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ATTRITION

SEEKING A CONSENSUS

BY:

TRG ASSOCIATES, INC.

4 POST OFFICE SQUARE

CLINTON, CT 06413

JOHN M. BRADY

JAMES LEESE

INTRODUCTION

MEASURING ATTRITION

WHAT IS ATTRITION?

ALTERNATIVES TO MEASURING ATTRITION

THE ATTRITION CALCULATION OF CHOICE

THE COST OF ATTRITION

WHAT ATTRITION MEASUREMENTS CAN TELL YOU

ABOUT A BUSINESS

TRACKING ATTRITION CAUSES

ATTRITION CASE STUDY

CONSENSUS AND ATTRITION MANAGEMENT

1

INTRODUCTION

The electronic security industry continues to prosper because of the increasing value that

people place on the protection of their loved ones and their personal/business assets. The

industry also continues to attract significant investment capital, management expertise

and debt liquidity due to the healthy economic returns that can be created within a liquid

market for a predictable cash flow margin enterprise – whose root dynamic is

preservation of the customer, the customer’s property and the customer’s peace of mind

through timely provision of services.

The other important characteristic of the electronic security industry is that its growth is

often fueled by making an investment in every new customer added. While the “zero or

low down, high volume” methods of marketing to increase market penetration had

transformed the industry in the early to mid 1990’s, the return to sounder “customer value

marketing” and the reduction of the “excessive” investment once considered “the only

way to grow”, has helped to reduce the necessary investment needed to remain

competitive in the marketplace. Despite that recent reversal, we still utilize financial

incentives (leasing, customer transfer/takeover, up-sell/high volume) to attract customers.

That investment or “Cost to Create a Customer” can range on average (2000-2001

activity) between a 15 to 31 multiple of recurring monthly revenue (RMR). While

market values of RMR have decreased since the “altitude ranges” of 48 to 60 times RMR

in the late 1990’s, they have settled (despite the downward pressure by the most efficient,

well financed buyers) into the 30’s to mid 40’s – a range similar to the late 1980’s when

the industry also had a similar 12,000 to 13,000 dealer participants as it has today.

The “ease of entry” that the electronic security industry is still characterized by, despite

ever increasing licensing and continuing education requirements, continues to work

against the normal industry maturity trend of settling in excess of 50% of the marketplace

within a single digit number of companies. Customer retention continues to be the single

largest management challenge inside a fluid, competitive environment for customers and

between alternative providers.

Management’s priority is to minimize the investment in customer growth. Some have

commented that it is “easy to give security systems away for nothing” but all good

dealers agree that it takes an enormous amount of “blocking and tackling” to keep each

customer after any sale. So much management effort and organizational focus goes into

growing each dealer’s customer base while often so little effort or organizational focus

goes into keeping those “precious assets”.

Since the late 1980’s, when the electronic security industry began to attract significant

new equity/debt capital, the industry has continued to improve at gathering and

cataloguing industry specific performance parameters – with the SDM 100 and other

public/private information sources beginning to keep track of market size, growth

dynamics, etc. Despite this new security information age, one continuing enigma of

2

industry measurement, critical to measuring value created and value lost, that is not well

maintained or commonly defined, is the qualitative and quantitative measurement of

customer attrition.

The ensuing discussion will focus on what attrition is, how to measure it, its intrinsic cost

and how to reduce or limit that basic measurement of “poor service”. This critical

measurement needs to be further discussed and gain some consensus both on the

definition and it’s utilization within the security industry.

The opportunity at hand is to settle on one or a series of attrition definitions and methods

to assist the industry with helping to clarify a vital measurement tool for those who work

within the industry and those who seek to understand the industry better.

3

WHAT IS ATTRITION?

Definition

Attrition measures the amount of recurring revenue lost during a particular time frame,

expressed on a monthly/annualized basis. Attrition can be measured in many different

ways. The nomenclature used to describe the measurement tool and methodology can

vary widely. Gross attrition is the absolute of customer losses without the inclusion of

any offset or reduction activity such as price increases, acquisition RMR or other “add

backs” to the customer base. Net attrition is the result of offsetting “like customer” gains

from the gross attrition losses.

