Calculating Your Account’s Life Cycle Value – Do you know how much an increase in your company’s account retention is worth?
It is a vicious cycle that even the most successful businesses have to deal with; the constant need to replace defected accounts with new ones. This cycle of winning, but not gaining significant net revenue or profits, is often referred to as “the gerbil effect”. The challenge then, is not how do you consistently acquire many new accounts, but how do you keep the ones you have already worked so hard to obtain?
There are multiple answers to this question, and they can be found in loyalty surveys, customer experience management programs, and in fancy words like attrition and retention. But how do you know if any of these initiatives are ultimately benefiting your bottom line? Calculating the economic value of your account’s life cycle is the first step to effectively and accurately measuring the impact of an increase/decrease in your company’s retention rate.
Calculating an Account’s Life Cycle Value; Step 1
First, you need to determine how profitable your average account is on a yearly basis throughout the age of the account. To do this you need to gather and analyze data associated with the costs and revenues of your accounts to create a life cycle profit pattern of your average accounts. Examples of the data you will need to collect include acquisition cost, base profit, revenue growth, operating costs, referrals and price premiums.
Calculating an Account’s Life Cycle Value; Step 2
Now that you know how much a account is worth based on life expectancy, the next question is logically; what is the average duration of a account?
The easiest way to answer this question is to calculate the retention rate and invert the fraction. To honestly determine the average duration of a account you need to develop retention rates based on the different classes of accounts that you have. Use company specific criteria to segment your accounts into classes. Examples of account criteria include age, source, industry and size. Next, develop annual retention rates for each class of account. Annual retention rates can be calculated by counting the number of accounts who defect over a period of time, annualizing that number, and then making it a fraction on top of the total number of annual accounts.
For example, 80 accounts defect over a 4 month period where your company had 400 total accounts. To annualize this number we multiply by 3, giving us 240 total annual defecting accounts out of 1,200 total annual accounts. As a fraction 240/1,200 is equal to .20. From this number we deduce that your company’s retention rate is 80%, and your company’s rate of attrition (defecting accounts) is 20%. By taking the inverse of this fraction we realize that your average account duration is 5 years.
Calculating an Account’s Life Cycle Value; Step 3
Now that you know how profitable your average account is throughout the age of the account, and you know the average age that account will realize, you can get an accurate estimate of the life cycle value of your average account. In terms of account retention, you can now easily determine how profitable it is for your company to retain accounts instead of acquire new ones.
These numbers are estimates and approximations of your company’s retention and attrition rates, and life cycle value(s). Approximating these numbers gives you and your company a good picture of how retention and attrition will affect your business but are not exact.
Use the following tips to further polish and refine these numbers:
- Attrition rates are not constant. Usually, attrition rates are higher in the first few years of the account and lower later on. Develop a model that categorizes attrition rates on a yearly basis and apply these to the account profit pattern model.
- Instead of using a single, static average of annual accounts think of classes of accounts moving through time. Remember you get a new pool of accounts every year and they defect at different times, but the investment is made into the whole pool. So to calculate the actual average present value of your account, you must study the entire group over time.
It is often more financially advantageous to save one account with a high life cycle value than to win three new accounts with lower life cycle values.
The path to increased growth and profitability may already exist…by working smarter to keep your current account base!