This is an excerpt from Sean Ellis and Morgan Brown’s latest book Hacking Growth, the definitive playbook on building and growing businesses from two Silicon Valley pioneers. To read the entire book, buy it here.
Legendary business expert Peter Drucker famously wrote many years ago that the purpose of business is to create and keep a customer. But even though no one would argue with the famous business maxim, the fact is that for most businesses, the rate of customer churn—the rate of loss of new users—is appalling.
This is unfortunate because high retention is generally the deciding factor in achieving strong profitability, for any kind of company.
Widely cited research by Frederick Reichheld of Bain & Company has shown that a five percent increase in customer retention rates increases profits by anywhere from 25 to 95 percent.
The flip side is that losing customers comes at great cost. One reason is that, it takes so much money to acquire a new customer, especially at a time when advertising costs are skyrocketing due to a surge in competition for prime online real estate.
And the more you have to spend up front to attract new customers, the more costly the loss of each customer becomes—making retaining customers that much more essential, both for recouping your spending on expensive ad campaigns and for preventing customers from defecting to the competition.
Here we’re going to breakdown the three major phases of product retention and what “good” retention looks like at companies, from Apple to Zillow.
Homejoy v. Amazon: 20/20 perspective
Homejoy, a home cleaning startup, once had a bright future, raising more than $64 million from some of Silicon Valley’s best investors. But the company is a prime example of the danger of poor retention. Despite having attracted an impressive number of initial customers through an aggressive promotional discounting strategy, Homejoy failed to live up to its promise, delivering service that customers described as “hit or miss.”
In addition, many customers couldn’t swallow a steep jump in price from a promotional first cleaning, at a special discounted price, to the regular price for the service; the result being that only 15 to 20 percent of customers ended up ordering a second cleaning.
Meanwhile, Homejoy’s competitors were achieving retention rates double those numbers. Making matters still worse, the company had spent heavily on customer acquisition. This combination of high acquisition costs and low retention led to its rapid demise.
Amazon, in contrast, is perhaps the gold standard example of retention prowess. The company’s subscription program, Amazon Prime, has been a particular triumph in retaining customers, largely due to the two-day free shipping included on thousands of items, but also many ancillary benefits that have been added to the program, such as its video and music streaming services.
Seventy-three percent of free trial subscribers convert to paying subscribers, and ninety-one percent of first year subscribers renew for a second year. What’s even more impressive is that retention continues to increase the longer customers have been subscribers, with the renewal rate for customers heading into their third year in the program at an almost unheard-of high of 96 percent.
Any company would dream of those retention rates. But before a product team sets its sights on those types of metrics, it’s essential to understand your customers (or users), and break down exactly which phase they fall in.
The Three Phases of Retention
Brian Balfour, founder and CEO of Reforge, and former leader at HubSpot, highlights that retention breaks down into three phases: initial, medium, and long-term.
The initial retention period is the critical time during which a new user either becomes convinced to keep using or buying a product or service, or goes dormant after one or a few visits.
Think of the initial retention rate as a measure of the immediate stickiness of the product. There is no fixed definition of the initial retention period; it might be as short as a day for a mobile app, or a week or two for a social network.
For a software as a service (SaaS) product, the initial retention period might be more like a month or quarter, whereas for e-commere companies it is often the first 90 days.
You should determine this period for your product based on both the data you can get about the standards for products of your type across the sector you’re in and by your own analysis of the behavior of your own customers over time.
The good news about this period is that research shows that users who get more value from a product during the initial period of use are more likely to stick around longer term.
Also, generally, there’s lots of opportunity to improve the user’s experience in this phase. This was the main impetus behind the start of the growth team at HubSpot, as explained by cofounder and CTO Dharmesh Shah.
“The reason we decided to kick off a growth team in the first place was that we felt there was a lot of low-hanging fruit in our trials/onboarding process.”
This initial retention phase is essentially an extension of activation; think of it as assuring that customers or users are truly active; that they haven’t just given your product a cursory once-over and then lost interest. It might seem to make better sense to just consider this as part of the activation process, but the distinction is meaningful.