Within both residential and commercial markets, there are various types of companies

that utilize different marketing strategies, which ultimately tend to yield different “built

in” averages of attrition by channel. In the residential market there are the traditional

security installation companies versus high-volume companies. As for the commercial

market, there is the traditional outright sale versus the leased system. On average, there

are industry ranges for net attrition. The following is a breakdown of the ranges that

TRG has encountered during its work with a significant cross section of the industry

involved in the residential and commercial markets:

Average Net Attrition Ranges

Market Type Low High

Residential Traditional Installation Co. 2.5% 7.5%

High-Volume Co. 8.0% 15.0%

Commercial Traditional Outright Sales 2.0% 6.0%

Leased Systems 3.7% 8.7%

Before determining the appropriate method of measuring attrition, we need to know what

is “in” and “out” of each company’s calculations. The measuring of customer losses on a

gross basis seeks to identify customer losses regardless of what actions caused the loss

and what actions were taken to mitigate or reduce those losses. Gross attrition is the

purest of the measurement tools, as it doesn’t allow for any qualitative decisions or

processes to obfuscate the loss. Net attrition seeks to measure the qualitative impact of

management’s effort to control and minimize customer losses. There is a fine

philosophical/cost assessment line between including “like customer” re-signs as an

offset to gross attrition versus as part of the “cost to create a new customer”. TRG has

found that for various reasons, such as the related economics and automation system

support to the gathering of data, the newly signed up customer in a “like location” is

often best counted as a new customer. This new customer and its related cost to create, in

excess of a 6 multiple of RMR (normal costs to program & transfer a system), should be

included in the new sale category versus as an offset to gross attrition. The old customer

4

who moved and whose system was re-installed at a loss may not be used as an offset

from gross to net attrition. The “like customer” who was “tracked” in your marketplace

and re-signed without an additional investment should be allowed to reduce gross

attrition. Similarly, a customer who cancels and was originally included in the gross

attrition but subsequently comes back to the company should be used to reduce that gross

attrition upon return. The tracking of offsets to gross attrition (or deciding what is “in” or

“out”) should be dictated by the following factors:

• Net investment to maintain the same customer (person or location).

• Time frame between the loss and the re-sign (maximum six months).

• Ease of data gathering as to the evolution of a re-signed customer.

• Specific loss/re-sign causes – bad debt cancellation made good should

be considered a re-sign.

• Specific departmental responsibility for tracking and effectuating resigns

and related compensation costs.

Regardless of the company’s policies or definitions, consistency in the calculation

method and in the definition of what makes up gross and net attrition is critical. The

attrition measurement is most important as to what it tells you about a company’s overall

performance versus any specific month’s results.

5

ALTERNATIVES TO MEASURE ATTRITION

TRG has encountered various methods of computing attrition during our years of

experience in the industry. The following table offers two different scenarios for our

sample customer base over a six-month period. The first scenario depicts a customer base

with no acquisitions; the second scenario includes an acquisition in the fourth month of

the reporting period.

Sample Customer Base

Scenario 1 Scenario 2

(No (Including

Acquisition) Acquisition)

Beginning + New +Acquired -RMR =Ending =Ending

Month RMR RMR RMR Cancels RMR RMR

1 $ 50,000 500 0 300 $ 50,200 $ 50,200

2 $ 50,200 700 0 450 $ 50,450 $ 50,450

3 $ 50,450 850 0 550 $ 50,750 $ 50,750

4 $ 50,750 900 20,000 750 $ 50,900 $ 70,900

5 $ 50,900 1,000 0 800 $ 51,100 $ 71,100

6 $ 51,100 1,200 0 900 $ 51,400 $ 71,400

5,150 20,000 3,750 $ 304,800 $ 364,800

Using the above customer base sample, we have calculated the attrition level using five

of the most prevalent attrition measurement methods currently being used in the industry.

a

(Multiple by 2 to annualize the cancellations for the six-month reporting period)

1. Typical Lending Covenant RMR Method

Step 1: Cancelled RMR for the Reporting Period = Monthly Attrition

Sum of Ending RMR for Each of the 6 Months

Step 2: Monthly Attrition (from Step 1)* 12 =Annualized Attrition

Calculation Examples:

• No Acquisition: Step 1: $3,750 / $304,800 = 1.2% Monthly Attrition

Step 2: 1.2% * 12 = 14.4% Attrition

• Acquisition: Step 1: $3,750 / $364,800 = 1.0% Monthly Attrition

Step 2: 1.0% * 12 = 12.0% Attrition

6

Pro’s & Con’s of Typical Lending Covenant RMR Method

Pro’s Con’s

Accounts for and weights RMR acquisitions Not the easiest of the calculations

Accounts for timing of acquired RMR

Accounts for rapid internal growth

Accounts for timing of rapid internal growth

Similar to many lending institution calculations

2. Modified Static Pool Method

Total Attrition for Reporting Period * 2

a

= Annualized Attrition

RMR Beginning of Reporting Period

Calculation Examples:

