How Lazy Risk Assumptions Impede Your Road to Innovation .. OR .. When Acquiring New Customers Is NOT More Costly Than Retaining Existing Ones

We've all heard the maxim that it costs less to retain customers than to acquire new ones. So if you believe this, you're not alone.

But you're wrong. At least some of the time.

It is a lazy risk assumption that holds businesses back on innovation. It keeps them mired in the old world, instead of entering the modern era.

I would hazard a guess that this concept is referred to in just about every university and business school. It is certainly regularly used by well qualified business consultants.

Over 20 years ago Frederick Reichheld even wrote a book about customer retention economics, strategy and tactics called The Loyalty Effect. If you've not read it, I highly recommend it. It is still completely relevant today. So much so, that most people will accept it as proven and unquestionable.

Some claim it is 3 times more costly to acquire a new customer, while others claim its 30 times more costly in their experience and in their industry. Reichheld even gives quite detailed analyses of the differences between companies on a case by case basis.

But just think about that last paragraph. This means that the cost of acquiring a customer in a low cost market, could be less than the cost of retaining a customer in your existing market.

A new market can have customer acquisition costs and risks far below that of your traditional market.

Like most blanket statements and management theories this one is simply not always correct.

The real answer is, it's not that simple. You should think hard before you dismiss an idea on a knee jerk reaction based on assumptions about the risks and costs of acquiring new customers in new markets.

If your managers, executives and directors are using this blunt cost-risk assumption to block innovative initiatives that would take the business down a "costly and risky" path of acquiring new customers and entering new markets, they are potential missing out on generating higher margin revenues and growth.

According to the Australian Chief Economist, the average gross operating profit of non-innovators is around $175k, new-to-business innovators is $350k, and new-to-market innovators (Blue Oceans) is $700k.

When Is This Assumption Wrong?

There are lots of cases where this view that acquiring new customers is more costly than retaining existing ones doesn't always hold true. Here are a few, in no particular order.

AND not OR: This first point is more about the investment mix, not whether the actual numbers are wrong. The original purpose of this maxim was to provoke managers into rethinking the balance of their marketing spend. To rethink their investment in replacing customers through a revolving door of acquisition and loss, and spend more on investing in lengthening the long tail revenue from existing customers. But I have certainly heard very experienced people misuse it as a blanket argument for not entering a new market at all. "It costs so much more to acquire new customers. We should just invest this time and money in our existing customers and market." But the maxim doesn't say "never invest in acquiring new customers". It's a question of how much to invest in new customer acquisition AND customer retention, not OR.

Thing 1 and Thing 2: Your second sale or long tail from a typical customer may not be homogeneous with your first sale. Therefore the cost of acquiring each new customer may be far lower than the cost of the second sale to an existing customer.

In my industry for example, the cost of each sale to an existing customer increases with every step. The cost of acquisition is lowest at the first stage of customer acquisition. One of the typical customer journeys in my industry is to purchase the Blue Ocean Strategy book (a sale of just tens of dollars), then some e-learning or webinars (hundreds of dollars), then a workshop (thousands of dollars), then a pilot project (tens of thousands) and then an enterprise-wide implementation (hundreds of thousands - or millions if we're talk about worth versus cost :)

So the investment in supporting an existing customer along their complete journey increases with every stage. The cost of customer acquisition at the top of the funnel, through the distribution or sale of a book or a webinar for example, is tiny compared with the investment in time to plan, propose and gain approval for an enterprise-wide application. But that too is worth it for the revenue and margin.

All markets are not born equal: As I pointed out above, the cost of your customer acquisitions are almost certain to be different in different markets. So launching a new product into a new market, may result in new customer acquisition costs that are far lower than the acquisition or even long term customer servicing costs of repeat customers. This up-ends this cost-risk paradigm straight away.

The Theory of Relativity: Taking the previous point one step further, if you enter into a less competitive market (a more monopolistic Blue Ocean) your pricing and margins can be more strategic. Rather than simply accepting the commoditised industry pricing, cost and margin norms of a highly competitive market, you can set prices strategically. The cost of acquisition of a new customer may well be higher, but relative to the revenue and margin you may be far better off chasing the new customer in the new market.

Dead End Streets vs New Highways: We all hear and see disruption taking place in industries we are in, or adjacent to. How long will it take before your existing customers become the newly acquired customers of a disrupter? Then, will you still be arguing about the cost of new customer acquisition?

Choose Your Own Adventure: Like my example above, we still talk about the sales funnel, as if everyone pours in at the wide end and drains out the narrow one. But modern customer journeys are more like flowing down one of multiple streams that form a delta, and empty into a wider ocean. Not all my customers start by buying and reading the book. Some come straight in at the end of the funnel and want an enterprise-wide implementation as our first engagement.

