The elasticity of customer value to retention: The duration of a customer relationship

Abstract

A cornerstone of the customer relationship management (CRM) and interactive marketing literature is the Reichheld and Sasser statement that “reducing defections by 5% boosts profits 25% to 85%.” The basic premise is that a relatively small increase in customer retention (loyalty) will drive relatively large increases in profits. As the practice of CRM matures, we believe that managers and researchers will be interested in a more exact quantification of the economic benefits of increased customer retention. This article develops methods for determining percentage increases in expected customer (and prospect) lifetime values due to increased retention. In particular, we derive an equation for the elasticity of expected customer future value, the component of customer lifetime value contingent on retention. This equation for “retention elasticity” is based on a general model of a customer-retention relationship in which margins, retention spending, and retention probabilities vary with tenure. Using a numerical example, we investigate the factors that affect retention elasticity. We also show that this retention elasticity is equal to the financial duration of the customer asset. This connection between retention elasticity and financial duration offers a new perspective from which to understand and interpret retention elasticity. For example, just as duration is an important measure of a bond's risk, so too is retention elasticity a measure of one source of volatility in the value of a customer relationship.