Merchandise Productivity Impact on CLV

It's just so darn important to put what the customer wants to buy in front of the customer.

I mean, it's more important to develop outstanding merchandise and to develop great creative presentation of outstanding merchandise.

But most marketers have no control over that - they might have control over what the customer sees.

Between what the marketer does and what the merchants / creative folks do, productivity will improve, and when it improves, long-term customer value improves.

Think about it this way ... let's assume that you acquire a customer, and over the next five years you generate the following:

• Future Demand = $60.00.
• Profit Factor = 40%.
• Future Ad Cost = $12.00.
• Future Profit = $60.00*0.40 - $12.00 = $12.00.

Now, between you and your merchants and your creative team (and others, yes), you increase merchandise productivity by 10%. What does future profit look like?

• Future Demand = $66.00.
• Profit Factor = 40%.
• Future Ad Cost = $12.00.
• Future Profit = $66.00*0.40 - $12.00 = $14.40.

In this example, a 10% increase in merchandise productivity yields a 20% increase in future profit (CLV).

Better yet, it means you can spend more to acquire the customer, which causes you to generate more new customers, which causes future sales to increase as well.

There are good reasons I consistently encourage you to focus on merchandise ... your marketing performance depends upon it!!

Who Is Buying? ICLV

In my Marketing Budget Experiments project development, I segment customers in two different ways.

1. New customers stay in a cohort through the rest of the year. They stay in the cohort in the subsequent calendar year as well.
2. Existing customers are modeled via regression models, and are split into twenty-five (25) segments of varying levels of customer quality.

Now, each marketing channel appeals to a different audience. Paid Social might appeal primarily to prospects, but not entirely to prospects. If you increase Paid Social spend by 50%, you will mostly generate new customers, but some existing customers will purchase as well.

This is where our Experiments become interesting.

With new customers, we balance the cost of acquisition with CLV ... customer lifetime value. Most clients look to be paid back within about 7-12 months. Most of the work I've performed suggests the payback window should be more than 7-12 months ... your mileage will vary.

With existing customers? Spicy nacho dip. Here you are looking at ICLV ... or "Incremental Customer Lifetime Value". When you take a customer who had Recency = 7 month and Frequency = 4 purchases and you convert the customer to Recency = 1 Month and Frequency = 5 purchases, you change ICLV (incremental customer lifetime value). The customer might have been worth $30 of profit in the next five years and the customer is now worth $45 of profit in the next five years. The difference ... $45 - $30, is ICLV. The marketing effort added $15 of CLV to this existing customer.

It turns out that ICLV plays just as big a role as CLV in determining if the long-term impacts of marketing outweigh the short-term cost of marketing.

Last Chance To Get In On The Trial Of Hillstrom's Marketing Budget Experiments!!!

You have until 8:30pm EDT / 5:30pm PDT on Monday (5/8) to communicate interest in participating in my trial of Hillstrom's Marketing Budget Experiments ... earning the right to pay just $12,000 for the project.

Interest has been high - I set a weekly record last week for people clicking on my "Hire Kevin" page. There may be a half-dozen trials based on current interest, likely more after this post is received.

I created a .pdf document outlining the trial ... click here to read the document.

If you cannot commit to the project yet (i.e. you need approval from your Executive Team), then please email me your interest by the deadline above and I will honor trial pricing when you get approval.

After 8:30pm EDT tomorrow, this project will cost $19,900 ... the normal price for this project ... so communicate your interest to me immediately.

Your Payback Window

Yesterday, we established the fact that ROAS is related to Profit per Customer/Order. The two metrics are directly related ... Profit per Customer/Order is directly actionable.

What makes this stuff fun is the balance between how much money you lose within campaigns (yes, you notice I said "lose" ... gonna be a controversial take going forward) and how much money you make thereafter. There is a balance, and it takes some sophisticated math to evaluate the balance. Fortunately, I have thousands of lines of computer code to perform the math required to evaluate the relationship.

In the scenario below (and this graph is important), we plot the relationship between how much we spend within marketing campaigns and how much long-term profit we generate. Each curve represents a payback window. If our payback window requires us to execute a profitable campaign, we can spend a small amount of marketing dollars. If our payback window allows us to make the most profit over time, we can spend a lot of marketing dollars. A lot!

Here's the relationship.

The arrows are important here. The arrows tell us how much to spend on marketing to achieve optimal profit. Each curve represents a different payback window.

If you need a lot of profit today, you spend a small amount on marketing.

If you want a lot of profit tomorrow, you spend a lot of money on marketing.

If you are unhappy with the size of your business today, it's the cumulative impact of many years of trying to optimize short-term profit that leaves you with too little profit today.

The optimal levels of profit above are illustrated in the table below.

ROAS-centric marketing requires a small amount of marketing spend to optimize campaigns right now. If your ROAS is high, you made sure you delivered profit today.

But if long-term value is sufficient (and in this case long-term value is sufficient - see below)?

