On Twitter, I get a lot of questions about lifetime value.
Lifetime Value, or "LTV" as some call it, is simply a measure of the future profit generated by a customer acquired today. There are 22,493 ways to calculate LTV ... so the point of this week isn't to teach you how to calculate LTV, though I will certainly share my thoughts about how I calculate it. Too many pundits, vendors, and analytical gurus will complain about any calculation style ... they're missing the point ... less than 10% of the companies I work with even bother to calculate LTV in the first place. Why have an argument about how to calculate LTV when almost everybody chooses not to calculate LTV?
Here's the interesting thing ... almost any statistical model created on an annual basis has LTV essentially built into it. Smart marketers who avoid all of the nonsense about individual campaigns tend to elevate the value of LTV to (at minimum) Marketing Leadership and Finance Leadership.
LTV requires the marketer/analyst to measure profit. Without profit, LTV has no meaning whatsoever. Who cares that a customer will spend $90 in the next twelve months if only 30% of sales flow-through to profit and the company will spend $30 in ad cost marketing to the customer?
Why was the last paragraph important?
- Profit = $90.00 * 0.30 - $30.00 = $27.00 - $30.00 = ($3.00).
See what I mean? That $90.00 LTV value is meaningless because it represents sales, not profit. Profit equates to a loss of $3.00. #OhBoy.
LTV, when measured in terms of variable profit (what some call "contribution" ... essentially it is profit prior to subtracting fixed costs), takes one of two trajectories.
- LTV is low, and tends to drop off quickly when annual repurchase rates are low.
- LTV is plentiful, and can actually increase over time if the customer has a 75% or greater annual repurchase rate and purchases 6+ times per year.
(1) is the reason that so many catalog brands are stuck and cannot grow. They cannot harvest enough long-term profit out of the customer (due to low annual repurchase rates and high ad-to-sales ratios) to overcome the steady decline in co-op response rates.
(2) is the reason that Wal-Mart, Amazon, Starbucks, McDonalds and many other "mega-brands" are what they are ... the customer purchases over and over and over and perpetually generates a mostly constant level of profit ... and this is what leads to the loyalty gurus claiming credit for their efforts (though their efforts have minimal impact on loyalty).
The worst companies spend to a cost-per-new-customer, independent of profit.
Good companies tend to calculate 12-month future profit for new customers, and invest in new customers to optimize twelve-month total profit among first-time buyers.
The best companies calculate future value for EVERY CUSTOMER in the database, regardless of where the customer is in the customer lifecycle. This allows the best companies to maximize future profit from EVERY CUSTOMER in the database.
More on this topic tomorrow.