Across the industry, management teams of companies of all sizes have begun to focus, in earnest, on measuring their customer cancellations. One’s ability to control and minimize customer attrition begins with recording and measuring customer losses on a monthly basis. The general manager of one of our clients commented recently that the “first step they took to control attrition was developing the record keeping system to record and track each customer loss in a cohesive management report that allowed them to understand the magnitude of the problem in definable and consistent terms.”
The value of measurement
The first step in controlling attrition is to measure it in a consistent fashion and make it an integral part of each employee’s job to watch for and react when they encounter an unhappy customer. Beyond tracking the number of customers lost each month and associated recurring monthly revenue (RMR), it is as important that the management team try to codify the reasons that the customers are leaving or decreasing RMR.
To determine the portion of cancellations that are controllable, the management team must establish a defined set of cancellation reasons. Employees must make certain to obtain from the customer, as best they can, the exact reason for the subscriber’s decision to leave the company. Monitoring the reasons for cancellations can help to identify the cause. Many management teams have found the real enemy is “looking at themselves in the mirror.”
There are proactive steps that can be taken by management teams to control and minimize collection issues and moves. These are the leading causes of cancellations. Developing a “move sales incentive plan” in advance that creates a customer incentive to save a “move within market” customer in the new location and obtain the new customer in the “existing location” is critical to have set out and ready to “pull off the shelf” by the proper member of your team. “No longer using the system” continues to gather a growing percentage within the reasons for cancellation. While a well-informed customer can reduce the incidence of problems with the system, the bigger problem is when a customer never sends any signals as they aren’t arming the system. Your automation systems can help you identify these prospects. You need to find a means to get in front of these customers and remind them of the capabilities of their protection system. If their system doesn’t include smoke protection, look at the opportunity to extend their system to 24/7 protection, even though they are not arming the intrusion segment of their system.
A number of security firms are now closely tracking the loss of customers and gathering information to feed to the resign effort that is part of the sales or retention effort within the company.
As we have expressed to our clients, “the ultimate security customer is actually the home or business where your company has installed the protection system.” Wherever your yard sign and equipment is already installed but inactive, you have the most inexpensive prospect to generate a new customer. There certainly are segments of your customer attrition that you did not cause and could not control but developing a serious, focused program to remember and peruse your “equipped but unprotected locations” is critical to reducing your gross attrition and truly managing your customer losses down to a lower net attrition (calculated with the benefit of the resigns added back) figure.
The length of time each customer remains performing is critical to determining the value of any customer base. A company’s attrition performance speaks to the strengths of the respective management team and the level of customer care that each customer base has experienced over time. The rate at which customers cancel or become non-performing (attrition) speaks directly to the longevity of a recurring revenue stream and in turn, the value that is placed on it by the market.
While attrition doesn’t measure the rate of growth of a company, it certainly impacts the net growth rate that the organization is able to maintain. As the saying goes, it is cheaper to keep a current customer than invest in creating a new one.
Attrition dynamics of targets
In concert with understanding the attrition dynamics of a target company you are looking to purchase, it is important to understand the reasons for attrition — what is causing customers to cancel or not continue paying. While a number of companies still do not maintain records (monthly or annual) of their customer cancellations and associated reasons — each entrepreneur will have an opinion as to what attrition level his or her company has experienced. With due respect, after all of our work looking “under the hood” at companies, we usually find the actual attrition rate is higher than the entrepreneur’s estimate.
When an offer to purchase another security company or customer base is being considered and you are fashioning your letter of intent (LOI) to purchase the target, always rely on the seller’s attrition representation in valuing the company but you should leave a mechanism to adjust “subject to due diligence” when the facts are in and irrefutable for the seller to gain perspective. This process makes for an equally informed buyer and seller to confirm or adjust pricing or deal terms.
As to valuation considerations — while there are always extenuating circumstances to explain high or low attrition rates — the buyer will initially value the company based, in large part, upon size, type of RMR and geographic density of the customer base. So, a $50,000 RMR company may be valued in a market range of a 28 to 35 multiple of RMR. But, which end of that range the buyer chooses will be dramatically driven by the “historical attrition rate” of the customer base.
Industry wide, net annual attrition (gross customer losses plus resigns and increased RMR for added services or price increase of like customers) will range from a low of four per cent (smaller companies) to a high of 12 per cent for companies over $500,000 of RMR. You can reference the TRG Annual Attrition Study for results by company size measured by recurring monthly revenue under contract (RMR). Below are some excerpts from the company size data reflected in the TRG Attrition Study over the last three years (see table).
Much like customer service expectations cannot be turned around over night after an acquisition, neither can very high attrition rates. A buyer must adjust the valuation of a target company or, at the least, adjust the LOI terms related to a holdback ($ or tenure or both) to protect themselves during the time it will take to bring the attrition down to a respectable level. Our industry offers the opportunity to structure a deal with an economic look back performance guarantee (holdback) for the benefit of the buyer. So, a company with $50,000 of RMR and a historical net attrition rate of say, 13 per cent, should be valued at the low end of the market range or a holdback of more than the traditional 10 per cent/one year should be negotiated.
On the flip side, if the attrition rate was in the four per cent range, expect to be at the higher end of the market range and to receive a good deal of “push back” from the seller when trying to negotiate any holdback protection, especially if that company creates new customers at less than a 10 multiple of RMR.
Controllable vs. uncontrollable
Another aspect of attrition that is often misrepresented is controllable versus uncontrollable. Higher levels of attrition are often explained away as uncontrollable. Based upon our work with a number of companies across the U.S., the largest single cause of high attrition (gross and net) is the company itself. While the reasons may be varied, you can usually translate the losses into some aspect of management’s performance or lack thereof.
Some of the best management teams in the country have gross attrition of 12 per cent but they manage their net attrition down to nine per cent or as low as seven per cent because of their focus on resigns, service add-ons, price reductions to save customers, smaller but consistent price increases, etc. They manage their customer losses by first measuring their performance and then addressing the varied causes of attrition as an organization.
The market rewards companies with impressive sales organizations (growth machines) that control their cost to create. It also rewards companies that manage their customer losses with similar management analysis, focus and concerted efforts to retain each customer or protected site.
Managing to reduce your net attrition by even one percentage point per annum can dramatically increase your cash flow and influence the ultimate value of your business.