Posted by: Julie McManus
October 26, 2007
Issue #265

The Beginner’s Guide to
Customer Lifetime Value

Dear Business Builder,

Happy Friday and welcome back to In the ‘Net Trenches. One of the most mysterious or confusing of the direct response metrics is customer lifetime value (LTV). When you ask many a direct marketer if they know the lifetime value of their customers, their answer usually starts with “Well (insert long pause) … we know they continue to buy, but we just don’t know exactly how much.” And that’s because lifetime value can be difficult and time-consuming to calculate.

In today’s issue, I’m going to try to clear the confusion and give you a good understanding of lifetime value, how you can start to calculate it, and exactly why this key metric is so important to your marketing efforts.

Understanding Customer Lifetime Value

Knowing customer lifetime value is truly where the rubber meets the road for any direct marketing business. Give a lifetime value report to a seasoned direct marketer and watch his eyes light up and get positively giddy with the possibilities. But what exactly is lifetime value?

Lifetime value simply gives each new to file customer in your database an average future value beyond their first order. It is a predictor of future sales and revenue. In active direct marketing businesses, it’s typically calculated in time increments of first 30 days, 60 days, 90 days, 6 months and a year.

At this point, you might be asking yourself (or your computer monitor), “how the heck am I supposed to know what my brand new customer’s next purchase is going to be and when … I’m not a psychic!” And neither am I, but herein lies the great beauty of direct marketing – unlike the current all the rage diet plan — all things considered equal, past results are indicative of future results. And that means we can analyze the transaction history of our current active customers to determine what our new to file customers are likely to spend in the future.

Are you starting feel like I might just be handing you a crystal ball?

Now, you might be thinking to yourself “but I’ve got hundreds (or thousands) of customers, how can I possibly look at every single thing they’ve purchased beyond their first sale?” And the answer is you can’t … and you don’t need to. But what you can do is start by looking at the specific channels you use to acquire new customers (e-mail, pay-per-click, direct mail, etc.) and as long as you’re tracking those individual efforts separately and your customers transactions are grouped under individual customer numbers, you have what you need to start your lifetime value journey.

You’ll start by selecting a few campaigns within a specific channel. Then take that sub-group of customers and analyze their individual purchases beyond the first transaction. Break the transactions down into 30, 60, 90 days, 6 months and one year increments (don’t worry if you don’t have a full years worth of data). Some will buy nothing more, some will jump out at you for the sheer volume of additional products they’ve purchased and some will be mediocre. That’s okay; the goal is to come up with an average. Then total the sales for each time increment and divide by the total number of customers in your sub-group to get the average for each specified time frame.

Congratulations you’ve just calculated a very top line customer lifetime value for that specific channel. You now know what a new customer that comes on file under a specific channel after buying a specific product is likely to spend in the future.

With that, I hope you’re starting to see the sheer power of understanding your customer’s lifetime value.

Four ways customer lifetime value
can make a big impact
on your marketing plans

Now that you’ve acquired an actual value per new customer beyond the first sale, you can start to determine how that value affects and shapes your future marketing plans.

Here are 4 big ways this metric can immediately impact your bottom line:

The More New Customers, the Merrier: When you have a clear estimate of what a new customer will spend once they come on file, the first thing it impacts is what you can afford to pay to acquire a new customer.

For instance, if your current marketing campaigns are built to break-even – for every dollar you spend, you need to make one dollar back in return or 100% ROI – you can then start to look at just how much money you can afford to lose on the front end to acquire more customers.

No longer are you locked into media or lists that perform at or above break-even, but you can plan campaigns that bring in even greater numbers of new customers but perform at just below break-even – you’ll lose 20% of your ad budget on the front end to acquire even more new customers, but you’ll make that 20% back (and then some) after 30 or 60 days.

By knowing this crucial key marketing metric, it allows you to take a measured risk that you might not have been able to otherwise.

Hey Big Spender: Everyone has those customers that just love them. They’re the ones that buy every product you’ve ever produced. They’ve been with you forever and spend boatloads of money. But do you know who they are? Most likely your biggest spenders (or best customers) comprise about 5% of your customer file. And perhaps you have more of them than you realize.

By singling out your big spenders, you can then tailor specific marketing campaigns that speak specifically to them. You can further solidify the relationship by offering them special discounts, special thank you gifts or invitations to special events.

You might even want to consider developing a product specifically for your best customers. One financial client of mine developed a $10,000 product that gave his best customers more personal access to him. It included monthly phone calls and a yearly pow wow in his office, plus it combined a host of other services he already offered.

By going through the exercise to determine lifetime value, you’ll also start to see a trend of multiple transaction customers that will allow you to determine exactly what dollar volume constitutes a big spender.

Channel Surfing: What marketing channels are your best performers? You may have a good sense of what channel brings in the most money or the most new customers, and you probably (I hope) have a great sense of what channels consistently meet your ROI targets. But do you know what channels bring in customers with the highest lifetime value?

By analyzing lifetime value data by channel, you can easily determine the best performing marketing channels for your offers. If you are doing multi-channel marketing, you might be surprised to learn that one channel has a higher lifetime value than others. With customer lifetime value at your disposal, you can focus your efforts on the channels that give you the biggest long-term bang for your buck.

Follow the Yellow Brick Road: In the process of determining lifetime value, you’ll also be getting an in-depth look at just what your customers are buying. In all likelihood, you’ll also start to see a trend as to what the most common next purchase is in the chain.

So let’s use golf equipment as an example. If the customers that buy golf clubs from you first are most likely to make a second purchase of golf balls in the next 30 days, you now know exactly what product to immediately promote and when to your first time golf club buyers.

With that information at hand, you can plan an arsenal of marketing promotions geared specifically to get that second sale and make a conscious effort to increase your customer lifetime value.

Customer lifetime value is not an easy direct marketing metric to calculate, but I’m sure you can see the tremendous impact it can have on your bottom line. So sharpen your pencils and get busy … the time it takes will be more than worth it in the end. Plus, when someone asks you if you know your customers’ lifetime value … you’ll look like a genius!

Hope that helped and have a great weekend!

Until next week,

Julie McManus
Editor, In the ‘Net Trenches
THE TOTAL PACKAGE
And Web Media Goddess

P.S. Are you in the ‘net trenches? Do you need help? Send
me an e-mail to AskJulie@MakepeaceTotalPackage.com and
I just might answer your question in an upcoming issue.

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3 Comments »

1. Comment by Donna Doyle — October 26, 2007 @ 9:05 am

   Thanks for the info, Julie! Great information on an important direct response principle.

2. Comment by Myles Saulibio — October 27, 2007 @ 12:40 am

   Mahalo Julie!

   Excellent write. I sense Web Analystics here and the scientific approach to predictive behavior is spot on. Where to concentrate effort to get %100 ROI is a keeper. I am wondering though—a gut feeling could also help to protect the bottom line. Rather than \”shot gun\” approach, use a rifle instead. Be careful though, there is someone among us who will get caught get in the analysis and forget to place actions before words or thoughts.

   Aloha and Best!
   Myles Saulibio

3. Pingback by Pricing Skills and Services as a Freelancer: Part 3, Understanding CLV (Customer Lifetime Value) | Freelancing and Outsourcing Tips, Commentary, Analysis, and News from oDesk — July 16, 2009 @ 11:00 am

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