• No Acquisition: ($3,750 * 2) / $50,000 = 15.0% Attrition

• Acquisition: ($3,750 * 2) / $50,000 = 15.0% Attrition

Pro’s & Con’s of Modified Static Pool RMR Method

Pro’s Con’s

Ease of computation Does not account for or weight acquired RMR

Widely used Does not account for or weight rapid internal

RMR growth

3. Monthly Attrition Method

Attrition for Most Current Month * 12 = Annualized Attrition

Ending RMR of Previous Month

Calculation Examples:

• No Acquisition: (900 * 12) / 51,100 = 21.1% Attrition

• Acquisition: (900 * 12) / 71,100 = 15.2% Attrition

7

Pro’s & Con’s of Monthly Attrition Method

Pro’s Con’s

Ease of computation Reporting period not substantial

Monthly results can vary greatly

Results do not provide a meaningful trend

4. Average RMR Method

Total Attrition for Reporting Period * 2

a

= Annualized Attrition

(Beginning RMR + Ending RMR) / 2

Calculation Examples:

• No Acquisition: (3,750 * 2) / 50,700 = 14.8% Attrition

• Acquisition: (3,750 * 2) / 60,700 = 12.3% Attrition

Pro’s & Con’s of Average RMR Method

Pro’s Con’s

Accounts for RMR acquisitions Does not account for timing of acquisitions

Accounts for rapid internal growth Does not account for timing of growth

Ease of computation

5. Roll Forward Method

Cancelled RMR During the Reporting Period * 2

a

=Annualized Attrition

Avg. Total of RMR Held During the Reporting Period

Calculation Examples:

• No Acquisition: (3,750 * 2) / 52,5751 = 14.3% Attrition

• Acquisition: (3,750 * 2) / 62,57511 = 11.9% Attrition

1 (New RMR for the Reporting Period/2) + Beginning RMR

8

Pro’s & Con’s of Roll Forward Method

Pro Con

Accounts for RMR acquisitions Does not account for timing of acquisition

Accounts for rapid internal growth Does not account for timing of growth

Complex calculation

Summary of Results from the Various Attrition Calculation Methods

The attrition calculation results obtained from the five methods are summarized in the

following table:

Summary of Attrition Calculations Results

No RMR With RMR

Calculation Method Acquisition Acquisition

Lending Covenant Method 14.4% 12.0%

Modified Static Pool Method 15.0% 15.0%

Monthly Attrition Method 21.1% 15.2%

Average RMR Method 14.8% 12.3%

Roll Forward Method 14.3% 11.9%

The significant variance in the results obtained from the various calculations, as

illustrated above, is the main reason for developing a consensus within the industry on

the use of one or two primary industry standards for measuring attrition.

9

THE ATTRITION CALCULATION OF CHOICE

Based upon our experience in the Security Industry and after encountering the various

attrition methods described in the previous section, we feel that the Security Industry

should adopt the “Typical Lending Covenant RMR Method” of calculating attrition as the

industry standard. This method of calculating attrition best represents a Company’s

attrition rate under a variety of different circumstances and situations. In addition to

accurately representing attrition for a stable, constant growth Company, this method

correctly represents the true attrition rate for Companies experiencing rapid growth

and/or doing multiple acquisitions. Due to the “weighting” given to the ending RMR

over the six-month reporting period, this attrition method is the most accurate of all

methods described and can be used under any situation a company may be experiencing.

Because of this, we feel the industry should standardize and use this common

measurement of attrition that all Companies can be gauged against knowing that the rate

of attrition was calculated in the same manner. The following template can be used to

calculate attrition using the Typical Lending Covenant RMR Method:

Lost RMR for the six-month period $ (I)

RMR for each of the months ending for the sixmonth

period:

Month one: $______________

Month two: $______________

Month three: $______________

Month four: $______________

Month five: $______________

Month six: $______________

$_________(II)

RMR monthly attrition is defined as the quotient of

(I) above divided by (II) above, expressed as a

percentage

_____%

Multiplied by twelve x 12

Actual Annualized RMR Attrition _____%

This method also facilitates rolling the measurement forward as the months (period)

progress.

10

THE COST OF ATTRITION

If the company and its management spent as much time and economic effort controlling

attrition – the loss of customers – as they did trying to find and buy into the next new

customer, the net value of the business would be enhanced.

