WHAT IS LTV and ROI?
LTV is the present value of the projected future cash flow your business will realize from a customer relationship. LTV pummels traditional return on investment (ROI) metrics because they only reflect the profit you make from a customer today. As an example, consider Domino’s Pizza. In this blog, we explain What is LTV in detail with examples.
If you’re Domino’s and you spend $8 to acquire a customer, and you get $15 revenue from that customer’s order, some might say that your ROI is $7. But you don’t want that customer for a single order, do you?
Ideally, you want them to download your app onto their mobile phone and order from Dominoes for years. And you also want to understand profit, not revenue. That’s where LTV shines.
The fatal flaw of traditional ROI measurements is that they’re based only on the cost of acquiring the customer for a single transaction. Acquisition cost is typically your highest cost.
Once you’ve acquired a customer, you’ll usually spend less to retain or upsell them and still make money from them as long as they do business with you. But there could be a real revenue opportunity here. You could spend a bit more to engage them, but that should increase their lifetime value.
With LTV, you can predict the lifetime value of your customers based on historical data. By looking at the numbers like the frequency of purchase, the total number of purchases before the customer churns, the profit per transaction, and the cost of acquisition, you can get a good idea of that customer’s lifetime value.
Customers who make the most purchases or spend the most money per purchase become your A-listers—the ones you work hard to keep happy. The people in the middle are your B-listers, the ones you try to upsell.
As for the cheapskates who rarely make a purchase, you can choose to stop chasing them and spend your money to acquire more potential A-list customers. For Domino’s, that segmentation looks a bit like this:
According to the RJMetrics eCommerce Buyer Behavior Benchmark, the top 10% of a company’s customers are worth 600% of the revenue of the average customer. The top 1% is worth 1,800% more. One customer from the top 1% will bring more billings than the entire bottom 50%.
In this case, it’s more profitable to pay $300 to acquire customers with a predicted lifetime profit of $2,600, rather than to pay $30 to acquire customers with a predicted lifetime profit of $15. Common sense, right? But is your marketing team working this way?
If you use LTV as your primary framework for success (which most companies should) then your CMO’s main job becomes:
1. Predicting which customer segments will have what potential LTV. In particular, identify the characteristics of the highest-value potential customers.
2. Engineering a cost of acquiring, retaining and upselling customers that is significantly lower than their predicted lifetime values, segment-by-segment. Do that with a few million customers, and you’ll create an enormous amount of shareholder value very, very fast.
CEOs (and CFOs) love lifetime value because it ties directly to shareholder value, which is what you were hired to protect and grow. I’ve even written an equation that shows how it works.
In essence, if you acquire two million customers for $25 per customer, but after accounting for the cost of retention and upselling, you determine you will make $100 over the lifetime of each customer, you’ll earn $75 on two million customers. That should increase your market value by $150 million, which will boost your share price.
Lose one million customers who would have generated $100 in profit per person, and your market value should drop by $100 million. This correlation between LTV and share price is what makes LTV such a powerhouse way of operating.
ILLUMINATING THE BLIND SPOT
LTV shines light into marketing’s biggest blind spot: the inflection point where long-term value begins to outpace short-term gain. Focusing on it will help you understand how much your customers spend, how often they spend it, and which campaigns and touch points are most likely to make them more valuable customers.
In fact, it’s probably possible to measure all business activity in terms of how the collective LTV of the current customer base has increased over time, minus the marketing costs required to drive that increase.
Do that equation and you’ll learn to think beyond driving one sale at a time to driving multiple sales from loyal customers. Even better, you’ll start to think in terms of schemes that increase the lifetime value of each customer.
You’ll also start thinking more strategically when it comes to retention. If you can predict which customers will churn, determine how much that churn will affect profits.
Value Creation Equals
The lifetime value of a customer is the present value and develop retention strategies that cost less than the predicted lost profits, you’ll have another way to quickly create enormous value.
So why isn’t everyone operating to understand and maximize LTV? First, because CEOs are not insisting on it. Second, because there’s no agreed-upon standard for figuring it out.
Calculating LTV is complex; I barely feel like I’ve reached a point of clarity on it, and the same is true of the world’s best marketing minds. However, it’s also where your biggest opportunity lies. The ability to develop a clear, long-term view of your marketing spend will give your company a lasting advantage over your competitors.
To be sure, there are substantial barriers to using LTV. It requires a massive amount of consumer data that takes multiple quarters (and even years) of focus to compile and analyze.
It’s expensive: there are IT costs, data purchasing, man-hours and more. It doesn’t yield many quick wins within the first year, which— is an era when the average CMO lasts less than three years and faces enormous pressures to show results now—can get in the way of enthusiastic adoption.
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IT’S ALL ABOUT THAT (DATA)BASE
Reaching LTV goals requires data. Lots of data. That database would try to link all customer data to two key unique identifiers: mobile phone number and email address. These are the critical ways of linking all your data about a customer to unique, personal, persistent data points tied to a specific individual.
The email address is the consumer’s primary digital ID for engaging in electronic commerce. It’s the best, most valuable piece of data you can acquire because you can link it to your accounts and then your sales database.
That’s the information that’s going to tell you what kind of ads to create, who your most valuable customers are, what’s working, and what’s flopping. It is also persistent, meaning it doesn’t change very often.
Think about your CRM database as a collection of answers to a lot of questions about your customers. For example:
What have they bought from us so far?
What have we said to them so far, using which media?
How did they react to each message?
Who are my most valuable customers, and what do they have in common?
How do their reactions and buying decisions correlate with what we know about their income, ethnic group, marital status, level of education, mobile device and so on?
What did it cost me to acquire each customer, and how does that compare to their lifetime value?
Slice and dice that data in every way that’s relevant. If you’re Toyota or Ford, correlate sales and response data with credit scores and data about who is driving which car (and how old it is) to find out who your best auto buying prospects are.
If you’re AIG, cross-reference your information with a pension database to figure out who’s ten years from retirement and in need of financial products.
Find great third-party data sources and don’t be shy about using them. In the digital world, with so much data available, your mission is to find actionable data—the facts about each consumer that improve your lifetime value economic model.
The goal is a unified view of each customer that you can cut and segment in different ways depending on your marketing objectives, from customer acquisition and retention to upselling, reactivating dormant customers to lead generation.
But don’t lose sight of the ultimate purpose: determining which customers have the highest potential lifetime value. Marketing based on LTV is the most important thing you will ever do, so having an amazing database is critical.
That’s where your profit is, and that’s why a solid gold CRM database is foundation job #1. Building that database and using it to maximize marketing ROI is why you hire a CMO in the first place. Chief Marketing Officer isn’t just a marketing job anymore; it’s also a data job.
Lifetime Value: Finally, a qualified CMO should have a pretty clear idea of LTV and how to determine it for your various target groups. Which group has the highest potential LTV and should be where you spend more of your budget? Also, the CMO should also know the optimal strategies to increase each audience’s LTV.