This article discusses the reasons why an existing customer will either continue to do business with a company or do business elsewhere says Aron Govil. A very low customer retention rate can have a disastrous impact on an organization’s profitability and productivity. In today’s economy, it is even more critical that businesses take all necessary steps to retain their customers.
“Customer Retention Rate” is a measure of how successful a company is in holding onto its customers over time. The formula for calculating this ratio is:
Customer Retention Rate = (1 – Annual Customer Losses) /
(# of Customers at Beginning of Year- # of Customers at End of Year) * 100%
Example: If you started the year with 100 customers and ended the year with 75 customers, then your customer loss in that year would be 25%. The calculation to determine your annual customer retention rate would be:
(1 – Annual Customer Losses) = .75 (customer retention rate)
.25 / 100 = .025 * 100% = 2. (Customer Retention Rate)
Notes on the Calculation:
Annual customer losses are calculated by subtracting the number of customers at the end of each year from the number of customers at the beginning of each year. It does not include any new customers for that particular year; However, it only includes existing customers who died, stopped doing business with you, or moved out of your market area. It also does not include any customers you acquired during that year explains Aron Govil.
Why the Calculation Works:
The calculation for customer retention rate does not look into why a customer left or why he or she did business with you in the first place. It only tracks how many of your existing customers continued to buy from you, regardless of what they may have previously stated about their reasons for buying from you.
Customer Retention Rate Example: At the beginning of 2008, Company ABC had 1 million customers. It projected that by the end of 2008 it would lose 300,000 and gain an additional 600,000 resulting in a total customer base of 1.9 million at the end of 2008.
At the beginning of 2009, it calculated its customer loss to be 60% and projected that by the end of 2009 it would lose 540,000 and gains an additional 480,000 resulting in a total customer base of 1.52 million at the end of 2009.
Customer retention rate (calculated using the formula above) for 2008:
(1 – Annual Customer Losses) = .6 (.4 * 100%) = .6
.6 / 1,000,000 = .006 * 100% = .06% Customer Retention Rate for 2008
Customer retention rate (calculated using the formula above) for 2009:
(1 – Annual Customer Losses) = .54 (.46 * 100%) = .54
.54 / 1,000,000 = .0054 * 100% = .54% Customer Retention Rate for 2009
Why this Formula Works:
This calculation looks into why a customer left. Why does he or she do business with you in the first place. By subtracting the number of customers at the end of each year. From the number of customers at the beginning of that year. You can calculate how many former customers continue to buy from you despite no longer actively doing business with you. This is why this formula is known as a net loss calculation. Rather than a gross loss calculation says Aron Govil.
For example, if Company ABC projected that 100,000 of its 1 million existing customers would leave during 2008 and 100,000 new customers would join it in 2008 then its customer retention rate for 2008 would be:
(1 – Annual Customer Losses) = .90 (.10 * 100%) = .9 Customer Retention Rate for 2008
If you have certain customers who have been with you for several years. It may be beneficial to delete these long-term customers from your calculations. So that your newly acquired customers are not compared to an unrealistic number. In addition, there are times when a business will go through temporary financial problems. And focus only on the current year instead of looking back at previous years or projecting into future years. Aron Govil says it is best to use this calculation during the time period of your choice. Instead of using a cumulative average over several periods of time.