October 13, 2016

In The Simulations, How Much Is The Customer Worth?

When you run a Lifetime Value Simulation (#LTVS), you learn how much downstream demand customers generate.

The curves frequently look similar to the curve depicted here - more downsteam demand happens in year one, then the rate of demand downstream flattens a bit.

In our example:
  • Cumm Through Year 1 = $59.36.
  • Cumm Through Year 2 = $92.69.
  • Cumm Through Year 3 = $121.69.
  • Cumm Through Year 4 = $149.47.
With the fitted relationship, we can estimate what happens even further down the road, right?

Then, you multiply demand by your profit factor and then you subtract ad cost, and all of a sudden, you have lifetime value by year. Let's assume the following:
  • Year 1 = Ad Cost of $12.00, Profit Factor = 35%.
  • Year 2 = Ad Cost of $9.00, Profit Factor = 35%.
  • Year 3 = Ad Cost of $7.00, Profit Factor = 35%.
  • Year 4 = Ad Cost of $5.00, Profit Factor = 35%.
This yields an annual view of Lifetime Value.
  • Year 1 = $59.36*0.35 - $12.00 = $8.78.
  • Year 2 = $33.33*0.35 - $9.00 = $2.67.
  • Year 3 = $29.99*0.35 - $7.00 = $3.15.
  • Year 4 = $27.78*0.35 - $5.00 = $4.72.
And the annual view is translated to a cumulative view.
  • Year 1 = $8.78.
  • Year 2 = $11.44.
  • Year 3 = $14.59.
  • Year 4 = $19.31.
This is where things get interesting.

Let's say you have your Paid Search program. You generate 100 clicks at a cost of $0.50 each - you obtain 2 orders at $40 each, with a 35% profit factor.
  • Demand = $80.00.
  • Profit Factor = $80 * 0.35 = $28.00.
  • Ad Cost = $50.00.
  • Profit (Loss) = ($22.00).
  • Profit (Loss) per New Customer = ($22.00) / 2  = ($11.00).
You lost $11.00 acquiring the customer (you measure Profit per New Customer and not Marketing Cost per New Customer ... right ... RIGHT?).

It will take two years to make up the money you lost acquiring the customer.

Do you acquire the customer?

This is where you need your Five Year Customer Simulation ... taken down to variable profit. Do sales and profit meet the expectations of your Chief Financial Officer? If the answer is "yes", you acquire the customer. If the answer is "no", you don't.

You need the Lifetime Value Simulation (#LTVS) to determine how much profit the customer generates downstream.

You need the Five Year Customer Simulation to illustrate to your CFO how much demand and profit your strategies generate.

You need the partnership of your CFO.

And then, you can apply your tactics to all marketing channels and bask in your customer development brilliance.

Right?