When Every Customer Is a New Customer

When Every Customer Is a New Customer

     
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When Every Customer Is a New Customer

Addressing High Turnover in a Customer Base

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  • When managers evaluate potential new businesses, it’s one of the first questions they ask: How fast is the market growing? By focusing only on growth, however, companies often overlook another critical measure of market potential—the turnover of the customer base. High turnover can make a market dynamic even when the overall growth rate is low.

    Consider the market for smoking-cessation aids, which hasn’t grown at all over the last ten years. During that same time period, though, the market shares of the leading brands, Nicorette and NicoDerm, were cut almost in half by the brands of Walgreen, CVS, Wal-Mart, and others. Compare this with the market for cigarettes. Although growth was equally flat during that time period, the market share of leaders such as Marlboro and Camel hardly changed, and no new brands, including private-label brands, gained a foothold.

    Why the difference? Customers of smoking-cessation aids turn over quickly—they either quit smoking or take up the habit again. In the cigarette market, by contrast, most customers stay put, and this low turnover protects incumbents.

    The same concept applies to fast-growing industries. Case in point: Nintendo’s position in the video game industry seemed unassailable in the mid-1990s, but Sony saw an opportunity as teenage players transitioned into adulthood. By 1999, Sony’s PlayStation had transformed the industry and dethroned Nintendo. The tables turned again when Nintendo’s Wii overtook Sony’s franchise through a combination of innovative game play—targeted in part at families—and low pricing.

    The bottom line: In high-turnover markets, customer loyalty is less meaningful, which can put market leaders at risk.

    Capitalizing on Customer Turnover

    Our research shows that growth alone doesn’t predict the percentage of new customers that a market will gain in any given year. In fact, low-growth markets may have a higher share of new customers than high-growth markets, and mature industries can be very dynamic indeed—if they have a high turnover rate.

    Three factors drive customer turnover: infrequency of use, product durability, and age specificity. Anything that is rarely used, such as funeral services or pregnancy tests, will have a constantly changing pool of customers. The same is true for durable products, such as cars or refrigerators, which customers tend to buy and hold on to. Finally, products that target a specific age group or life stage will have a customer base that turns over regularly—baby products and teen magazines are good examples.

    To calculate a market’s turnover rate, first establish the overall size of the market by taking the total number of customers at the beginning of a year, adding the number of customers who entered the market over the course of the year, and subtracting the number who exited. Then divide the number of new customers by the ending number of total customers to find the net turnover ratio (NTR). The higher the NTR, the greater the opportunity for new entrants—and the greater the risk for established players.

    Let’s apply this formula to the cigarette market. In the U.S., about 40 million people smoke, and 3,000 to 4,000 people start every day. That’s about 1.3 million new smokers per year versus the 6 to 7 percent who quit. This results in a customer entry rate of about 3 percent, a customer exit rate of about 6.5 percent, and an NTR of only 3.4 percent. Compare this with the smoking-cessation market, which renews itself every year and has an NTR of virtually 100 percent.

    The turnover map in the exhibit below shows the net turnover rate of a market as a function of the percentage of customers entering the market (vertical axis) and the percentage exiting the market (horizontal axis). This “heat map” ranges from blue (cool) to red (hot) to reflect the growth and turnover conditions that create the greatest opportunities.

    exhibit
    Winning Strategies for New Entrants

    High-turnover markets offer exceptional opportunities to new entrants because so few customers have established loyalties. But winning these customers can be challenging. They may be risk averse or reluctant to try something new—especially if they’re unfamiliar with a company’s name or brand. Then there’s the financial outlay needed to acquire new customers. The costs of product development and marketing and sales add up. New entrants can offset these challenges with the following strategies:

    • Make it easier to buy or cheaper to switch. The goal here is to overcome customers’ inertia or reluctance to try something new. When Sony entered the video console market, the Nintendo and Sega systems were well entrenched. Sony was unknown and untested. To gain share, Sony equipped its PlayStations with a CD drive, essentially creating the cheapest CD player in the market. Customers got two uses out of one system, which increased its perceived value and offset their concerns that the new system wouldn’t be a hit. Sony used the same strategy when it launched the PS2 (with a DVD player) and the PS3 (with a Blu-ray player).

    • Use bundles or brand extension to drive adoption. Bundles give customers more value than existing products offer. To compete in the browser market that was dominated by Netscape, Microsoft seamlessly bundled Explorer with its highly valued Windows operating system. Apple took a different but equally successful approach, shrewdly extending its powerful “i” brand—from iPod to iPhone to iPad—to enter markets dominated by Sony, Nokia, and Amazon.

    • Form alliances with reputable partners from low-turnover markets. Unknown new entrants can increase the comfort level of potential customers by forming alliances with established, reputable partners that can provide referrals. For instance, real estate agents gain credibility by associating themselves with banks and insurance companies—stable players in low-turnover industries. And textbook publishers build long-term relationships with professors to get their books on the reading list in the high-turnover college market.

    With these strategies, ambitious competitors can break into new markets and upset the status quo. But established players can fight back and defend their positions with their own series of strategic maneuvers.

    Defensive Strategies for Incumbents

    Established players must look for ways to defend and grow their positions by putting the brakes on customer turnover wherever possible. Three strategies can help companies retain existing customers and acquire new ones:

    • Provide a migration path. When customers see ways to extend the value of an existing product or service—and how it can meet current and future needs—they have fewer incentives to leave. Loyalty programs such as the “frequent flier” membership clubs that airlines offer can help retain customers by offering progressive rewards at different levels, such as silver, gold, and platinum. Similarly, Lego gets toddlers started with Duplo and offers increasingly diverse and sophisticated Lego products for young adults that may even entice them away from video games.

    • Increase total value. Customers like products that provide additional, often unrelated, value. Airline or bank loyalty points that become a currency for buying other highly valued products and services—such as hotel rooms, golf clubs, electronic devices, and even once-in-a-lifetime experiences—can help to retain current customers and attract new ones. Similarly, “family and friend” packages for mobile phones increase customer loyalty.

    • Build alumni networks. High-turnover markets have many more “alumni” than current customers. These former users can become powerful allies, effective spokespeople, and an excellent source of referrals. Universities use alumni reunions, conferences, and sporting events to leverage the loyalty, support, and recommendations of past students. Similarly, consulting firms seek referrals from the executives they’ve worked with—many of whom are “graduates” of the firm and an ongoing source of new business. Even hospitals minimize patient churn by scheduling follow-up appointments for x-rays, treatments, and checkups.

    Fast turnover of a market’s customer base can present major growth opportunities for newcomers and incumbents alike—if they have the right strategy for gaining, growing, and keeping share. Of course, turnover can change as markets age, creating new openings and risks. It is critical, therefore, that companies monitor the turnover rates of their different products and revise their strategies accordingly, making informed decisions about when to decelerate turnover to defend their positions or accelerate turnover to gain more share. The turnover battle is never at an end, but companies with the right strategy can consistently beat out lesser competitors and reap exceptional rewards.


    The ideas in this article originally appeared in “When Every Customer Is a New Customer,” Harvard Business Review, May 2011.

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