As we all know, user acquisition is required in order to grow any business. There are many different ways and channels to explore in order to improve user acquisition of your product. Apart from having a great product, many companies believe that acquisition is the most important aspect of their business and focus most of their efforts on improving their acquisition strategies and tactics. Unfortunately, this focus on acquisition often comes prematurely before having implemented proper retention rates. This may lead to an increase of users on a short-term basis, but can be very costly in the long run, particularly when we are talking about paid acquisition channels. Within this article we want to explore why retention is king and why retention fuels acquisition and not the other way around. We will also explain why you need to focus on retention early on even if it may seem counterintuitive. Throughout the article we are mostly focusing on subscription or transaction based monetization models.
While we expect that you know the basics of acquisition and retention, we want to provide at least a high-level overview before making our point on why retention is king.
There are many different strategies for user acquisition. On the highest level you can either acquire users organically or by paying. Organic user acquisition includes strategies such as word-of-mouth, search engine optimization, referrals, or content marketing. Paid acquisition, on the other hand, includes channels such as offline and online ads, influencer marketing, or affiliate programs. Over the past years, acquisition costs have increased across most channels; in particular bidding on keywords in paid search has become more expensive due to more and more competition.
Retention describes how many of your existing customers keep using your product repeatedly over time. The inverse to retention is churn which describes the number of customers who stop using your product. As described in our previous article about engagement metrics, you should make sure to measure the retention based on an actionable event which may not necessarily be just product usage but could also be events such as listening to a song or making a purchase. There are three common ways of how retention rates look like when depicted on a chart:
What you should avoid at all cost is to invest heavily into user acquisition without having established proper retention rates. This will only bring you short-term success on a number of vanity metrics such as number of downloads, number of users and even monthly revenue. This can be tempting because it is easy to calculate and show, but is not sustainable. Over time, you will not be able to keep up with spending these amounts of money without retaining your customers at sufficiently high levels.
Another temptation of investing into user acquisition comes from the fact that it is much faster to show results. The number of newly acquired customers or even more advanced metrics such as the return on ad spend (ROAS) can be calculated within a matter of days, while calculating the impact of new retention measures usually takes multiple weeks or even months (depending on your product).
Let us have a look at what happens when you are investing into user acquisition without having established sustainable retention rates first. In the following example we assume a starting user base of 10,000 active users that each generate $10 revenue per month. The business has a declining retention rate (as depicted in the previous section’s figure) that does not flatten and instead hits a retention rate of mere 6% after eight months.
As you can see, the generated revenue per month declines quickly from $100,000 per month to mere $6,000 within a duration of 9 months. Within the next section, we will have a look at how an increased retention rate will help drive revenue.
First and foremost, you cannot simply increase your user retention overnight. This is hard work that requires lots of dedication and continuous experimentation. Typically, improved retention rates go hand in hand with improved customer experience.
It should come at no surprise that educating your customers and providing stellar customer support are two of the main levers when it comes to retention.
If improving your customer experience through retention is not satisfying enough for you yet, don’t worry - there is more to increased retention rates. In most product businesses, improved retention rates will also increase your product’s revenue. In subscription models, the longer your customers retain, the more frequently they will pay for your product’s subscription. In transaction models, your customers will pay for more transactions by retaining longer. And on top of that any business with successful retention benefits from having more chances to upsell to existing customers and a higher likelihood of receiving referrals (for free).
Lastly, improved retention fuels your acquisition and allows you to spend more on acquisition. When your retention is higher than your competition’s retention, you can afford to spend more on acquisition (to acquire more users which in turn leads to increased revenue) while still keeping the same LTV:CAC ratio for your product.
In the figure below, you can see how higher retention (= a higher number of retained users) leads to higher revenue and thereby allows you to reinvest a higher amount into retention and acquisition which, again, improves retention, increases revenue, and so on. It is essentially a compounding growth loop. The result of this compounding growth loop is indicated on the right side of the figure where you can see how being able to reinvest a higher amount into retention leads to higher compounding revenue over time.
Let’s have another look at the same example from before with the only difference being that this time the retention rate flattens at 35%. As a reminder, we are looking at 10,000 active users generating $10 revenue each in month 0.
By only changing the retention rate, the total revenue from one cohort of active users increased by $88,000. Considering that this change will not only impact one cohort of users joining you in a given month but every newly acquired user, the impact on revenue from this single measure is actually much larger (but we will leave this calculation for yourself for the time being).
Now, you may say that we cheated by only comparing the revenue from a business with a decreasing retention curve to one with a flat retention curve. So let’s have a look at one more example where all assumptions remain the same apart from the retention rate - the retention rate, this time, lies continuously 5% below the one of the previous example where the retention curve flattened at 35%; in the following example, flattens at 30%.
What we can see is that the total revenue decreased by $40,000. Again, this $40,000 reduction is only for one cohort of users. This result may be surprising considering that the monthly revenue in month 8 still looks decent with $30,000, but illustrates the importance of even minor improvements to your retention rate.
If your business is generating a meaningful amount of referrals per user per month, then looking at the retention chart with your referral coefficients (percentage of users that send a referral to their friends, number of times they send this referral, and percentage of friends that accept the referral and sign up) instead of revenue per user per month will provide you with an equally important picture. You will see similar results of how only marginal improvements to your retention rate will greatly improve the number of users joining through your referral program month over month.
Although this article sounds like a hymn of praise on user retention, there are phases where you definitely should put your main focus on user acquisition. When you are just getting started, it is mandatory that you first acquire some customers to use your product. Otherwise you will not have any customers to figure out your product’s product-market-fit or retention. The same holds true when you are entering new markets or are trying out new acquisition strategies. Every market and channel behaves differently, so you need to pay proper attention at these stages.
In addition, there may be times where you need to acquire a certain number of users for your board or investors, e.g. to prove your ability to scale at a certain cost level, even if it may not be the most sustainable thing to do at that time.
Another time when you should focus on user acquisition is once you have established proper user retention rates. Your retention charts will help you understand when you have arrived at this point. However, keep in mind that spending more money on acquisition may impact your retention rates negatively as well as you might not be acquiring the ideal customers anymore. Another way to understand whether you have increased your retention rate to a sustainable level is by looking at your (anticipated) ratio of LTV to CAC; usually you will aim for a ratio of about 3:1. At this point in time, you should reap the benefits of your hard work and invest into user acquisition to grow your business.
Based on the described benefits of retention, it should come as no surprise when both Harvard Business Review and Forbes write about it being 5 to 25 times more expensive to attract new customers compared to retaining existing ones. The same studies also make a point that improving your retention rate by only 5% increases your profits by 25% to 95%. As a reminder, in our simplified example where we only looked at one single user cohort over the period of nine months, we already saw an increased revenue of 10% when changing the retention rate by 5%. And these numbers do not even consider the additional benefits you get out of improved retention rates such as increased customer experience and satisfaction with your product as well as additional monetization and engagement possibilities along the extended customer journey.
Are you interested in exploring and improving the retention rates of your business? Get in contact with Kasva.
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