How Do You Balance Acquisition and Retention?

Graham Hill
Guru
Member

Posted 28-Feb-2005 09:54 PM

Reading through the latest edition of the Journal of Marketing, I came across Werner Reinartz's latest research on balancing acquisition and retention spending.

The research identified that the strategy that maximises long-term customer profitability DOES NOT maximise customer acquisition or the length of the relationship. It also identified that under-spending on customer retention has a bigger negative effect on customer-profitability than underspending on customer acquisition.

In otherwords, managers have to make difficult trade-offs between spending on customer acquisition and spending on customer retention to maximise customer profitability.

The $64,000 Question

How do you manage these trade-offs?

Do you spend enough on customer acquisition and retention?

How do you know when to stop spending?

Please tell us—in your role as CRM Managers—how you make these difficult decisions.

Graham Hill
Independent CRM Consultant
Customer Value Management Guru

For the complete article see
Reinartz et al, 'Balancing Acquisition and Retention Resources to Maximise Customer Profitability', (2005), Journal of Marketing Vol 69 No 1

Simone Oltolina
Member

Posted 03-Mar-2005 01:34 AM

Graham,

first of all thank you for opening this interesting discussion, I'm really looking forward to reading the many answers that hopefully will follow....

As you know I'm no CRM manager, just a quasi-graduate student but I've read many articles on the subject so I'll bring my contribution, albeit limited.

You're surely aware that authors like Blattberg, Deighton, Getz and Thomas wrote extensively on this very subject. They propose a "marginalistic" model that tries to balance acquisition & retention spending (they also add add-on spending to the mix) by estimating the impact of these allocation choices on the overall Customer Equity (which you might call "long-term customer profitability" as well) of the enterprise.

Still, I think their model has some major limitations (some of which are acknowledged even by their authors). Let me list them:

1)first of all the model takes for granted that the firm has only 3 investment alternatives (retention programs, acquisition programs and add-on selling efforts). This is nonsensical of course. What prevents the same company from investing in R&D or staff training? those choices could have a much bigger impact on the overall CE than any of the aforementioned strategies.... For instance, I could dish out a new, innovative, product/service "stealing" my competitors' customers (their retention efforts notwithstanding)

2)the model is built on several equations but most of the variables that go into them are exogenous (a critical assumption). Basically you can only act on the three spending levels (which have a direct impact ONLY on the success probabilities of the 3 strategies)

3)the retention rate does not change over time (again, a critical assumption)

4)when considering "acquisition equity" the authors fail to acknowledge (or so it seems me) that newly acquired customers's value trascends present-year earnings (this also seems a bit incoherent. How can you talk about the importance of Lifetime value and then, in the very same model, forget about it? newly acquired customers have a LTV too!). To be completely honest, they seem to realize this, judging by an equation published in the beginning of the book, but they seem to forget it again later on.

5) it is fairly obvious that the whole model, as presented in "Customer Equity—Building and Managing Relationships as Valuable Assets" has mostly the intent of popularizing the concept of Customer Equity, without actually delving into its complexities. It's all a bit like "hey, you gather the numbers, throw them into the equation, do some statistical magic and, Bam!, you get the results" (there is alot of casual namedropping throughout the book: sensitivity analysis, logit models, etc.)
This should come as no surpirse though. Customer Equity, at the OPERATIONAL LEVEL, isn't something that the average marketing manager can do. You need data miners, mathematicians, statisticians, etc. Really, any good book on the subject should start with this premise (Blattberg et al. hint at the problem but I would have liked to see them stress the point much more).

Of course, alternatively you can embrace Sunil Gupta's perspective (whom I wholly agree with) and simply state that "even with the most detailed and sophisticated data and modeling, estimating CLV requires a host of assumptions and subjective decisions that make it far less precise than many of us would like to believe". Given that assumption you might as well shun Blattberg et al. attempts of rigorous modeling and stick to managerial insight or some rudimentary tecniques (like: every year I lose about 10% of my customers. Given my growth target, acquisition should bring in 20% annually. How much would this cost? Can I afford it?).

