`Lifetime value’ a vital yardstick

First, let us state the obvious: today's lean marketing budgets have to work harder than ever to find new customers and sales.Not only that, now that we have all 'smelled the coffee' and realize it costs five times as much to...

First, let us state the obvious: today’s lean marketing budgets have to work harder than ever to find new customers and sales.

Not only that, now that we have all ‘smelled the coffee’ and realize it costs five times as much to get a new customer as to keep one you already have, companies are starting to allocate funds to customer retention and loyalty programs.

Targetted prospect groups

More and more, direct marketing is being used to achieve these objectives because of its ability to reach targetted prospect groups to generate new sales, and then nurture an increasingly profitable relationship over time through individually tailored information, service and cross-sell/upgrade offers.

But where do you draw the line between spending ‘too much’ and ‘not enough’ in finding and, more importantly, keeping your customers?

One way is by using a yardstick called the ‘lifetime value of a customer,’ or ltv for short.

Simply, ltv is based on the idea that a customer’s value should not be gauged solely on what he or she is contributing to your bottom line through purchases this month, this quarter, or even this fiscal year.

It should consider all the revenues you stand to gain from that customer over the lifetime of your company’s relationship with him or her, versus the cost of generating those revenues.

It is a fundamentally different way of viewing customer transactions.

ltv looks at a sale not as an individual one-time event, but as the beginning of an association that continues to generate sales over a ‘lifelong’ marketing relationship that can – and should – last years.

Once you know the ‘lifetime value’ of your customers, you can determine how much to invest in getting new ones, when that investment will pay off, and to what degree.

Direct marketers have always been able to analyze how much it costs to get a customer for the first time, and that you can actually lose money on that first sale by the time you factor in all costs.

If other marketers were able to do the same analysis, they would undoubtedly find the same thing. Where you make your money is on repeat purchases. That is where keeping those customers loyal comes in.

It is an old marketing maxim that your existing customers spend more, buy more often, complain less, and are more likely to buy brand-related, but untried, products from you.

That is what makes them worth spending money on to keep. But you have to know when to stop spending. If you do not know how much a customer is worth to you over the life of your relationship, how do you know how much to spend to keep the relationship alive?

Key information

To measure lifetime value, you need several key pieces of information based on historical data: the likely term of the relationship, the average revenue generated per year, average margins, the fixed and variable costs required to generate that revenue/margin per year, and a factor to convert the result into present-day values.

(If you really want to get carried away, you can factor in assumptions on future market conditions, policy changes, etc.)

With the advent of marketing databases that combine individual customer demographic and attitudinal information with response and transaction histories, the basic ltv formula can be overlaid with other factors so that lifetime values can be identified according to geographic or demographic criteria, customer type (eg. Compusearch ‘Lifestyles’ codes), the source of a customer (eg. in-store promotion, direct mail offer, newspaper ad, walk-in), you name it.

Computer modelling

Depending on how much data you have available to include in the calculation and whether you can track their historic impact on sales (and, therefore, ‘lifetime value’), you can get into some interesting and revealing computer modelling based on various future ‘what if’ marketing scenarios.

All of which helps you spend scarce marketing dollars in an informed and appropriate manner, focussing on the best sources of new customers and the segments of your existing customer base that will yield the best returns.

And isn’t that what it is all about?

Paul MacMahon is vice-president, general manager of Gaylord Direct Communications, the direct/database marketing division of The Gaylord Group, Toronto.