Example

�� $50,000 RMR Company

�� Adding 50 new customers per month at $30 for monitoring/service per month

�� Market Value Assumption – 35 Multiple

�� Static Pool Method of Attrition Measurement

Net Ending RMR

Year 1 Year 2 Year 3 Year 4 Year 5

6% Annualized Attrition 65,000 77,876 89,984 101,360 112,502

8% Annualized Attrition 64,004 76,880 88,724 99,632 109,664

11% Annualized Attrition 62,504 73,628 83,528 92,336 100,184

Valuation Difference

Year 1 Year 2 Year 3 Year 4 Year 5

6 vs. 8% Annualized Attrition 34,860 34,860 44,100 60,480 99,330

8 vs. 11% Annualized Attrition 52,500 113,820 181,860 255,360 331,800

6 vs. 11% Annualized Attrition 87,360 148,680 225,960 315,840 431,130

A 2% attrition difference can make a significant difference in the ultimate value of the

entity/customer base. Thus the importance of implementing meaningful and effective

management tools such as attrition measurement and attrition cause analysis to help the

management team focus on the symptoms of attrition within their organization. The

whole management team and work force must be guided and motivated to minimize

customer losses.

11

WHAT ATTRITION MEASUREMENTS

CAN TELL YOU ABOUT A BUSINESS

Attrition can indicate direct and indirect conclusions about a business.

Direct Conclusions Possible:

• Indication of a company’s ability to set effective priorities

• Indication of the quality of customer care and service

• Indication of a company’s operational strengths and weaknesses

Indirect Conclusions Possible:

• Probability of the company retaining remaining customers and to what extent

• Probability of the company attracting new customers and to what extent

• Company’s strength in managing their business in a competitive environment

The attrition results can be traced back, in part, to the origin of the new system as

marketed or sold. It continues to be supported by the figures that the greater the customer

investment in a security system, the more likely that you will experience less attrition or

customer losses. The financial community continues to focus on the credit score of a

customer as a leading indicator of the likelihood of losses that a low credit score will

yield. In the current multi-credit check environment that exists today, access to customer

credit history is readily available. This multi-credit check environment has a negative

impact on a consumer’s credit score through activity, which has nothing to do with

increasing credit risk. This “personal attrition characterization” continues to lose some of

its newfound validity as a leading indicator of predicting customer’s attrition.

12

TRACKING ATTRITION CAUSES

Attrition is a measurement of the company’s ability to provide timely and competent

service, from the installation thru to the termination process (move to a rest home/nursing

care). There will be Acts of God (Hurricane Andrew – Homestead, Florida in 1992) and

economic downturns (1991 Recession with the Northeast and Southwest United States)

that also impact attrition beyond “service” causes. The reasons for the “dissatisfaction

measurement” are, for the most part, company caused and the attrition tracking process

should be managed to identify and rectify those causes within each organization. Listed

below are some of the main reasons why an account cancels its monitoring/maintenance

service:

• Poor Service

• Slow Respond to Add, Move and Change

• Lost to Competitor

• Out of Business

• Relocated Out of Market

• Bad Debt

• Monitoring Response Problems

• Billing Problems

• Deceased/Rest Home

• Price Increase

• End of Contract Term

TRG Associates implemented a universal Excel/Lotus attrition tracking system that

creates a template by which to measure the causes and amount of attrition. A copy of the

template is attached in Exhibit A.

13

ATTRITION CASE STUDY

Recently TRG Associates, Inc. (TRG) completed an historical attrition analysis on one of

the larger electronic security alarm companies in the industry. The company had

accumulated customers through all the varied growth channels, which offered an

opportunity to complete an attrition analysis on those different channels. TRG’s analysis

was designed to segregate the existing customer base by the various types and sources in

order to determine which segments of the base were responsible for the majority of the

Company’s attrition. Clearly, the growth channel analysis that follows demonstrated that

the customer origination channel contributed to the attrition characteristic of that segment

of the base. The following is an overview of the analysis process and associated results.

Analysis of RMR

The customer database provided both active and inactive customer RMR, the information also

included several identifying codes designed to give company management the ability to track

the customer RMR using various criteria. The following tables describe the segregation of the

RMR by types and sources included in the data:

RMR By Type

Commercial Accounts

Residential Accounts

Dealer Program Accounts

National Accounts

Wholesale Accounts

Other Accounts

RMR by Source

RMR by Acquisition

RMR by Dealer

Internally Generated RMR/ Other

The annual attrition calculation was based on the RMR at the start of each year plus the

RMR added during the year (Modified Static Pool Calculation).

It is important to note that the amount of RMR cancelled in the analysis was in part due

to an over 90 day accounts receivable status (120 days for National Accounts) and was

not adjusted for slow pay accounts (accounts that pay RMR charges consistently despite

maintaining a balance past due 90/120 days or more). All accounts with an over 90/120

status were simply cancelled in this calculation process to yield a “conservative” nonperforming

account status and thus force the account into a cancelled status.