If you can afford sophisticated modeling (and if you BELIEVE in its value) I'd urge you to look more at the work of Roland T. Rust (author of "Driving Customer Equity" and the recent "Customer Equity Management". Their approach, albeit still suffering from some limitations, is conceptually more sound than that of Blattberg&Co. The premise is more or less the same: let's use a marginalistic approach (costrained optimization tecniques?) to see wich kind of investment has the bigger impact on Customer Equity. In this case, though, the authors acknowledge that there is wide array of drivers and subdrivers acting on it (which they class into three main groups: value equity, brand equity, retention equity. Still, if I remember correctly the authors didn't properly consider customer acquisition...oh, and I forgot to mention the CUSAMS model by Bolton et al. Anyway, to be completely honest with you, I'm not able to delve into the intricacies of those models, not having a statistics phD.

the bottom line: to this day I can't answer your question satisfactorily. Which is why I'm so glad to hear what the other members will say on the subject.

Jim Novo
Member

Posted 10-Mar-2005 09:18 AM

I just wrote about this topic in my newsletter. There are quite a few examples out there of Acquisition programs creating negative value customers and driving higher customer defection. If you have an unlimited Acquisition budget you don't have to worry about Retention. If you have a fixed budget and are looking to maximize profits, Retention should drive acquisition by pointing out where Acquisition is failing. See:

When Acquisition Spoils Retention

Jim Novo | Author: Turning Customer Data into Profits
http://www.jimnovo.com
Co-Author: Marketer's Common Sense Guide to E-Metrics
http://www.hiqhq.com/marketersguide.asp

Jeremy Cox
Member

Posted 17-Mar-2005 08:58 AM

The trade off is considerably easier to make if you take the first step of assessing the current and potential profitability of your customer portfolio. Once this is understood you will identify customers who if they leave may destroy your business, others who if you keep them may drag your business down, and still others who might become more profitable if you change the way you service them.

If you then make a business decision about which to acquire, keep and develop, the next step is to find out what it will take to make that happen.

From there you can develop appropriate strategies and operational tactics to achieve your business goals. Any trade off that is required will then be pretty obvious.

The difficulty comes with jumping the gun, diving into technology without much intelligent thought up front.

This simple framework helps firms think CRM through, so that such decision can be made rationally, for the good of the business.

strategic framework

Jeremy Cox MA DipM
Managing Director
The Wisdom Network Ltd,
www.thewisdomnetwork.com

Behram Hansotia
Member

Posted 25-Mar-2005 11:26 AM

Tis problem ideally should be addressed in the context of capital budgeting. Line up all the acquisition and retention projects (and other firm projects)and evaluate them on the basis of Internal Rate of Return (IRR)or Net Present Value (NPV). Accept all projects with IRRs larger than your firm's cost of Capital (COC) or those with positive NPVs or Life Time Values, LTVs (assuming you use the COC as the discount rate.) Conceptually this is straight forward, however the devil is in the details. Estimating the size and timing of the customer generated cash flows (revenues and profit margins) is a significant challenge, let alone identifying and estimating all the fixed and variable costs at the customer level.

To apply this approach requires firms to have several customer acquisition and retention opportunities available and be able to evaluate these on the basis of LTV. If the opportunities are large, hopefully it can divide the prospect and customer groups into smaller cells and then evaluate each of the cells. Several challenges will remain. However, I feel even if there are no correct answers to some of the questions, (for instance, how far into the future should we estimate the cash flows) if a firm uses a consistent approach, I believe it will make more correct decisions as it systematically attempts to make investments that exceed its cost of capital. This in fact is a key strategy for continuously enhancing firm value. I would recommend that firms start with simpler models and over time refine them. Continuously identifying acquisition and retention opportunities requires continuously understanding customers' needs and even training them how to: percieve your brand, differentiaite among competing brands and to make their brand selection decisions. It also implies ongoing testing to identify the best opportunities out there.

This is a highly dynamic game and if you are to succeed not only should you be doing ongoing evaluation of the programs but defining the rules of the game for your industry. I believe this is called a Market-Driving Strategy.