Question: You lose $8 profit acquiring a new customer. The customer generates $7 profit in year one, $5 profit in year two, and $3 profit in year three. Which time horizon should you maximize long-term value upon?
- You lost $8 profit, so stop marketing to this source of new customers.
- You lost $8 profit, and you do not make up the difference in year one, so stop marketing to this source of customers.
- The customer generates $15 profit in three years, more than offsetting the $8 lost in year one. This customer source is profitable, and should be profitably mined.
- You were not give enough information to make an informed decision.
What is your answer?
The right answer is to run a long-term simulation, and let the simulation determine if you generate enough long-term profit to maximize shareholder value. In other words, the answer is (4).
On average, simulations show that there is a direct correlation between annual repurchase rates and the length of time you are willing to wait for payback.
In other words, if a new customer has a 20% annual repurchase rate, then there is very little future value generated, and as a result, you're going to have to break-even up-front on customer acquisition costs.
If a new customer has a 50% annual repurchase rate, then there is significant future value generated, and as a result, you may be able to wait three years or four years to make up acquisition costs.
But you have to run the simulations to know the right answer.