Repeat customers are the only source of profit for any business. It is not until a customer buys from you a second, third, or fourth time that any profit is earned. The cost of attracting and learning how to serve first-time customers consumes any potential profit that might be made.
Modern accounting methods are very precise in the measurement of costs, expenses, worth of inventory, and the relationships of these values. However, modern accounting methods are nearly worthless when it comes to measuring the value of customers and their relative loyalty. Your accountant or accounting department can tell you to the penny how much profit you made last year. Unfortunately, accounting principles do not reveal and, in fact, hide which customers produced the profit.
For example, I shop for office supplies at Office Depot. They have a great selection, good prices, and their store is close to my home-office. Office Depot advertises on television and in the newspaper and offers their products for sale on the Internet. They also send advertisements through the mail and have a display rack in the front of their store with flyers that describe their current specials. The Office Depot at which I shop is open from 8 a.m. till 9 p.m. The store is well staffed with bright and helpful employees.
As a writer, I use a lot of printer cartridges, paper, and other office supplies. When I visit Office Depot, I do not need an employee to help me find what I'm going to buy because I am already familiar with the location of the supplies I need. I usually shop mid-morning during the week, so its extended hours during the week and weekend hours of operation are of no interest to me. I pay for my purchases with cash, so I do not use the credit terms they offer. I am pleased with Office Depot and visit the store regularly. Its advertisements, special offers, and Internet store are enticements that do not really apply to me. I am a loyal customer of Office Depot but I use very few of the added benefits they provide.
When Office Depot's executives report to their stockholders through their annual report, I am not mentioned. The few thousand dollars I spend with the company each year are mixed in with the rest of the $11 billion in revenue. The executives and stockholders cannot see that most of their expenses in additional hours, advertising, Website maintenance, and employee training are wasted on me. If all of Office Depot's customers were like me, it could save a fortune. I'm not a big customer for Office Depot, but on the basis of an expense to revenue ratio, percentage-wise, I'm a very profitable customer for this company. Modern accounting methods will never disclose this profitability. All of Office Depot's customers, just like everybody else's customers, must share the burden of the company's total expenses.
All of this is to say that modern accounting methods do not fairly describe the true profitability from a loyal repeat customer. However, Frederick F. Reichheld, loyalty expert and author of The Loyalty Effect, reports that even a marginal increase of just 5 percent repeat business produces a whopping 60-percent increase in profit.
When your customers come back to buy from you a second, third, or fourth time, they already know where you are located and what service and products your business provides. You don't have to educate these people about your business because they already know, so you do not have the expense of advertising in order to attract them. These repeat customers are easier to do business with because of what you know about each other. Time and money are saved and you earn a profit where profit did not previously exist.
We saw how Horace's inability to adapt was its downfall. Adaptability is important, even critical, to our continued success, but we also must be able to predict the behavior of our customers. Predictability is an important benefit of having loyal customers. Predictability allows a business to maximize its resources today and plan for the future. When you can predict your customers' buying habits, you are also able to predict staffing, inventory, and every other aspect of your business.
Dean was let go from his corporate position with Sears when the company was going through one of its many downsizing efforts. As a result, he bought a fairly elaborate and sophisticated hot dog cart and began an entrepreneurial adventure that far surpassed his fondest expectations. No one wants to be fired from their job, but Dean took it in stride and said he looked forward to being his own boss even if it was only as a hot dog vendor.
Dean towed the sophisticated hot dog cart behind his car to a spot in front of the courthouse every day it was not raining or too cold. On the way he stopped to buy hot dogs, buns, and other supplies. When he first started his business, he usually bought too many hot dogs. On a good day he would sell 50 to 60 hot dogs and would have to throw away as many as 20 to 30 hot dogs and buns. Dean only wanted to offer the freshest product and refused to sell hot dogs that were a day old. You don't need to do the math to understand his problem. He was buying too many hot dogs for the amount of customers he had. His inventory costs included the price of 90 hot dogs and buns, but he only had the revenue from the sale of 50 or 60 hot dogs. He was spending too much for inventory, but on the other hand, he didn't want to run out of hot dogs to sell. Dean thought that if he turned a customer away because he was out of hot dogs the customer might never come back again.
Fortunately, Dean very quickly began to predict his inventory needs by noting how many customers he had each day. Not only did this predictability allow him to regulate his inventory, he also was able to determine his most productive sales hours. He refined his calculations for time of year and weather conditions. Pretty soon Dean could predict within three to five hot dogs exactly how many hot dogs he would sell on a given Monday, Tuesday, Wednesday, Thursday, or Friday. Because Dean had developed a loyal (predictable) customer base, he purchased almost the exact amount of product he would sell and he knew which were his best hours of operation. His inventory cost became a much smaller amount in relation to his sales. Dean had very little wasted product, and so his profits doubled. Not only did his profits double, but he was working fewer hours because he knew when his loyal customers would show up hungry.
It is interesting to note that in his first year of business, Dean was earning more money selling hot dogs than he ever did working in corporate America.
Dean's hot dog stand is a simple business model but it makes the point that the predictability that comes from repeat purchasing by your customers will substantially increase your profit, as well as reduce the time it takes to make it.
Predictability is only one advantage to having loyal customers. The cost to attract a new customer is a large expense that is affected by customer loyalty. General Motors recently disclosed that it spends as much as $2,500 to attract each new customer. All of its customers are not new, but General Motors spends considerable sums of time and money trying to attract more than 20 percent new customers each year. The $2,500 General Motors spends on each of these new customers cancels out every penny of potential profit.
The average price of a new General Motors automobile is approximately $20,000. According to its annual reports, GM's earnings are traditionally less than 10 percent of its revenue. Ten percent of $20,000 (its average-priced automobile) is $2,000. That means its average profit per automobile is $2,000, while its average cost to attract a new customer is $2,500. General Motors spends $500 more to attract each new customer than it can hope to make. In order for General Motors to make any profit from these people, it has to sell them a second, third, or fourth automobile.
Advertising, signs, promotions, and special sales are just a few of the additional expenses of attracting new customers. If you consider all of your expenses in trying to attract new customers you'll discover that you are not making any profit from new customers on their first purchase. As with General Motor's customer, your customer has to come back a second or third time for you to make a profit.
The customers you have today know your business: They know your location, your selection, and how you do business. You may want to advertise to your current customers to inform them of a sale or special promotion, but generally your current customers already know all about you. How much does it cost to attract new customers that don't know about you?
Johnny's Steak House is a terrific restaurant located in northern California. The restaurant is situated not far from Interstate 5, but you can't see it from the highway. This restaurant has enjoyed a loyal clientele of local folks for many years. Recently, a large billboard sign was erected on the Interstate that posts directions to Johnny's Steak House. The billboard sign costs the restaurant's owner $1,000 a month to rent. When a new customer sees the sign and comes into Johnny's, the owner doesn't make a profit. He doesn't make a profit until enough new customers come in each month to pay for the sign. He didn't need the sign for his regular customers because they already know that Johnny's is a terrific steak house and they know where it is located. The sign is only needed to attract new customers.
Once someone has been to Johnny's they know where it is, so the directions on the billboard are no longer necessary for them. When new customers come back a second, third, or fourth time, the restaurant makes a profit. There is no cost, or at most a reduced cost, to attract repeat customers; consequently, they are the only source of profit for a business.