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Lifetime Value and Online Marketing

What is the value of a purchase?

Clearly, ringing the cash register has some immediate benefits:

  • sales revenue which (hopefully) more than covers the cost of goods and other variable costs
  • inventory turnover: allowing the retailer to stock up on new/different merchandise
  • capturing market-share: taking that order denies the order to competitors, providing marginally increased leverage in the industry

However there are long term benefits as well which are the focus of this piece:

  1. Lifetime Value: Happy customers buy from you more than once, on average. Profit generated from those subsequent sales less the cost of marketing to existing customers is often the major profit center for retailers.
  2. Referral Value: Happy customers tell their friends about you. This “free” marketing is tremendously powerful and often overlooked.

Most direct marketing companies think about and talk about “lifetime value”, but really measure and study values over a defined period: 3-month, 6-month, 12-month. The defined periods make sense in that values calculated over 5 year and 10 year windows by definition don’t reflect the behavior of more recently acquired customers.

Measuring and tracking a one-year customer value should be studied by acquisition channel. You’ll probably find that the channel credited for the first order by a customer greatly impacts the later value of those customers. You may also find that customers acquired at your peak seasons have lower long term value than those who make their first purchase in the “off-peak” periods.

Fold into the efficiency targets for each channel some notion of the fraction of new buyers versus repeat buyers, and the long-term value of the customers you’re attracting. Those channels with few new buyers and low long-term value scores should be held to tighter efficiency standards: if this sale is the last you’re likely to get, you need to make it profitably.

Many direct marketers, however, fail to factor in the referral value of a happy customer. Every retailer gets a slug of orders from people who can’t be tracked back to any advertisement. They either direct load your site, or search for you by name (we don’t consider an ad on your brand name an ad — that person was walking through your front door, proverbially speaking) and place an order, but you don’t know why.

A down and dirty call-back survey of those folks asking: “why did you come to our site?” — which can simply be tacked onto a customer satisfaction survey — can be enormously revealing. Some find as many as half of these untracked customers identify themselves as “referred by a friend”. You may also find a surprising number of these folks say they’re longtime customers; that may indicate flaws in the customer de-duping process.

If these untracked buyers account for 20% of your sales (not uncommon), and half of those are “friend referrals”, it’s reasonable to credit new buyers with an additional future value amounting to 10% of their order.

Combining this with the long-term value of the customer herself/himself, you may find you can and should push the gas significantly harder on channels that drive new buyers.

George

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Comments
8 Responses to “Lifetime Value and Online Marketing”
  1. Ned says:

    George, great post and I totally agree with your point about folks underestimating or even neglecting the value of referrals for LTV (well, truth be told I would say that LTV itself is not used by many when in fact they should be).

    Two points I would add based on my own experience is the cost to serve future customers (an estimated percent) and loyal folks using multiple channels for their repeat visits. Without going into any detail, the former gives you a more conservative number for your LTV (and so gives you a realistic chance to hit the targets) and the latter dishes up additional incremental value for certain channels.

    Enjoyed the read.

  2. Eric says:

    George great post. I agree wholeheartedly that marketers forget to quantify the value of referrals. Word of mouth marketing is becoming more and more important as social media takes hold. In addition, i particularly like your comment regarding measuring LTV based upon acquisition channel. This is highly disregarded and is extremely relevant.

    Thanks for the post.

  3. Ned and Eric, thanks for your excellent comments.

    Yes, calculating one-year value (or whatever) requires that you deduct the cost of marketing to that cohort. That’s pretty straight forward with direct mail, but almost impossible with online interactions with Display and PPC ads.

    Your other point is well-taken also. It is difficult, but important to tie the thread, recognizing that the guy who bought online with one email address is the same guy who bought from you previously with a different email address and a different Credit Card. CCOA and NCOA were awesome tools for direct mailers, but the web has definitely added complexity to de-duping.

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