10 Reasons Why Cohort Analysis Can Ignite Explosive Growth
Irrespective of the business model you pursue, you have two very important high growth levers: ensuring strong and very efficient customer acquisition as well as striving for outstanding customer retention. Many founders focus too much on new customer acquisition and underestimate the importance and growth impact of their customer retention.
In a separate blog post of my FastScaling blog, I have touched upon the correlation between customer success (leading to strong customer retention) and the potential exit valuation. In this article, I am going to elaborate on how conducting a thorough cohort analysis process can ignite explosive growth and help founders achieve both strong customer acquisition and outstanding customer retention.
WHAT IS COHORT ANALYSIS?
Cohort analysis can be described as a behavioral analytics tool that helps businesses analyze their customer and user data with the ultimate goal to improve customer acquisition, customer retention and revenue retention. Rather than looking at all customers and users at once and as a single group of customers or users, cohort analysis looks at customers and users broken down into related groups. These related groups, or cohorts, usually share common characteristics. They are, for instance, acquired during the same time frame (Acquisition Cohorts) or share a similar behavior (Behavioral Cohorts).
The most common starting point for cohort analysis is to divide customers into subgroups that have been acquired in the same year, quarter, month, or week, and then track how these subgroups behave over time in terms of customer retention and revenue retention. Below, you see an example of a cohort analysis analyzing the 24 months revenue retention of customers acquired in specific months. You can see that the cohort revenue retention improves over time, i.e. the younger cohorts show better revenue retention than the older cohorts. You can also see that newer cohorts generate higher revenues in the first month.
At the same time, the revenue retention improvement is not outstanding and the first month overall cohort revenue increase can have several reasons (simply a higher number of customers acquired, or higher revenues generated from the same number of customers). Looking at customer and revenue retention should therefore only be the starting point. If you want to improve your business, you need to delve deeper into your cohorts to figure out what you must focus on. Below, I share with you 10 reasons why you should embrace cohort analysis and what you can learn from it.
10 REASONS WHY COHORT ANALYSIS CAN HELP YOU IGNITE EXPLOSIVE GROWTH
Reason 1: It helps you define your key target customers
In FastScaling, my growth handbook for founders, I advise founders to disregard all non-key target customers and instead focus all efforts on their key target customers. Focus is king, complexity a growth killer! As your products and services do not solve the major pain points of your non-key target customers, such non-key target customers are harder to attract and harder to convert. In addition, they usually need more support and ultimately churn anyway. Time, effort, and related costs are better spent acquiring, retaining, and supporting your key target customers. Cohort analysis can help you define your key target customers.
Break your cohorts down into key customer characteristics like industry and size and understand and compare how these subgroups behave over time, especially in terms of engagement, retention and support needed. You could, for instance, compare customer and revenue retention of small, medium-sized and enterprise customers. You will notice that some subgroups show better patterns than others and that you may have found product/market fit in some customer and market segments and have not yet found it in others. You can then decide whether to focus on the relevant subsegments and/or refine your product and service offerings so it better suits the needs of other subsegments, too.
Reason 2: It helps you improve your go-to-market strategy
You can also compare customer retention and customer behavior considering the channels through which your respective customers have been acquired. For instance, you can compare the customer and revenue retention of customers acquired through inbound, outbound and partner channels. This analysis may reveal that certain channels generate ‘better’ customers than others and that you have found product/channel fit in only one specific channel. Focusing on this specific channel may help you improve your customer acquisition costs (CAC) and your overall growth efficiency.
Product/market fit is not all that matters. What good is product/market fit without a channel through which you can sell your products efficiently.
Reason 3: It helps you better convert leads into new customers
You can also break down your new customers acquired through a specific channel in relation to the marketing and sales resources they have been confronted with. Have they visited different websites? Have they been provided with different content? When have marketing qualified leads been handed over to sales? Have the customers been converted by different sales teams? Have they had a different customer onboarding experience?
Comparing your customer cohorts in this regard should enable you to improve your conversion funnel, which, in turn, will improve your customer acquisition costs (CAC).
Reason 4: It helps you improve your marketing campaigns
Cohort analysis enables you to track the success and long-term effects of your marketing campaigns.
For example, if you pursue an e-commerce business model, you could try to acquire new customers by promoting products with negative contribution margins, i.e. you sell products at a loss. Selling negative contribution margin products is generally not a good idea, unless the customers acquired through this specific marketing campaign do also purchase additional positive gross margin products in the future. While the marketing campaigns first generate a loss, they may create long-term profits. Certainly, you can also experiment with campaigns and compare their success with each other.
