Most Startups Ignore the 1 Statistic That Leads to Long-Term Success. Here’s What You Need to Know
To ensure the long-term health of your company, make sure you’re keeping track of this metric.
PHOTO CREDIT: Getty Images
If that number is higher, great; If it's lower, not so great. Right? Well, not necessarily.
There's one key financial metric that many business owners ignore, even though it's almost as important as revenue or profit (and maybe in the long term even more important): the percentage of customers you lost over the past year.
I'll refer to this metric as "cancellation rate" even though that term is most applicable to subscription-style business models. Another term that's sometimes used is "retention rate," which is 100 percent minus the cancellation rate. Both are measures of "customer loyalty," which is a concept rather than a metric.
So here's the thing: even if your revenue and profit are up for the quarter, if your cancellation rate is high, you're losing money.
Allow me to explain with a (highly simplified) example.
Suppose that in 1Q17 you had 100 customers, each whom generated an average revenue of $10,000. Your revenue is therefore (of course) $1 million.
Now suppose that in 1Q18 you have 100 customers, each of whom is still generating an average revenue of $10,000, so your revenue is still $1 million.
So it's a wash, right? Well... again, not necessarily.
Let's also suppose that during the year, you lost 20 customers (for whatever reason). Therefore, to keep your quarterly revenue flat, you had to acquire 20 new customers. So rather than doing "okay" with a flat revenue, you're actually in an Alice Through the Looking Glass situation:
"'Well, in our country,' said Alice, still panting a little, 'you'd generally get to somewhere else--if you ran very fast for a long time, as we've been doing.'
"'A slow sort of country!' said the Queen. 'Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!'"
Many companies--especially those with aggressive sales teams--get so focused on acquiring new customers that they ignore their existing customers. This reduces your profitability in three ways, even if you're growing like gangbusters:
1. Higher Customer Acquisition Costs
It is almost always cheaper to sell to a current customer than to acquire a new one. While this varies from industry to industry, the difference can be huge. I've seen many situations where landing a new customer costs 10 times more than selling the same amount to an existing one.
2. Increasing Customer Acquisition Costs
The cost of acquiring a new customer typically increases over time, because eventually your sales team will run through all the low-hanging fruit, and then through the medium-hanging fruit, and then all you've got left are the hardest-to-sell fruit at the treetop.
For example, suppose you've carefully compiled 10,000 subscribers to your newsletter. Your first sales campaign is likely to land the most prospects, while your second (all things being equal) will land fewer prospects, and so forth, until the list is tapped out.
Furthermore, the leads who respond to the later mailings are likely to be harder to develop than the leads who responded to the earlier ones, because if they were "ready to pop" they'd probably have responded to the earlier mailings.
3. Decreased Competitive Advantage
Every time you lose a customer, you're potentially creating a customer for your competition.
What's worse, if you've lost the customer to your competition because the customer is unhappy with the experience, you may have created a fountain of bad publicity: the customer could leave bad reviews, diss you at industry conferences, tell colleagues to avoid you, and so forth, all to the benefit of the competitors picking up the slack you created.
That's why it's crucial to check your cancellation rate at the end of every quarter. A rule of thumb: if your cancellation rate is higher than 10 percent, consider reallocating some sales and marketing resources away from growing the base and toward keeping your existing base happy.