July 25, 2016

Payoff Horizon

Let's work through a very simple example.

Let's say that there are only two customers I can acquire each year.
  • Each newly acquired customer generates $20.00 profit in year one, $12.00 profit in year two, and $8.00 profit in year three.
  • Customer #1 can be acquired at a loss of $10.00.
  • Customer #2 can be acquired at a loss of $25.00.
What should the strategy be for this company?
  1. Do not acquire either customer, because the company loses money acquiring the customer?
  2. Acquire only Customer #1, since Customer #1 is generated at a better profit rate than Customer #2?
  3. Acquire both Customer #1 and Customer #2 each year?
This can be answered easily, by simply doing a bit of math. Let's run a three year scenario for each strategy.

If we do not acquire either customer, then here's what happens.
  • Year 1 = $0.00 profit.
  • Year 2 = $0.00 profit + $0.00 profit.
  • Year 3 = $0.00 profit + $0.00 profit + $0.00 profit.
  • Three Year Profit = $0.00.
Let's say for each of the next three years, we only acquire Customer #1 each year.
  • Year 1 = -$10.00 + $20.00 = $10.00 profit.
  • Year 2 = $12.00 (from year 1 customer) + (-$10.00 + $20.00) = $22.00 profit.
  • Year 3 = $8.00 (from year 1 customer) + $12.00 (from year 2 customer) + (-$10.00 + $20.00) = $30.00 profit.
  • Three Year Profit = $10.00 + $22.00 + $30.00 = $62.00.
Let's say that for each of the next three years, we acquire both Customer #1 and Customer #2. We already know the following for Customer #1:
  • Year 1 = $10.00 profit.
  • Year 2 = $22.00 profit.
  • Year 3 = $30.00 profit.
So let's run the same scenario for Customer #2.
  • Year 1 = -$25.00 + $20.00 = $5.00 loss.
  • Year 2 = $12.00 (from year 1 customer) + (-$25.00 + $20.00) = $7.00 profit.
  • Year 3 = $8.00 (from year 1 customer) + $12.00 (from year 2 customer) + (-$25.00 + $20.00) = $15.00 profit.
  • Three Year Profit = -$5.00 + $7.00 + $15.00 = $17.00.
In total, then, the company that acquires both Customer #1 and Customer #2 generates the following:
  • Year 1 = $5.00 profit.
  • Year 2 = $29.00 profit.
  • Year 3 = $47.00 profit.
  • Three Year Profit = $5.00 + $29.00 + $47.00 = $71.00.
Which business do you wish to manage?
  • Do Not Pursue Customer 1/2 = $0.00 + $0.00 + $0.00 = $0.00 three year profit.
  • Pursue Only Customer #1 = $10.00 + $22.00 + $30.00 = $62.00 three year profit.
  • Pursue Customer #1 + #2 = $5.00 + $29.00 + $47.00 = $71.00 three year profit.
If your goal is to never lose money acquiring customers, you go with the first strategy, and in three years, you have no incremental new profit.

If your goal is to maximize 12-month return on investment, then you go with the second strategy, and three years from now you have a customer file generating $30.00 of incremental profit, and for the three-year period, you generated $62.00 profit.

If your goal is to maximize the long-term health of your business, then you go with the third strategy, and three years from now you have a customer file generating $47.00 of incremental profit, and for the three-year period, you generated $71.00 profit.

THIS IS WHY YOU HAVE NO CHOICE BUT TO CALCULATE LIFETIME VALUE.

NO CHOICE.

Don't you think your Executive Team wants to have a discussion about whether they should pursue just Customer #1 or pursue both Customer #1 and Customer #2 each year?

Ever wonder why your business doesn't grow? Maybe you are not pursuing Customer #1 and you are not pursuing Customer #2.

Ever wonder why your business grows slowly? Maybe you are not pursuing Customer #2.

Ever wonder why profit as a percentage of sales is sluggish but total profit is good? Maybe you are pursuing both Customer #1 and Customer #2.

Show of hands ... 
  1. How many of you calculate Lifetime Value?
  2. How many of you know specifically which of the three strategies outlined above your business should execute to achieve company goals?
If you didn't raise your hand to #1, it's time to hire somebody like me, or hire your favorite vendor. There are many credible vendors who can help you measuring long-term value.

If you didn't raise your hand to #2, don't you think it is time to learn what your business will look like in the future based on different payoff horizons? Contact me now (kevinh@minethatdata.com) and let's get busy.