When Every Customer Is a New Customer

When evaluating potential new businesses, one of the first questions managers ask is: How fast is the market growing? But managers who think only about growth rates may be missing real opportunities. Another factor can make even slow-growing markets highly dynamic: rapid turnover of the customer base. Consider two markets that have seen little growth in recent years: smoking cessation aids and cigarettes. The market for the former has been flat for a decade, during which the shares of the leading brands, Nicorette and NicoDerm, were cut almost in half by Commit lozenges and other new products. Despite stagnant sales, the market was dynamic. Growth in the cigarette market was even negative at times, but the share of longtime leaders like Marlboro and Camel held steady. In this case the market was not dynamic. Why the difference? Customers for cessation aids turn over quickly—either they kick the habit and no longer need to buy the product, or they soon revert to smoking. In this type of situation, customer loyalty is moot, so established market leaders are at risk. In the cigarette market, by contrast, most customers stay put, and the low turnover protects incumbents. High customer turnover creates opportunities in fast-growing industries as well, and the upsets can be stunning. Video games provide a case in point. Nintendo’s position seemed unassailable in the mid-1990s, but Sony ingeniously used the transition of teenage players into adulthood to hoist itself into the market. By 1996 its first gaming console, the PlayStation, had dethroned Nintendo and transformed the industry. The tables turned again a decade later, when Nintendo’s Wii overtook PlayStation through a combination of innovative games, low pricing, and skillful targeting: Although Nintendo still aimed for young gamers, this time it included the emerging segment of family entertainment. More recently Sony and Microsoft have launched new, motion-based games that are challenging the Wii’s dominance. These shifts demonstrate how dramatically a company’s fortunes can rise or fall when the customer base—in this instance, young players and families—turns over quickly. Measuring Customer Turnover Three factors drive high customer turnover. The first is infrequency of use by any one person. Products and businesses that have had a constant influx of new customers for this reason include funeral services, landscaping projects, pregnancy tests, real estate agencies, and moving companies. The second factor is durability. We use cars and refrigerators all the time, but because they typically last for many years, we buy them only once in a while. People who purchase such products therefore behave like new customers; unlike consumers of toothpaste and other disposable products, they’re not constantly in the market. The third factor relates to how narrow the age range of the intended audience is: Products and services aimed at specific age groups have high customer turnover rates. Think of diapers, young-adult books and movies, bridal magazines, and retirement communities. A good way to differentiate high-turnover from low-turnover markets is to calculate what we call the net turnover rate (NTR). To determine this rate, first assess the overall size of the market in the previous year. Then add the number of customers entering in the current year and subtract the number exiting. This gives you the total number of customers. Divide the number of new customers by the number of total customers to get the NTR. The higher the NTR, the greater the opportunity for new companies—and the greater the risk for established players. Let’s return to cigarettes and smoking cessation aids. In 2009, by conservative estimates, about 40 million people in the U.S. smoked. Each day some 3,000 to 4,000 start, for an annual total of roughly 1.3 million. Each year about 2.6 million quit. Thus the number of smokers in 2010 was 38.7 million, and the NTR was just 3.4%. The smoking-cessation-aid market, as discussed, is constantly renewing itself; its NTR is close to 100%. That’s why new companies have been able to gain so much share. Any high-turnover industry has many more former than current customers. These “alumni” can be tapped to expand the customer base. NTR can vary widely by product category within an industry. For example, pharmaceutical companies would usually rather market drugs for chronic diseases (cardiovascular conditions, diabetes) than for acute ones (ear infections, influenza), because the turnover rate among patients with chronic diseases is much lower. And different kinds of customers within the same product category may have very different turnover rates. Whereas patients churn in and out of acute disease markets, their doctors typically prescribe the same meds for years. So although these patients have no reason to display customer loyalty, their doctors are likely to, which makes it harder for new companies. In general, the professional segments of a market have a lower customer turnover rate than the “occasional use” segments: Professors are a more stable segment than students, contractors are more stable than do-it-yourselfers, and so on. Breaking into High-Turnover Markets The fact that high-turnover customers don’t have established loyalties doesn’t necessarily mean they’re easy game. The costs associated with pursuing them may be large, or they may be unusually risk averse. New competitors can exploit such conditions with the following strategies: Cut customers’ trial costs. Lowering the cost may persuade customers to give new products a chance. When Sony entered the video game console market, it had to woo consumers away from the well-known Nintendo and Sega systems. So it equipped the PlayStation with a CD drive, essentially making it the cheapest CD player on the market; even if the game system failed to take off, consumers still would have a CD player. The company adopted a similar tactic with PS2 (which doubles as a DVD player) and PS3 (which includes a Blu-ray player). Offer a gateway to the competition. Entrants can also sway customers by providing a link from their product to an established competitor’s. Apple’s tagline and commercial “I’m a PC too” enticed many to try the new Macs, reassured by their ability to run familiar PC software. Extend bundles to drive adoption. Apple has very shrewdly used its set of “i” products (iPod, iPhone, iPad) to take increasing command of markets once dominated by Sony, Nokia, and Amazon. Leverage the reputation of low-turnover segments. Real estate agents operate in an extremely high turnover environment. They gain credibility by associating themselves with banks and insurance companies. Similarly, building-materials companies try to exploit their relationships with architects and designers to persuade the large number of contractors (and the even larger number of home owners) to adopt their products. Maintaining Your Position in High-Turnover Markets High-turnover markets are evergreen; they will always have new consumers. Once companies have established themselves in these markets, they need to defend their positions by decelerating market turnover while continuing to build a customer base. Here are some useful strategies: Provide a migration path. When customers see that they can advance within the network of a product they’ve chosen, they’re less inclined to leave. Systems like the airlines’ silver/gold/platinum loyalty programs help retain customers. Lego gets toddlers started with Duplo blocks and offers increasingly sophisticated products for older children, thus keeping customers into their teenage years. Gerber adopted a similar tactic. (See “How Gerber Manages Turnover.”) How Gerber Manages Turnover Baby food is a classic high-turnover category, with newborns entering and toddlers exiting constantly. But Gerber maintains its 65% share and has grown sales by segmenting the market and moving customers from one stage to the next—and by keeping kids eating “baby food” long after they’re babies. Birth+ Infant milk formula Supported Sitter First solid foods: cereals and pureed fruits and vegetables Sitter New tastes, including meats, cereals, and desserts Crawler Pureed, but with chunks to help babies learn to chew Toddler Entrees, such as chicken and carrot ravioli, that encourage the use of utensils Preschooler Full meals and snacks, with an emphasis on convenience and nutrition Increase platform value. Consumers are drawn to products that provide something extra rather than simply meeting the need that originally attracted them. Airline and credit card reward points dissuade many customers from shopping for better deals. Mobile phone “family and friends” packages keep them from switching providers. Facebook creates extra value—and stickiness—for regular and business members by enabling social commerce in addition to social networking. Create and leverage “alumni” networks. Any high-turnover industry has many more former than current customers. They can be the best spokespeople for a product and valuable agents in expanding the customer base. Universities have long organized alumni events to grow and leverage the loyalty, support, and word-of-mouth of past students. Consulting companies generate many new assignments by tapping executives they once served who have since moved to different companies. Customer turnover is a rip current that can sweep established players off their feet and create great opportunities for new competitors. But it’s important to remember that as markets change, so do turnover rates; the opportunities ebb and flow. Most companies have a range of product lines, each with a different turnover velocity. They need to know where and when to decelerate turnover to defend their position or accelerate it to gain share. In markets where turnover is immutably fast, the battle for customers is never decisively won. However, the rewards for even temporary victors can be large indeed. Calculating Net Turnover Rate: The Market for MBA Programs It’s intuitive that the market for some products—bridal magazines, say—experiences high customer turnover. For other markets, quantifying the churn can help new competitors understand the opportunities. For example, the market for MBA programs may seem exceedingly stable, with the top-ranked programs having held their positions for decades. But beyond the elite schools, the market is surprisingly dynamic: In recent years applications to one-year programs and for-profit and online schools have increased significantly. The opportunity for new competitors can be seen clearly by calculating the NTR—the ratio of new students to total students. Using conservative estimates: Number of U.S. MBA students in 2007–2008: 240,000 Number who graduated in 2008: 100,000 Number who entered in 2008: 110,000 Number of U.S. MBA students in 2008–2009: 250,000 Net Turnover Rate (entrants divided by total students) 110,000 / 250,000 = 44%

When Every Customer Is a New Customer

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