This means that each customer chooses their the own path. Some new customer will make rapid and spontaneous decisions to buy, and have very low acquisition costs. But some repeat customers want to do their due diligence on the next up-sell or repeat sale to make sure you've kept up to date with the latest. They'll visit your website several times to download every one of your free content pieces, call or email or use your online chat facility and pepper your staff with questions, query your pricing versus your competitors, and come to your store or office twice for meetings and demonstrations and clarification discussions before finally making a purchase, or not. Give me the spontaneous acquired new customer over the overly-cautious repeat customer every time.

One Swallow Does Not a Summer Make: If you are a bookstore, repeat customer's may buy book after book, so once you've acquired them as a customer, you should be able to lure them back again and again with some simple emails etc. 

But if you're the author of the book, and you only have one book, there simply may not be any such thing as a long tail to each new customer. Once acquired, the customer's whole lifetime value may have been captured. 

But! I hear you say, you should write a second book in the hopes of luring back the original fan. But is the cost of promoting your second book and making the fan aware of its existence really any different to the cost of promoting your first or the cost of promoting your book to new readers? Is the cost of the repeat sale to that reader any less than the cost of acquiring a new reader?

In any case, if your first book was a success, you'll probably want to invest more, not less, in the promotion of your second book. So the cost of your second sale to existing customers may in fact be higher, unless you can simultaneously acquire lots of new customer-readers and drop the average cost per sale across the total population.

Zero to Hero: If a customer walks off the street and buys a coffee from your cafe, the acquisition cost of that first sale may have been close to zero - eg. signage that is permanently in place or a free listing on Zomato etc. But once they are on your mailing list and loyalty card, each subsequent sale may be costing you more than the first in rewards and discounts alone, even though the product is identical each time (ie. not Thing 1 and Thing 2).

So that's what? Eight explanation or scenarios where this management theory at least needs to be questioned. You may be able to identify more from your business and industry, and if so, I'ld love to hear them.

The next time someone uses this lazy new customer acquisition cost argument against your innovative plan to enter a new market, don't let them off lightly.

So What Are Our Take Aways?

Management thinking often falls into paradigms. We think we have a proven model, only to realise later that it was just a theory, backed by some evidence, but not proven to apply in all cases.

I'm partly writing this to help managers to better understand, and to make the case for creating their own Blue Ocean Strategy. BOS is about creating new markets and new demand, and by definition acquiring new customers in new markets where we have created new demand. By their nature, Blue Ocean markets are somewhat monopolistic in the opportunities to own a market, become the sole supplier, and price strategically to maximise the size of the market, optimise margins, and raise barriers to replication.

It is based on research stretching back over 100 years and across over 30 industries. The research found that products and services that are launched back into red oceans (well known markets with lots of existing customers) are far far less profitable than creating a new blue ocean market and creating new demand.

So the next time someone uses this lazy new customer acquisition cost argument against your innovative plan to enter a new market, don't let them get off lightly. Debate it. I'm not saying create a war of words. Get them involved in a fair process of proper investigation. Ask them to help you question and prove the assumption based on the multiples in your current and proposed markets, new and existing customers, and on the different products and journeys that customers take.

It is a lazy argument at best to say all new customer acquisitions cost more than retention and long tail returns from existing customers . All businesses have to weigh up and balance their decisions on how many new customers they need to acquire, to maintain the status quo and to grow. An investment is required in both areas - acquisition and retention.

So don't make a lazy decision - work it out.

Prologue: The Cost to the Australian Economy

The Australian Federal Government's Office of the Chief Economist releases an annual report on the Australian innovation system.

The 2016 report highlighted that Australia generates only 7.2% of export revenue from innovative products and services, compared with the OECD average of over 19%.

Also, the Australian Chief Economist produced a graph illustrating that the average gross operating profit of non-innovators is around $175k, new-to-business innovators is $350k, and new-to-market innovators (Blue Oceans) is $700k.

That's somewhere in the region of $25bn per annum in lost revenue, that our lack of innovation is costing the nation.

There are two reasons given for this under-performance. One is that our large corporations don't do their fair share of innovation. In Australia, innovation is still very much carried by small and medium business. And secondly, most of our innovations are process innovations, and therefore mostly aimed at lowering our operating costs and improving efficiency in existing industries, rather than creating a new innovative products or service for export. The opportunity cost to our economy is in excess of 10% of our total export revenue, even if we just rise to the middle of the pack. By my rough calculation that's somewhere in the region of $25bn per annum revenue, that our lack of innovation is costing the nation.

Australians carry a mantle of being risk averse. Some seem to revel in it, while others express frustration with it. I'm more in the second camp. Not because I want us to be greater risk takers, but because I want us to get better at making educated risk decisions. The Australian economy was originally built on the sheep's back, but let's not all be sheep and blindly follow old paradigms and assumptions that hold us back, without investing some of our considerable capacity for analysis and original thought.