Best Practices

In most industries, generating new business can be a very costly venture. The effort to bring in just one new customer can range from hundreds of dollars to produce a simple business letter to thousands or tens of thousands of dollars for direct mail, advertising, and other sales and marketing programs. As a result, the reoccurring expenses sustained when companies implement these types of activities can dramatically affect profit margins.

Yet, businesses need to generate ongoing sales to produce revenue. The debate is whether to focus mainly on acquiring new customers or retaining active and inactive ones. A proposed answer comes in the form of the Pareto Principle also known as “The 80/20 Rule.” In other words, spend 80 percent of the time on customer retention strategies and 20 percent on acquisition tasks. This conscious business decision not only saves the company both money and time, but contributes to increased profit, as well. That’s why customer retention should be considered the backbone of the business.

Profit Vs. Contribution

Frequently, profit is a misunderstood term. It is not any one product or service produced by a business that generates a profit. Only the company itself can show a profit. The item or service produces revenue when it is sold. Then, the expenses tied to making the item or providing the service are subtracted from the revenue. In other words, these specific direct expenses would not occur if the product (or service) was not sold to the customer.

This includes purchased materials, subcontract labor, sales commissions and any other expenses incurred exclusively because of this sale. It does not include any allocation of in-house labor or overhead expenses as these would be the same even if the product was not sold. The re­maining amount after this deduction of direct expenses is called contribution or “throughput.” A company’s operating expenses (including labor and overhead) are paid for out of the sum of all products/services’ contributions, and whatever is left is a company’s profit. Treating in-house labor as a fixed expense may be somewhat controversial. However, most personnel on a staff are not hired or laid off on a daily basis as projects come and go.

Typically, unless the company is working on only a single project, the sale or daily revenue created by one product or service activity does not create enough contribution to pay for one day’s operating expenses. If the contribution from the services or products sold in one day does not ex­ceed the amount of the daily operating expenses, the company is losing money. Once the company sells enough products or services each day to accrue enough contributions from these sales to pay all of the operating expenses and has revenue leftover, then the company shows a profit.

Productive Capacity

The productive capacity of a company is determined by the number of products that can be produced or services that can be provided in a specific time period with available resources. What restricts a company’s ability to provide a service or sell a product, thus limiting its contribution and profit? It may be a lack of resources (i.e., raw materials) needed to produce enough products to satisfy the marketplace. Or, it’s possible that the company doesn’t have the productive capacity (i.e., labor) to satisfy the demand. In many cases, it is neither capital equipment nor labor, but the poor policy (or management) decisions a company makes in deploying their resources effectively.

The limitations of a company’s productive capacity mean that companies repeatedly weigh the benefits of selling more to the same customer vs. seeking new customers. Part of this discussion inevitably includes an analysis of the effort required for new customer acquisition, including items such as:

  • The time and cost of acquiring productive leads
  • The cost to make initial contact and canvas the lead base
  • The potential cost of learning new techniques or technology to address market segments not already addressed
  • Setting up necessary internal systems to process business transactions with the new customers
  • Using crucial resources, such as time and the legal fees, for negotiating the contracts
  • Researching customers’ backgrounds to determine credit and trust worthiness
  • Identifying specifications important to new customers to provide the seamless service that will ensure a long-term relationship.

It is important to recognize that when companies engage in these activities, they are spending valuable resources and not earning revenue. In other words, the company is redirecting some of its productive capacity to acquiring new customers rather than actually producing products or services for existing customers. The result is a loss of sales revenue, which can be a more significant factor than the money spent for the development costs associated with acquiring a new customer.

What Customers Want

An important step in maximizing a company’s productive capacity is to make customer retention a key organizational strategy. This is ac­complished through changing the corporate mindset and culture. It involves a more customer-centric orientation, paying close attention to and understanding exactly what customers are purchasing from the business. While some may consider the answer obvious (i.e., they are purchasing a new home, a remodel, or electrical or plumbing renovations), what customers really are buying is what those products and services do for them. That means pride of ownership, satisfaction of emotion, comfort and convenience, security and protection, desire for gain or avoiding fear of loss.

In other words, customers want the experience the house gives them by living in it. If a business provides customers with physical structures that don’t satisfy their needs, they will not be happy. For example, let’s say a customer wants to have an electrical system renovated. If the contractor hired for the job doesn’t provide fast, reliable and responsive service; doesn’t place the outlets exactly where the customer wants them; or only installs the single on/off switch for the hall light instead of pointing out the value of two-way switches, the end result is not considered the best solution. Even though the company did the work and installed the required number of outlets, or the requested switch, it didn’t solve the customer’s problem or address the underlying need. It’s unlikely that this customer will stay with the contractor.

To understand what a customer is really purchasing and how to best satisfy the customer, it is important to collect information by asking key questions such as:

  • How does the company make business transactions painless and easy?
  • Does the company make sure there is clarity and agreement with the customer in the project’s goals and objectives before the work is started?
  • In what way does the company show a sincere interest in customers?
  • How are customers’ expectations uncovered, identified and fully explored?
  • What does the company do to show that it is responsive to customers’ needs and requests?
  • What questions does staff ask customers (or potential customers) to assist in identifying the problem that needs to be solved?
  • How does the company collect data about customers’ experiences in doing business with the organization?
  • What is the company’s success rate? Are projects completed correctly the first time, ensuring happy customers while saving expenses and time associated with rework/call-backs?
  • What problem-solving tools and training does the company give its employees and how often?

While the answers to these questions focus on gathering data to understand the customer/client relationship in greater depth, there is one question, above all else that every business owner must ask: What am I doing right now to push my customers away? Then, when the question is answered, the company must stop doing whatever is causing the problem immediately. This simple step can provide the basis for a sound customer retention strategy.

The Balancing Act 

When does a company stop recruiting new customers and focus only on retention? The answer is never. To stop recruiting basically means the company does not desire to grow. The quandary isn’t whether a company should continually recruit new customers or focus on retaining existing customers. Rather, companies can learn how to maximize their productive capacities in order to do both. For instance, owners can use idle resources to conduct recruiting activities (e.g., identifying new markets, preparing mailers) by offloading these tasks to employees with spare time. Or, companies can elect to pay for these services using outside consultants and services. Owners create contribution through selling and delivering products and services at higher rates than their employees. Therefore, engaging in acquisition activities will cost a company substantially less if someone else is paid to do them.

It is the owner’s responsibility to identify, establish and monitor the company’s approach to addressing customers’ needs — whether current or new customers. Assuming that employees or even outside consultants know exactly what needs to be done is a mistake. Successful acquisition and retention strategies are based on core values  that come from the top.

When owners take the time to investigate customer interactions, barriers and road blocks to satisfaction can be identified and removed. The result is happy customers — those who will come back time and time again to the company for more products and services.

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