The retention rate is one of the most important metrics for any organization that has customers paying on some kind of regular or subscription basis. From wireless telecom service to insurance coverage to banking products and more, the ability to retain customers over time is critical for success. The typical measure of retention is one that calculates the percentage of existing customers that remain over a one year period. You start the year with 100 customers; one year later, 80 of them are still on the books: the retention rate is 80%.
That’s simple enough. The tricky part with any retention rate formula however, is how to deal with new customers who come in during the year. Ideally you separate them out, and indeed some companies do separately track retention on existing customers versus new. But there are some definite challenges with that approach: the minutiae of tracking all the different types and timings of attrition can often lead to numbers that “don’t add up”; there is the complexity of providing two different measures of retention, leading to the inevitable request for a third measure that combines existing & new customers; and finally, there is the question of whether the time and cost are worth the effort.
Be that as it may, let’s presume your measure of retention is for new & existing customers combined; what formula do you use to measure retention? Recently, I did a Google search on measuring retention, and by far the most common formula I came across was the following:
Formula #1: Retention Rate (RR) = (End – New) / Start
Very simply, one subtracts new customers from the count of ending customers, and divides that amount by the starting customer count. In the equation, the starting point is 1 year prior to the end point, and new customers are the count of sales during those intervening 12 months.
To demonstrate this retention formula, as well as two other formulas to follow, let’s use a simple example where we start and end the year with 100 customers, and during the year bring in 20 new customers.
Formula #1: RR = (End – New) / Start
Example: RR = (100 – 20) / 100
RR = 80 /100 = 80%
In this example, we start the year with 100 customers, see 20 new customers come in during the year, and end with 100 customers. If we subtract out the new customers, we see that we’ve retained 80 customers, giving us a retention rate of 80 over 100, or 80%. Nice. Simple. But unfortunately, not very accurate. Next week, we’ll see why.