Flavors of Lifetime Value

Mar, 24 2013

Observation and definition of the question

Although often over quoted, the term Life Time Value (LTV) is one of the most underutilized but fundamental marketing concepts. The concept is based on the belief that the customer is the unit value for an enterprise and the sum total of customer value is equal to the enterprise value ( see Customer Equity).   How useful is this concept for those involved in the daily grind of running a marketing department?

We’ve been talking to several potential customers who have talked with marketing intelligence companies that provide on-demand LTV predictions that are updated nightly.  While most organizations are interested in understanding the future value of their customers, they don’t necessarily know how they’ll use LTV predictions because it can be interpreted in several different ways.

Value – can be revenue, margin, variable contribution margin and may include or exclude acquisition cost depending on the use case

LT – Lifetime :  can be historical, projected, upside etc.

Based on these definitions, LTV could be
1) LTV-Historical: Historical value of customer looking back since acquisition or last X months
2) LTV-Projected:  Projected value of a customer looking forward X years
3) LTV-Upside: Potential upside in customer value per year

These three different measurements/predictions can be utilized in different ways:

1) LTV-H:  This metric can be used to understand customer value trends, including whether a customer’s value is trending up or down, or if they are new/reactivated, or lapsed or inactive.  The change in LTV-H can be used to trigger lifecycle campaigns.

2) LTV-P:  This metrics is best used for both acquisition source optimization and customer onboarding.

  • Acquisition Source Optimization: Based on short term LTV-P projections, a marketer can estimate which acquisition channels provide the best customers.  It is best to use short-term data for this calculation due to the changing nature of sources of acquisitions and offers.  If a marketer makes decisions based on projected LTV derived from old data, the calculations will not account for fast changing digital flows that happen in ad networks, keyword trends, and other modern acquisition channels.
  • New Customer Onboarding: Another application of LTV-P is onboarding customers.  When a new customer is acquired, utilizing LTV-P and other observed and implicit properties of the customer (e.g., demographics, first order revenue, categories, email, web behavior, etc.), marketers should devise an onboarding process to ensure a successful second order from the customer.  Customers are usually very expensive to acquire, and more than 50% of new customers never come back to make a second purchase.  Successfully onboarding a customer could significantly increase LTV, impacting value in a compounding manner.  In other words, increasing new customer retention metrics will have a compounding downstream effect on the value of customers, and thus the value of the company.

3) LTV-U:  This is the most underutilized LTV metric.  Most organizations observe and predict value based on customer transactions.  However, very few companies calculate and utilize the upside potential of a customer.  Successfully calculating and operationalizing this metric will allow marketers to focus on the high potential customer within the context of acquisition, reactivation and growth objectives.
 
How to calculate LTV – components of the equation

LTV is defined as the net present value of profits from the customer.  Profit incorporates the following components that are the levers to increase the lifetime value:

  • Number of Orders
  • Products per order (product mix)
  • Product Margin %
  • Product Price
  • Quantity per product
  • Discount cost
  • Promotion cost (cost to reach)
  • Acquisition cost
  • Retention rate
  • Cost of capital

In various cases, acquisition cost can be included or excluded in the calculation depending on the use case.  In other words, if a customer is acquired, putting the customer acquisition cost in the equation will not be actionable, since this is already a sunk cost and we need to make sure for all these customers, we need to maximize the future profits.  Whereas if we’re trying to allocate resources for acquisition sources, we should include the LTV by source including the Acquisition cost, since we want to acquire customers who will deliver positive ROI within a certain period of time.

It changes, keep up

The lifetime value of a customer, whether predicted or calculated, changes over time.  This change signals underlying trends, risks and opportunities.  Make sure you don’t have a static view of LTV calculations, but look at as snapshots in time and calculate transitions.  When a High LTV customer is trending to Low LTV over the past year, it signals a valuable at-risk customer.  You as a marketer need to focus on this.  Each customer lost, especially a high value customer is extremely expensive to replace.

Conclusion
Focusing on LTV is very important, but using LTV to create actionable triggers is perhaps more important than knowing exactly what the LTV is.  Additionally, once triggers have been set, it’s the campaign effectiveness that allows a marketer to achieve customer objectives.  I’ll discuss campaign effectiveness in a separate post.