Lifetime Value Vs. Profit

As much as we try to treat them that way, not all customers are created equal.

Your customers vary considerably across the board in terms of challenges, costs, and yes, even value.

As entrepreneurs, we spend a lot of time finding new customers and looking for ways to keep the profit rolling in. And while there’s nothing wrong with broad, wide-reaching marketing tactics, the truth is that there’s an often-overlooked aspect of customer acquisition that we should be paying more attention to: that is, a customer’s lifetime value.

As Gary Cokins, founder of Analytics-Based Performance Management says, “To remain competitive, companies must determine how to keep customers longer, grow them into bigger customers, make them more profitable, serve them more efficiently, and target acquiring more profitable customers.”

How can you tailor your marketing strategy and customer acquisition process to help ensure that the most profitable customers are the ones that make it through the net? And just as importantly, how can you keep your good customers for longer?

The answer to these questions can be found in two key metrics: Customer Profitability (CP) and Lifetime Value (LTV). Understanding and paying attention to these two metrics will help you to identify which customers you should be targeting, and show you how you can increase your average customer lifetime value.

Lifetime Value (LTV) and the Roll It Plays

Technically speaking, Customer Profitability (CP) is the profit that a company makes from serving a customer or customer group over a specified period of time. Lifetime Value (LTV), on the other hand, is the forward-looking measure of the value that you can derive by serving a customer.

By using LTV as a metric, you’ll begin shift how you think about customer acquisition costs. For instance, instead of going with the cheapest method for customer acquisition, you’ll be able to go with the one that will give you the most lifetime value.

“For example, one particular customer acquisition channel might bring you new patrons at the lowest possible price, but when you consider the CLV of customers from that channel, they might not be your most profitable,” says Michael Deely with Big Sky Associates. “Your best strategy is to optimize the acquisition channel with the highest CLV so that you minimize customer acquisition costs and maximize your bottom-line growth.”

Understanding the LTV of your customer will help you determine which customers are the ones that you’ll want to specifically focus your marketing efforts on.

Basic factors that determine a customer’s lifetime value include:

• Average number of purchases per year
• Average gross margin
• Direct marketing costs per customer per year
• Average spend per purchase
• Average customer retention rate

And more!

Having this information is tremendously valuable for any business today, when we have a wealth of tools available to help us determine individual customer LTV. It’s easier than ever to obtain accurate information on your customers –even on a case-by-case basis. Of course, you could also segment your customers and determine the average LTV of each group, instead of individually, and many companies find this is an easier and less time-intensive task.

It’s worth noting that while you can easily track the lifetime value of customers that visit your website, it’s far more difficult to calculate this if you don’t have a website in the first place, but are instead using a platform like Amazon.

While you may have a cash machine on Amazon, you don’t have a true business when you don’t have any control over the customer or their experience. If you’re looking to scale your business more efficiently, it may be an idea to go ahead and set up your own website, instead of solely relying on third-party platforms.

Now, let’s take a quick look at a few ways that accurately assessing your customers’ lifetime value can benefit your company.

Benefits of Tracking Your Customers’ Lifetime Value

Tracking your customers’ lifetime value and taking steps to increase it can have a big impact on your company’s bottom line.

Here’s how:

Allows You to Create More Targeted Advertising Campaigns

Paying attention to your customers that have a high LTV will show you where you should be focusing your efforts. This will allow you to form more targeted marketing and advertising strategies. Once you know who your target customers are, you can then tailor your outreach to draw in more of the same.

Increases Your ROI

Having a clear understanding of your customers’ lifetime value will give you a great measuring tool that you can use to track your marketing efforts, allowing you to ensure that you don’t waste money on campaigns that’ll provide a short-term gain, but will result in relatively low lifetime value.

Overtly promotional sales tactics, aggressive coupon strategies, and taking a special effort to attract visitors who are purely interested in discounts, for example, are all ways to attract customers with a low lifetime value.

Saves Money

When you’ve identified your customer segments with the highest lifetime value, you’ll be better able to reach, and others like them, more effectively. Focusing your efforts on your existing customers is a lot less costly than acquiring new ones, and will help you to increase the average LTV of your customers.

Shows You Where You Should Be Spending Money

Likewise, tracking your customers’ LTV can show you where you should be spending your money. Instead of looking solely at profit, you’ll be tracking actual lifetime value, which will show you just how much a potential customer could spend in the long run. Say you have a $40 product, with a profit margin of $15.

