This is one of the first questions I ask all my clients. The answer usually comes back including some aspect of “buy low, sell high” and other margin-related facts. Regardless of the complexity or depth of the answer, one word is always included.
The magic word is “people.”
So why isn’t all marketing done on customer lifetime value (LTV)? What are the five things you need to consider when developing LTV-based models that allow you to build CPA (cost per acquisition) based marketing plans?
You typically don’t make money on the one-shot sale. Your automobile dealership didn’t make money strictly on the sale of your car, unless you struck an extraordinarily poor deal. It was the financing, insurance, trade-in and accessories that made the transaction palatable to them.
The real money is in the service and the 2nd and 3rd cars that you might buy in the future. (Along with the ancillary financing, insurance, trade-in and accessories associated with those sales.) Acquiring you as a customer is the key to long-term profits for the dealership.
Why doesn’t everybody consider an LTV-based marketing model?
I was speaking to a potential client last week and asked them “how much did it cost to acquire new customer?” and “what is the lifetime value of your customers?”
The fact that they didn’t know the LTV of their customers wasn’t a surprise. It was a new business, after all, and they didn’t have any history. What was surprising was that they didn’t believe customer LTV and having a solid CPA was the way to look at the business. Marketing was not looked at as a revenue-generating component of the business. Rather, it was seen as an expense and nothing more than a percentage of sales.
I thought this was interesting. Is it true that there are some businesses where looking at customer acquisition costs and calculating customer LTV doesn’t make any sense?
I thought about it all weekend and came to the conclusion that–in the B-to-C space–the answer was no.
If you generate profits by selling to customers, then you need to calculate and understand customer LTV and use that to understand your allowable CPA.
Estimating (or calculating exactly) customer LTV fundamentally only includes about five factors. They are:
- Understanding your conversion funnel. You have to have some idea of the Suspect to Prospect to Lead to Buyer flow. You have to know that conversion rate, because your marketing activities will bring in people in different parts of the funnel. Sometimes, your marketing effort will get you no more than a suspect. Other times, such as in SEM, you’ll get somebody who’s ready to buy right then. Knowing and understanding the flow of suspect through buyer will help you allocate your marketing dollars more effectively across all your channels.
- Initial unit of sale and margin on the unit. You need to know what the initial unit of sale is and the level of profit (before marketing expense) is included in that unit of sale.
- Opportunity for repeat purchase. Is your product one that needs to be replenished periodically? How frequently? How many of the initial buyers will replenish from you, as opposed to your competitors?
- Ancillary purchases. What other products and services do you sell? What is the attach rate for each of those to your new customers and installed base? In our case of the automobile dealership, what percentage of the new car buyers will choose to come back to the dealership for routine maintenance? (And what kind of marketing activities will you have to undertake to encourage them to do so?)
- LTV window. This is probably one of the most important things to consider. In the case of our automobile dealership, the lifetime value window for a car buyer in her 30′s might be 5 or 10 years. In the case of a digitally-delivered product–say, music downloads–I think you’d be taking on a lot of risk to consider a window longer than 18 to 24 months.
The rest is just building an Excel model to determine how much you could spend and then developing a bottom-up plan to exhaust all possible marketing channels that can deliver against that allowable cost per acquisition.
Yes, sometimes you’ll have to make some assumptions and sometimes you’ll not have all the data you’d like. But if you know the ballpark you’re playing in, you’ll know which marketing channels might make sense and make your ROMI goals. You’ll also know where to take calculated risks to stretch your marketing budget and grow more quickly.
Summary and takeaways
- Every business should know the value of a customer over some reasonable time frame, because profits come from selling products and services to customers.
- It’s relatively easy to calculate customer LTV. Even if the data isn’t entirely clean, it’s still pretty easy to determine at least the rough value of a new customer.
- Build your acquisition marketing plans using a known allowable CPA. Once you know how much a customer is worth, it’s easy to figure out how much you’d invest to get them to buy from you.
So what do you think? Can you really calculate customer LTV for businesses as diverse as magazine subscriptions, convenience store customers and shoe store customers?