Reason 5: It helps you turn new customers into loyal customers
Sustainable high growth is not only a result of successful customer acquisition, but also of strong customer retention. The longer you can retain your customers and the longer your customers return to buy your products and services, the bigger your existing customer and revenue basis gets. As it is usually also cheaper to retain your customers than to acquire new customers, improving your customer retention is also a more cost-efficient way to grow your business.
If you want to improve your customer retention, look at your cohorts and try to identify patterns. Are there specific points in time when customers churn and do not return? Why do some customers churn at that point in time, while others become loyal customers? Compare your cohorts and test what you can do about the churning customers. Experiment until you understand how you can better satisfy the needs of these customers and work on your customer retention. You can act based on facts, not gut feeling, and better turn new customers into loyal customers.
I highly recommend you read Hacking Growth by Sean Ellis. Throughout this great book, you will read about why and how you should track your cohorts. He also touches upon this reason 5.
Reason 6: It helps you understand whether you have achieved product/market fit
Product/market fit has been achieved if your products solve a significant customer problem and satisfy a market need. Getting to product/market fit implies not only the development and improvement of your products and product features until they solve your customers’ significant problems. You must also figure out how to assess when they do it.
In FastScaling, I have written a complete chapter about how to generate and measure product/market fit. When it comes to measuring product/market fit, analyzing your customer retention cohorts is more insightful than looking at any other metric like e.g. the net promoter score (NPS). If you satisfy the needs of your customers, why should they churn? Hence, the better you retain your customers, the closer you get to product/market fit.
In this regard, you may also read the Science of Scaling by Mark Roberge.
Reason 7: It helps you improve your revenue retention
You can generate similar insights looking at your revenue retention cohorts. If your customers love your products and services, they should be prone to up- and cross-sell, which, in turn, should lead to higher revenue retention. Break down your customers into higher-value and lower-value customers and look for patterns in your cohorts. Why can some customers be retained longer than others? Why do some become high-value customers and others do not? What makes them different, the location/geography, size, industry, gender, age, types of items purchased and features used, etc.?
Reason 8: It helps you improve your customer lifetime value (CLV)
If you analyze your customer retention cohorts and improve your customer retention rate, you improve your customer lifetime. Customer lifetime is one variable of the customer lifetime value (CLV) calculation. The customer lifetime value reflects the value you extract from a single customer over the customer’s lifetime with your company. In order to calculate the customer lifetime value (CLV), you add up all contributions from a customer over the customer’s lifetime. Hence, the longer the customer lifetime, the longer the customer lifetime value (CLV).
Nobody describes the CLV/CAC topic than David Skok in his fantastic blog.
Reason 9: It helps you understand whether you develop products customers need
If you have read my book FastScaling, you know that I am obsessed with the concept of customer success. Focus on making your customers successful and the rest will follow almost magically. In my view, customer success can be broken down into a great customer experience (CX) and a strong return on investment (RoI). Cohort analysis can help you better understand whether you develop products and product features your customers genuinely need. Look at your cohorts and their engagement with your products and product features. What are the characteristics of those customers that use new products and new product features? What is the long term impact of customers using these features? Longer retention? Higher willingness-to-pay?
Reason 10: It helps you better forecast your future revenues
Lastly cohort analysis can be used to better forecast your future revenues. It allows you to understand how much revenue an average customer generates per month over the customer lifetime. If you make reasonable assumptions as to the number of new customers you acquire per month, you can calculate how much revenue will derive from such new customers acquired. If you then put strong focus on retaining existing and new customers, you are well set for igniting explosive sustainable growth.
Especially when I look at marketplace business models and their business plans and revenue forecasts, I use cohort analysis in order to check whether the revenue forecasts are reasonable and make sense in light of the past behaviour of the respective company’s cohorts.
LeadX Capital Partners
At LeadX Capital Partners, we are experienced growth capital investors who help our management teams achieve sustainable high growth. We work closely with them on planning their high growth journey and executing it successfully.
If you are running a mature B2B company headquartered in Western Europe, active in consumer industries and looking for growth capital, please reach out to us. We look for bootstrapped and venture-backed companies with at least 10m in revenues.
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Patrick is a partner and growth expert at LeadX Capital Partners. You will find more insights about how to achieve sustainable high growth in his blog (fastscaling.io) and in his book FastScaling.