If you generate $46 of profit over five years, you might be willing to lose $30 per customer/order within a marketing campaign (which yields an amazingly low ROAS) because the long-term health of your business is assured.

I created an algorithm ... thousands of lines of computer code. The algorithm tells the secrets to marketing investment for your company. Based on how much your customers pay you back and based on how sharp the law of diminishing returns is for your brand, your future is determined by the decisions you make today. Said differently ... if you aren't happy with today, it is quite likely you didn't invest properly over the past five years.

As I mentioned on Friday, you can jump in on the development stage of the algorithm through this weekend at approximately 40% off (click here for the full price). By Monday, it's full price, and based on the feedback I received over the past eight days, it's gonna be a busy period!

And it's gonna be ... SO ... MUCH ... FUN ... to learn how short-term marketing investments relate to long-term business health.

Long-Term Profit Covers Up Short-Term Losses

Let's set up a relationship that we'll explore tomorrow.

Ok, here are some metrics from a marketing campaign.

• Sales = $300,000.
• AOV = $100.
• Customers = $300,000 / $100 = 3,000.
• Ad Spend = $150,000.
• Profit Factor = 40%.

With the available metrics, we can calculate ROAS.

• ROAS = $300,000 / $150,000 = $2.00.

Oooooh ... not good.

Let's calculate profit:

• Profit = $300,000 * 0.40 - $150,000 = $120,000 - $150,000 = ($30,000).

We lost $30,000. No bueno.

The key here is to map profit to customers. We had 3,000 customers purchase.

• Profit per Customer = ($30,000) / 3,000 = ($10.00).

There it is! That is the number that matters. Not ROAS. Profit per Customer. We lost $10.00 to generate each customer who purchased from the campaign.

The secret now is to calculate how much we increase customer spend in the future as a consequence. There are two parts to this ... any new customer delivered via this campaign has a downstream value that is easy to quantify ... and any existing customer migrates to a higher segment and the incremental future value of that segment less the incremental future value of the segment the customer previously belonged to contributes to the CLV delivered by the campaign.

Let's assume the weighted average of the two audiences yields the following:

• Year 1 Profit = $18.00.
• Year 2 Profit = $11.00.
• Year 3 Profit = $7.00.
• Year 4 Profit = $5.00.
• Year 5 Profit = $3.00.

The customers who responded to the campaign deliver $44.00 of future variable profit, with $18.00 coming in the first year. This more than offsets the $10.00 you lost per customer in the campaign itself.

I mean, you invest $150,000, you lose $30,000 on the campaign, and then you make 3,000 * $18.00 = $54,000 ... your campaign pays you a 16% interest rate over the course of a year. And after that you keep producing interest.

So yes, long-term profit covers up short-term losses.

How much more long-term profit is generated? In other words, could we spend more than $150,000, get even worse short-term results, and still come out ahead over time? We'll have a different example tomorrow that answers the question, as we build out our framework for Marketing Budget Experiments.

ROAS Converted into Profit ... Short-Term Profit

In this example, I depict three different relationships.

ROAS is in turquois. This company spends $100,000 on digital marketing, and we can see how ROAS changes as the company spends more and more on marketing (yes, you should be varying your marketing spend on an experimental basis so that you understand what happens when you greatly increase/decrease marketing spend).

When you obtain profit factors from your Finance team, you can convert ROAS to Profit per Customer or Profit per Order. That relationship is depicted in blue. Spend more, generate less profit per customer/order.

The maroon-thin line shows the incremental profit generated per customer for each additional $10,000 of marketing dollars spent. This number drops below $0 at $40,000 of marketing spend ... right around a cumulative (not incremental) ROAS of $4.00.

You are halfway toward an actionable outcome. Many digital marketers stop here, seeking to generate sufficient ROAS on efforts to guarantee profit.

This guarantees profit on individual campaigns.

Does it guarantee profit over time, and yield a healthy brand?

Absolutely not.

P.S.:  Remember, to get 40% off your Marketing Budget Experiments project, you need to respond by end of day Sunday. Join other readers who have already responded with an enthusiastic "yes" to prototype this project at significant cost savings (click here).

ROAS-Based Digital Marketing

ROAS. Return on ad spend. The inverse of the old-school 1980s catalog metric called ad-to-sales ratio (yes, they are the exact same thing).

It's a metric that dominates digital marketing. If you don't have access to profit information (or gross margins at bare minimum), it's the metric of choice. It correlates directly with profit, so it is a metric that has value.

Your challenge (and you already know this) is that you don't truly know if a ROAS of $14.00 or $2.75 is appropriate. You know $14.00 is likely profitable ... highly profitable. You know $2.75 is probably marginally unprofitable ... but is that bad?

Tomorrow, we'll explore math that reveals how much we've been deluded to think that we must have a high ROAS or we are failures as marketing professionals. All of this is leading us toward the value of Marketing Budget Experiments.