Rethinking customer retention vs. acquisition

Which approach generates the best ROI?

When spending money to attract customers, business leaders must first prioritize who they are targeting – new customers or familiar faces. The conventional wisdom in most consumer businesses, especially the restaurant, hospitality and retail sectors, is that 80% of a business’s sales comes from the top 20% of its customers – the “80/20 rule.”

Following this logic, leaders in these sectors commonly make large investments in customer retention marketing strategies, often in the form of loyalty initiatives. These strategies can be expensive – paying for the incentives and the related technology and marketing – but the overwhelming importance of customer retention makes it worth the investment. No business wants to put 80% of its sales in jeopardy.

But what if the 80/20 rule isn’t true? What if the most frequent customers are overvalued?

Grant Thornton’s research into consumer markets reveals a different answer. There is no 80/20 rule – rather, most often, it’s closer to a “50/20” rule. “On average, 50% of a company’s sales come from the top 20% of its customers, not 80%,” according to Kevin O’Connell, a Grant Thornton managing director in Strategy and Transactions. “Why does this matter? Businesses are likely focusing too much effort on customer retention and frequency and missing their best opportunities for growth. The reality is that more than half the sales for almost all brands come from infrequent customers, and this is where most of the growth opportunities lie.”

Businesses can’t grow effectively by simply focusing on their best customers. There simply aren’t enough of them. To achieve true growth, companies need to continually increase market penetration.

Why do companies miss this insight? Many brands don’t have visibility to their whole customer base. When they do have broad customer data, the first instinct is to look for the most valuable customers and figure out how to create more of them. Unfortunately, the high-value customers tend to be a small group. They also tend to be “high frequency category users” – i.e., they’re the best customers for many brands.

“If a business believes in the 80/20 rule and sees that the vast majority of their customers aren’t that frequent, the tendency is to double down on loyalty initiatives because they think they’re failing,” O’Connell said. “In reality, this is simply normal market behavior, and intensifying a focus on loyalty initiatives diverts resources away from the true source of growth – attracting more customers.”

Our studies have shown that almost all consumer behavior could be described as “randomly frequent.” According to O’Connell, “‘Loyalty’ is not a driver of consumer behavior. People buy when they have a need or want, and those needs and wants differ depending on the variables in their daily lives.”

Research by the Ehrenberg-Bass Institute for Marketing Science, a world leader in marketing research, has found that customer frequency patterns tend to “regress to the mean” over time – basically, today’s frequent customers may be less frequent tomorrow and vice versa. Why is that? Life happens. People experience big life events (move, get married, get a new job, have a child, start a new hobby, join a new group) and little life events (go to a meeting, work late, start a project, go to the gym, have friends over, watch a sporting event, read a book), and all these experiences affect demand – the products and services people need and when they need them.

Brands don’t create demand. They capture share of customers in the market, and they do it through brand awareness and accessibility and differentiated products and experiences. The best loyalty strategy is to deliver a better, more consistent experience for the customers who have a need for the product. Analytics of customer behavior proves this. A coffee outlet that adds a drive-through window improves customer accessibility and experience, and its sales will increase. The key to winning customer decisions is to understand the key buyer values in your market and differentiate your business in a meaningful way from the competitive alternatives.

Market penetration is the only sustainable winning growth story, and investments in customer acquisition efforts will deliver a better return over time.

Customer retention vs. acquisition? The math is pretty clear.

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