For many products, solidifying the appreciation of the value of a product or service requires new customers returning for an additional experience with it a certain number of times within a certain time period.
For example, Pinterest might determine from analysis of user data that if a new user doesn’t return to the site at least three times within the first two weeks after signing up, they are highly likely to abandon use.
This means that the growth team would want to work intensely on getting them back that minimum number of times within that time frame, and anyone who has signed up for Pinterest will find that the company is indeed vigorous in encouraging return visits beginning right after initial sign-up.
Once new users have crossed the threshold of initial retention, they move into the medium retention phase, a period when the interest in a product’s novelty often fades.
The core mission for growth teams in retaining users who are in this midterm phase is to make using a product a habit; working to create such a sense of satisfaction from the product or service that over time, users don’t need to be prodded to use it again because they have incorporated the use of the product into their routine.
Think of the Snapchat user who constantly checks her friends’ stories while having breakfast and again after dinner.
Or the Amazon shopper who always thinks of searching there first for any given product he’s looking for, no prodding required.
Understanding the psychology of habit formation (which Nir Eyal speaks to in-depth in his book, Hooked) and then introducing growth tactics is key for increasing the number of initially retained users who become habitual ones.
This is the phase in which growth teams can help to assure that a product keeps offering customers more value.
Teams must experiment with ways to keep improving the product, helping product development teams to determine the timing for introducing enhancements of existing features or entirely new features.
The key here is to keep refreshing the customer’s perception of the product as must-have.
But what does good retention really look like?
It’s important to discuss the data that growth teams must be tracking and how they should be parsing it in order to find opportunities for hacks to try. First, different companies will want to measure their retention rate in different ways.
This is due to the fact that the frequency with which customers return to purchase items or use a service will in large part be determined by the nature of the product or service.
Some things we need or want often, and others much less so.
While Facebook wants users to be returning daily, Apple knows that purchasers of an iPhone will likely not buy a new phone for several years (except for the raving fans who always immediately purchase the newest version), so it won’t know if a given iPhone buyer has been retained until perhaps three years, maybe more.
This is a key reason that Apple’s evolution into a provider of the services people use with their products in addition to the devices themselves, was such a brilliant growth tactic; it allowed the company to capitalize a great deal more on its retained customers in between product releases.
The frequency with which buyers search for listings on sites like Zillow also varies from how often diners search Yelp for restaurant recommendations, just as the search and purchase frequency for customers looking for mattresses will differ from those looking for a new pair of shoes.
For e-commerce, the basic metric of retention is the repurchase rate of customers, which might, for example, be the number of times customers make a purchase per month.
Many e-commerce companies, for example, measure the repurchase rate per 90 days, but again, this time frame varies depending on the product sold.
Since most people shop for groceries at least once a week, our grocery app team would want to be looking for more frequent purchases, say, every ten days or so, as a sign of healthy retention.
The key point is that in crafting your retention metrics, it’s important to benchmark your results against the best information you can get from market research about the typical retention rates for your kind of product or service, and any information you can find about the performance of successful companies you are competing with.
These benchmarks are the only way to tell whether what you’re seeing with your customers is typical, better, or worse than expected.
A company like Airbnb can never expect to get as much engagement and retention as a social network, so these benchmarks become important in pinpointing how your retention is faring.
Sources such as industry publications, trade associations, and research companies Forrester and Gartner can offer industry-specific insights.
While we’ve so far discussed retention in terms of the customers you keep, it’s also critical to track the flip side, the customers who defect, or churn, from your business each week or month.
Your churn rate is essentially the inverse of your retention rate; so, for example, Costco’s 91 percent membership retention rate is also a 9 percent annual churn rate.
Some churn is unavoidable, even for the best-loved products. But clearly, for all businesses, the lower rate of churn, the better.
For a deep dive into Sean Ellis and Morgan Brown’s expertise on product retention (as well as acquisition, activation and renewal) read the entire book, Hacking Growth.
|Adapted from HACKING GROWTH: HOW TODAY’S FASTEST GROWING COMPANIES DRIVE BREAKOUT SUCCESS
Copyright © 2017 by Sean Ellis and Morgan Brown. Published by Crown Business, an imprint of Penguin Random House LLC.