like I did:

Consider what Wharton Marketing Professor Peter Fader told me recently in an email interview: “Here’s my take on that old belief: who cares? Decisions about customer acquisition, retention and development shouldn’t be driven by cost considerations—they should be based on future value.”

Fader added, “If we could see CLV as clearly as costs, all firms would get this. But because costs are so tangible and CLVs are a mere prediction, it’s really hard to get firms to adopt this mindset.

CLV is the important statistic for your business to really get right in order to answer that retention vs. acquisition question. While CLV should always be improving (which means your business is becoming more “sticky” and loyalty is increasing), it may not be big enough to sacrifice acquisition spend. Or alternatively, if your CLV is great due to your churn rate being so low, then retention is already doing well and the focus should be on acquisition.

At the end of the day, no generic statistic should drive the direction of your business. Software like Lendio can help you determine where your expenses are going and the ROI of your spend in order to give you actionable financial data to keep growing efficiently.

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