From the July 1997 issue of Entrepreneur

Goldmine Software Corp. doesn't have to take back product bought by a retailer, but odds are they will. If customers demand weekend delivery of a shipment--even at GoldMine's expense--better listen for your doorbell Saturday morning.

"Words like `It's not our policy' or `I can't help you' are words we avoid here," explains Jon Ferrara, executive vice president and co-founder of the 80-person contact management software company in Pacific Palisades, California. "We do our best to empower the people who are touching the customer to resolve issues to the customer's satisfaction."

Behind Ferrara's client coddling is a goal to never lose a GoldMine customer to a competitor. "It's expensive to lose a customer," Ferrara explains. "And it costs a lot more to get a new customer than to keep [an old one]."

Ferrara's focus on controlling customer defections is right on, according to proponents of a management concept called "zero defections." Not only is it cheaper to keep existing customers, but longtime clients buy more, pay higher prices and are more loyal, says Allan Magrath, author of How to Achieve Zero-Defect Marketing (Amacom).

"Retaining customers," Magrath says, "is a fantastic way to make a lot of money and grow."

Roots Of Zero Defections

The term "zero defections" was coined in 1990 by Frederick Reichheld, a consultant with Bain & Co., a management consulting firm in Boston, and Harvard business professor W. Earl Sasser Jr. It's derived from the "zero defects" goal of manufacturers pursuing increased quality, says Reichheld, author of The Loyalty Effect (Harvard Business School Press).

"If you looked at all the improvements over [the past] few decades, that was the one that most revolutionized manufacturing costs and effectiveness," Reichheld says of zero defects. "But [zero defects] just applied within the four walls of the plant. For most companies, the bulk of their cost structure is outside the plant."

So instead of focusing on the dangers of defective products, Reichheld began to consider the impact of defecting customers. "You invest in customers and employees," he reasoned, "and to have them defect prematurely is wasteful."

Reichheld's research found customer retention has a powerful effect on profits. Surveying 100 companies in two dozen industries, Reichheld consistently found that the longer a company keeps its customers, the more money it makes. One auto-service firm made three times as much profit from fourth-year customers as from first-year customers. Reducing that company's customer defections by just 5 percent increased overall profits by 30 percent, Reichheld says.

Customer retention also helps overall growth. For a typical company that loses 15 percent to 20 percent of customers annually, Reichheld says, cutting defections in half will double its growth rate without having to introduce new products or develop new markets.

Cutting Defection

Reducing customer defection starts with calculating it. This will vary among businesses. A car dealer who doesn't sell to a particular customer for a couple of years, for example, hasn't necessarily lost that customer because most people purchase autos infrequently. A hair salon, on the other hand, may consider customers lost after they miss a single regular appointment.

Changes in the amount of business a customer does with you may also point to defection. A trucker may consider a customer lost if he or she shifts a majority of goods to competitors, even though the customer still sends some business his way.

Identifying defectors also requires collecting accurate and detailed information about your customers. While firms such as mail order companies and magazine publishers may already have adequate customer files, others don't keep track of them at all. Retailers are especially ignorant about who their customers are. Membership cards, frequent-buyer plans and similar information-gathering techniques can help retailers identify their customers and track defectors, Reichheld says.

Computer databases help identify customers--and defectors--but you don't need to invest a fortune to set up a simple tracking system. Reichheld says one restaurant was able to spot defectors by inputting its reservation records into a computer and then looking for names that stopped showing up.

Once defectors are identified, Reichheld advises calling them to find out why they left. Ask specific questions to try to isolate the problem that drove them away. You may not get these customers back, but you can use that information to hold on to other clients. If, for instance, customers say they left because competitors' prices were lower on particular products, you could also lower your prices on selected goods. According to Reichheld, this kind of target marketing program is more effective and less costly than slashing prices across the board.

Retention Risks

If you find your customer defections are far from zero, don't give up: Businesses inevitably lose some customers--possibly for the better. Some customers will never be loyal, Reichheld says, and straining to court them is a wasted effort. Others require too much time and trouble to service or simply don't buy in enough volume to justify keeping them. It takes careful analysis of your business to spot such customers.

When short-term, low-profit customers are identified, businesses may want to raise prices or reduce service to them to make them profitable. But keep in mind, some types of businesses don't typically retain long-term customers. At a gas station on the interstate, for instance, a majority of sales may come from people who are just passing through. In this case, Reichheld says, an entrepreneur should place the emphasis on retaining employees rather than keeping customers.

As a general rule, Reichheld says, the greatest impact in a customer-retention program comes from upfront screening. In other words, you will get the highest return for your efforts by identifying the customers who are least likely to be long-term buyers and not marketing to them. For instance, Reichheld points to one insurance brokerage that tells agents to refuse business from prospects who switched insurers more than twice in five years.

"Most companies spend a lot on new-customer acquisition," Reichheld says. "When they look at their economics, they'll find a healthy number of those customers don't pay back their acquisition investment." Filtering them out may be the best way to get a return on your investment.

Making It Work

Fitting zero defections into a business strategy is no easy task. Traditional accounting systems aren't set up to measure things such as the lifetime value of a customer or the relative profitability of short- and long-term customers, Reichheld says. It can also be challenging to educate employees about the value of long-term customers and to develop systems to keep those loyal shoppers.

At GoldMine Software, says Ferrara, chasing zero defections has meant increased overhead, hiring more employees and constant reminders about the importance of customer service. But since starting seven years ago, GoldMine has doubled revenues every year and, Ferrara believes, hanging on to customers has a lot to do with it. "Customers want to be loyal, and they're looking for someone to reward," he says. "If you invest in services and building relationships, your customers will reward you."