If you are looking at profit, then you’ll only be able to spend $15 to acquire that customer before you start to lose money. But let’s say that by tracking LTV, you discover that your customer is actually likely to order four times from you over the lifetime of their engagement. This would mean that you have a LTV of $60. If you focus on LTV, it allows you to potentially spend more to acquire that customer, up to $60 in this scenario.

If your competition is only looking at profit, then you can quite literally outspend them in order to acquire the same customer. All other things being equal, he who can afford to spend more on customer acquisition wins!

Determining Your Customer Acquisition Cost (CAC)

Now, before we go any further it’s important to take a look at another metric: your customer acquisition cost (CAC). This is relevant, since you’ll want to ensure that the amount that you’re spending to acquire new customers isn’t greater than your customer lifetime value.

A simple way to calculate your CAC is to divide your total marketing costs by the total number of new customers that were generated from your marketing efforts. However, many companies find that it’s extremely helpful to pinpoint the CAC of each individual marketing channel that they use, to see which one’s more cost-effective in generating new customers.

Determining the CLV of Individual Marketing Channels

In addition to identifying the CAC of your individual marketing channels, you can also identify the LTV of individual marketing channels in order to see which ones are generating the most profitable customers.

You can use web analytics to determine where your customers are coming from, and to track the success of your ads and promotional campaigns. Keep track of how your customers find you, and then run the numbers to get an idea about their LTV. See how many times they purchased from you in a year, what their average spend was each time, what you expect their retention rate to be, and how much you estimate it cost to acquire them as a customer.

Generally speaking, the more frequently they shop, and the larger their average order, the higher their LTV will be. This data will show you whether or not that marketing channel, or campaign, offers a good ROI in terms of drawing in customers with a high lifetime value.

Tips for Increasing Your Customer Lifetime Value

Creating a retention plan starts with determining which customers you wish to target. After all, you are looking to increase your customers that have a high lifetime value, so employing marketing tactics that’ll help you to draw them in, and keep them, will increase your chances of success. With this in mind, let’s look at some ways that you can increase your average customer lifetime value.

Determine Which Customers Have the Highest Lifetime Value

Of course, before you do anything, you should first determine which customers have a high lifetime value. As I said, you can do this on a case-by-case basis, or you could segment your customers and run the numbers for that specific group.

Using a tool like this one on HBR can be a great way to quickly discover which customers have the highest lifetime value. Once you know which group offers the highest value, you can then tailor your advertising and marketing efforts to attract more of these types of customers –and will be able to focus your retention strategies on keeping them for longer too.

Choose Your Communication Channels Carefully

Not all customers are the same, and the means that the channels that you use to reach them should vary as well. Determining which advertising and promotional campaigns produce customers with the highest lifetime value will show you where your advertising dollars would be best spent.

Work to Increase Customer Satisfaction

Paying attention to your customer satisfaction levels matters, and perhaps not surprisingly, it’s also one of the best ways to increase lifetime value. Research has found that a 5% increase in customer retention can increase profits by 25% to 95%. That study also found that it costs an average of 6-7 times more to obtain a new customer than it does to retain an existing one. It’s worth keeping your existing customers happy!

Streamline Efficiency

A customer’s experience will impact their overall loyalty. If they receive slow service or are treated badly, chances are they won’t be returning. Work on streamlining your efficiency and ensure that your customers always have a positive experience to help boost their LTV.

Implement Loyalty Programs

Since repeat visits, and the lifetime of a customer –or, the number of years that they’ll stay with your company, are major contributing factors to lifetime value, you’ll want to do everything you can to reward customer loyalty. Encouraging repeat purchases will help increase your chances of earning some high lifetime value customers.

Consider implementing a loyalty rewards programs to incentivize repeat purchases and keep your customers coming back for more.

Ask for Feedback

Finally, all customers want to feel appreciated. Ask them for feedback on their experience and then make sure you work on improving any areas where there was less-than-satisfactory service. While it does take time and effort to track your customers’ lifetime value, the truth is that it’s something that’s definitely worth doing.

Doing so will allow you to tailor your advertising and customer retention strategies so that you can ensure that you’re focusing your efforts on customers that will provide the highest lifetime returns.

Have you taken steps to determine your customers’ lifetime value?