Writing for Forbes, Bill Gurley points out the dangers of being seduced by Customer Lifetime Value, and it is true that this metric is not without risks, especially when it is used to portray a rosy Utopian future. But it can also be valuable when used as tool in your strategy, rather than as the strategy itself.
When using Customer Lifetime Value to help move your business forward, the trick is focus on growing actual Customer Lifetime Value, rather than to use it in terms of projections.
Balancing Cost to Acquire Customers and Customer Lifetime Value
The Cost to Acquire Customers (CAC) and the Customer Lifetime Value (CLV) are two important measures for any business, not only online businesses. These two terms should be very familiar to you by now, but let’s do a quick recap of what they are:
Cost to Acquire Customers
CAC is exactly what the phrase implies: how much did you spend over a specific period in order to acquire new customers. This is calculated by adding up all of your sales and marketing costs (including salaries) for a predefined period, and then dividing the result by the number of new customers you gained in that period.
It is a fairly simple calculation, but once you are comfortable in working it out you can start using the same formula for more detailed analysis in relation to each marketing channel. Instead of only calculating your CAC, you can also start looking at the Cost of Customer Visits and the Cost of Lead Acquisition.
Customer Lifetime Value
Calculating the CLV is a little more complicated than CAC since, in order to get a more accurate representation, you need to first calculate your Customer Retention Rate: how long is your average customer sticking around. Determine your Customer Retention Rate (CRR) by doing the following:
- Select a period you intend measuring. This can be anything from 3-months to 12-months and longer.
- Establish the number of customers you had at the start of this period (S).
- Establish the number of customers you acquired during this period (N).
- Establish the number of customers you had at the end of this period (E).
Once you have these values you apply the formula ((E-N)/S)*100, with the result being your retention rate as a percentage.
Now for the fine print.
Once you have read the fine print above and properly calculated your CRR in each segment, you can calculate the average CLV within each segment using the following (simple) formula:
(Average Transaction Value) x (Number of Repeat Transactions) x (Average Customer Retention Time, in months or years)
By way of example, if your business offers a monthly subscription service of $10 per month, and your average customer stays loyal to you for two years, your calculation would be:
giving you a CLV of $240. This is, again, a fairly simple calculation, with more complex equations taking into consideration:
- Profit margin per customer
- Gross Margin per customer (over the average lifespan)
- Rate of discount (used in cash flow analysis)
Which formula you use ultimately depends on what you intend using the results for, and how accurate a result you need for this.
The Purpose of Calculating CAC and CLV
The ideal scenario for any healthy business is to have a CLV that is at least equal to their CAC, but preferably higher. How much higher? For businesses with a recurring revenue model (subscription based businesses) the norm is three to five times higher, with a goal of recovering CAC in less than 12-months.
Both CAC and CLV are not fixed, and are influenced by various factors. In order for your business to keep moving forward you need to constantly work at reducing your CAC, while growing your CLV.
Reducing your Cost to Acquire Customers
- Outbound Marketing – Traditional advertising in the form of TV and radio commercials, all forms of print media, tradeshows, cold calling and email blasts.
- Sales – Specifically the cost in time and effort required to close each sale, and the need for external sales offices and field sales.
Image Source: forentrepreneurs.com
In the introduction to Jay Baer’s Youtility, Marcus Sheridan shares some insights into how content marketing benefited his business:
I analyzed behavior patterns on our website in hopes of better understanding why some visitors fill out a contact form on the site but never advance past that point, while others eventually become customers. As I compared these two groups of site visitors, one number jumped out at me . . . thirty. It was the tipping point. If a visitor to our website reads at least thirty pages of our information before we go on an in-home sales appointment, they buy a pool 80 percent of the time. Considering the industry closing rate average is around 10 percent, this was a shocking revelation. They weren’t just self-educating, they were self-qualifying, too. By the time they contacted us for an in-person appointment, they were predisposed to working with us.
He goes on to add:
In 2007, when the economy was going great and pool sales were easy, we spent about $250,000 in advertising to achieve roughly $4 million in sales. In 2011, when the economy was a mess and luxury spending was in the dumps, we spent $20,000 in advertising to generate $4.5 million in sales.