14

Attrition Results

Based on the review, TRG compiled a detailed RMR analysis by customer RMR source

and type (channel). These calculations reflect the gross attrition levels experienced by

the various segments of the customer base, and do not take into consideration any

account re-signs or other RMR “Adds, Moves and Changes” that may have coincided

with the cancellations. Any account with an over 90 day due status, regardless of

extenuating circumstances, was included in the attrition figures at the point the account

became 90 days past due. We purposely pushed the attrition back to properly restate the

import of non-paying accounts that were still active in the billing system.

Acquired RMR The customer base included customer accounts divided almost equally

between residential and commercial. It is important to note that the National account

RMR and the Wholesale account RMR were analyzed separately, and are not included in

this Acquired RMR attrition analysis. The attrition rates for the acquired RMR portion of

the base were calculated as follows:

Acquisition Coded RMR – Gross Attrition Analysis

Commercial Commercial Residential Residential

(No Over 90 (Including Over (No Over 90 (Including Over

RMR

Adjustment)

90 RMR as

Attrition)

RMR

Adjustment)

90 RMR as

Attrition)

Year 1 Annual 26.57% 26.97% 26.47% 26.56%

Year 2 Annual 16.14% 19.36% 14.99% 16.74%

The early acquisitions suffered from all the “ills” of account assimilation, as the

acquisition program remained active during Year 1. As the acquisition pace slowed, the

newly acquired RMR of Year 2 cancelled at a slower pace. Also the Year 1 acquired

customer bases were predominately residential. The later acquisitions were more focused

on the commercial market place.

Internally Generated RMR The customer base included customer accounts that were

approximately 2/3 residential and 1/3 commercial. The attrition rates for this portion of

the base were as follows:

Internally Generated RMR – Attrition Analysis

Commercial Commercial Residential Residential

(No Over 90 (Including Over (No Over 90 (Including Over

RMR

Adjustment)

90 RMR as

Attrition)

RMR

Adjustment)

90 RMR as

Attrition)

Year 1 Annual 21.84% 22.45% 24.30% 24.38%

Year 2 Annual 13.88% 18.09% 10.95% 15.22%

15

Even in the most difficult of operating environments, the internally generated accounts

experienced lower attrition characteristics versus the Acquired RMR.

Dealer Program RMR The customer base included accounts that were obtained thru a

national dealer program. The attrition rates for this portion of the base are as follows:

Dealer RMR – Attrition Analysis

Residential Residential

(No Over 90 RMR

Adjustment)

(Including Over 90 RMR as

Attrition)

Year 1 Annual 34.87% 35.55%

Year 2 Annual 13.77% 29.79%

A significant portion of the RMR added in Year 1 and the beginning of Year 2 came from

aggressive mass marketing efforts, and as a result the quality of customers added during

the period slipped. These efforts were significantly scaled back towards the end of the

year 2 and as a result, the attrition levels consistently decreased.

National Account RMR The customer base included a substantial amount of actively

billed National Account RMR. The attrition rates for this portion of the base were as

follows:

National Account RMR - Attrition Analysis

(No Over 120 RMR

Adjustment)

(Including Over 120

RMR as Attrition)

Year 1 Annual 22.3% 22.3%

Year 2 Annual 22.4% 60.7%

The high levels of attrition experienced in early Year 1 were in part due to the method

employed to convert the billing of acquired accounts into the billing software used by the

Company. The Company did not eliminate inactive accounts from the acquired databases

prior to converting to a new billing system; instead these accounts were transferred into

the new system and then eliminated (cancelled).

During the project, TRG worked to remove the impact of some of the data base

inaccuracies so as to be dealing only with the customer’s start date, last pay date or

cancelled date which ever was earlier. We also worked to transpose the appropriate

customer start date versus the acquired date (date of assimilation) as we presented the

vintage of the “performing account” base by channel. This analysis led to being able to

represent the true length of service that the segments of the performing customer base had

been active for – no matter when acquired or internally generated.

16

CONSENSUS AND ATTRITION MANAGEMENT

While we have discussed multiple methods of calculating attrition and given examples of

TRG’s clients most frequently used methods; the purpose of this discussion is to generate

a conversation/exchange of ideas about these methods to encourage forming a consensus

on the measurement methods and definitions for attrition terms. With a common,

selected method or methods, the industry can begin to better identify, in a comparable

form, the attrition characteristics of a customer base as a whole or within the channels of

the customer base as we described in our example.

This dialogue on Attrition is intended to generate an exchange of ideas that will

culminate in a special presentation on Attrition in April at the Mid-Year CSAA meeting

in Tucson, AZ. As importantly, we will discuss in detail, at that time, the various

methods, policies and incentive plans available to minimize attrition – gross and net.

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