I was brought up on the law of diminishing returns. This states that in any production or service process, if you increase one of the inputs without increasing the others the additional returns per unit of that input will fall. This applies to every marketing input advertising, mailshots, even sales people. Of course, the relationship is often complicated.
For example, if you have a good sales and marketing infrastructure and strategy, but too few sales people, the first few extra sales people you take on may give you increasing marginal returns because they work well as a team and specialise. To put it another way, when one input is very low compared with the rest, you might experience increasing marginal returns.
Enough of the economics and back to marketing. Recently, I have seen the extent to which companies understand fully the economics of customer recruitment and retention, especially as it applies to new products and services and new and existing customers. I do not mean the old chestnut, customer retention is more cost-effective than customer acquisition, although it is part of the story and a story that shows how rotten that chestnut is. Poor acquisition strategies lead to retention problems, so it is worth spending good money on acquiring good quality customers. Nor do I mean the Pareto 80:20 rule, though that kind of imbalanced customer profitability or value is an inevitable result of what I’m examining.
No, the area that interests me is the law of diminishing customer returns. This states that the larger your customer base for a given proposition, the lower the average value of additional customers. It’s not really a law, but it reflects the reality of most companies. If you have a good proposition and you market it well, your earlier customers are the ones who found your product most valuable, and may be prepared to pay more for it. In terms of the classic product life cycle, the customers whom you attract in the early stages often form the bulk of your valuable users later on. Later additional customers are harder to attract. If you went for a skimming model of market development, rather than one of market penetration with low prices designed to knock your competitors out, they may not have been able to afford your initial pricing.
The end result is that as many companies try to grow by acquiring new customers and developing existing ones, they find they hit a brick wall when it comes to new customers. The average new customer may be more price sensitive, less valuable, less loyal, slower to pay and perhaps even less creditworthy than the existing customer. This can lead to the situation in which a good proportion of these customers are unprofitable, or make a minimal contribution.
The evidence I have is that it is definitely worth confronting this law. Start by due diligence ensuring you gather and analyse data on your recent customers for a particular proposition separately, to see what happens to them in their first couple of years compared with the other customers. Did they stay or go? Did they buy much? Did they pay on time? Did they threaten to leave to obtain discounts? Were they expensive to service? Did they recommend other customers? When you profiled them against external data sources, how did they look compared with the rest of your customers?
However, you must also be honest about whether your proposition really suited them. Did you attract them by push marketing, with a proposition that was more suited to your most valuable existing customers but did not suit them? Did you service them too expensively? Did you sell through the wrong channel? Did you assume that they would be just like the rest of your customers? Did you assume you could sell them the same additional products as the rest of your customers?
Of course, what I’m advocating is strong cohort analysis analysis of customers by their recency (a horrible term, but very concise) of take-up of your new proposition, in particular focusing strongly on comparing recent with earlier cohorts. It’s also worth comparing the performance of different sales people, because some may only achieve sales at the expense of recruiting lots of weaker customers, while others may be able to keep recruiting good quality customers.
Any comparison must also take into account the extent to which competitors for your new proposition have been trying to steal your best customers (and of course to palm off their worst customers on you). This applies particularly when you are one of just a few companies competing for the whole market. Also, the length of your own and the industry product life cycle has an effect specifically the period between major innovations because this may dictate the need to re-recruit your own best customers. It also indicates when old propositions become obsolete and valuable customers come to the market looking for replacement.
In summary, the cohort approach, which requires good data and analysis, can be a great way to target your market development it is just a pity that so few companies actually do it properly.