All of this was achieved primarily through content and inbound marketing, with Marcus using his company website to comprehensively answer possible sales questions, and to address (and answer) common objections that may come up during a sales call. By making all of this information easily accessible to any potential customers, he was able to substantially reduce the time and effort spent on field sales and, most tellingly, dramatically reduce his advertising spend.
Increasing the Lifetime Value of Customers
It is easy to become blind in your marketing, and to put all of your effort into acquiring customers, without ever considering the benefit of also increasing the CLV of your customers. Just as content and inbound marketing can be used to reduce your CAC, so too can they be used to increase your CLV.
Arecent survey conducted by Econsultancy and Sitecore revealed four areas that could most likely increase CLV:
- Improved customer experience (this includes customer service as a whole)
- Better use of data
- Increased personalisation
- Better customer insight (single customer view)
Image Source: Econsultancy
with respondents citing the following tools/strategies as being the most effective at improving CLV:
- Single Customer View
- Customer Experience Management solutions/platforms
- Strong interaction between online and offline channels
- Dedicated retention team
- Highly trained call centre staff
Image Source: Econsultancy
Content marketing remains a powerful strategy for improving some aspects of the customer experience; when it is utilised correctly. Your content marketing strategy has to be meaningful, not simply a matter of publishing articles haphazardly and hoping they resonate with your customers. If your business is relatively young, without a solid history of customer pain points, you should still be able to publish articles that are slightly targeted based on your initial market research. If, however, your business is older than 6-months, with a robust customer base, you simply have no excuse not to have your content marketing specifically address actual customer pain points.
Your marketing team should be working with both your sales department and your support department, sifting through all customer interactions and identifying problems customers experience, complaints they have, and even obstacles to closing sales. These should then be addressed in future articles on your website, and even used to add more substance to your FAQ. Returning to Marcus Sheridan’s introduction to Youtility:
…consumers of all types expect to find answers on the Internet now, and companies that can best provide that information garner trust and sales and loyalty. Success flows to organizations that inform, not organizations that promote. […] My new plan was simple: I decided to act like a swimming pool consumer instead of a swimming pool installer. I applied this methodology in two ways that changed my company and my life. First, I brainstormed every single question I’d ever received from a prospect or customer. Since I had been selling swimming pools for about eight years at the time, this list quickly grew to hundreds of questions. Then I answered every single one of those questions with its own blog post, adding hundreds of new pages to my website in the process. I’d already answered these questions face-to-face, on the telephone, and through e-mail, so I knew the answers; I’d just never considered putting them on a blog.
He didn’t guess what his customers concerns where, he had built up a history of them, as would any organisation older than 6-months. This ties up with better use of data; are you collecting data on your customers simply because that’s how it’s always been done, or are you doing it to improve your sales and your interactions with your customers?
Josh Ledgard from KickoffLabs analysed his sales funnel to identify where the biggest drop-offs occurred and then set about putting measures in place to reduce this. Some of this meant providing customers with additional information on the website, as identified by the KickoffLabs team, while other problems had to be identified by first engaging with customers who had abandoned the process.
Image Source: KissMetrics
Ultimately though, increasing CLV is not simply a matter of more efficiently targeting your high value (and happiest) customers. It is also about engaging with your least satisfied customers and addressing their concerns. Done smartly, this can turn them into high value customers, while simultaneously reducing your churn. As was the case withHubspot who, by reducing churn by 57%, were able to increase CLV by 215% in less than 24-months.
Image Source: Forbes
In 2011 and early 2012 we used this chart to guide many of our business decisions at HubSpot. By breaking LTV:CAC down into its components we could examine each metric and understand what levers we could pull to drive overall improvement.
It turned out that the levers we could pull varied by segment. In the SMB market for instance we had the right sales process in place – but had an opportunity to improve LTV by improving the product to lower churn and increasing our average price in the segment. In the VSB (Very Small Business) segment, by contrast, there wasn’t as much upside left on the LTV (VSB customers have less money and naturally higher churn) so we focused on lowering CAC by removing friction from our sales process and moving more of our sales to the channel.
Moving your business forward is not simply about acquiring new customers. New customers add little value if you aren’t also focused on retaining customers, and increasing the real value of all your customers. Measuring and knowing your CAC and CLV are not without risk, but when these metrics are used wisely, as part of a broad strategy, the returns will be noticeable. Not only to you, but also to your customers.