Commentary

Lifetime Value Of A Customer

by David Baker , Op-Ed Contributor, June 4, 2012

If you asked a new hotel staff member what a guest was worth when he or she first walked through the front door, you would get responses like $150-$200 or even a bold guess of $300. When you tell them they are actually worth over $50,000, disbelief usually leads to an explanation of how this is factored. If a guest has a good experience, he or she will likely visit twice a year for at least 10 years and would also tell five other people, 20% of whom would stay as well, and hopefully a similar dynamic would prevail.

Now ask that question of the person who is running the email program for that same hotel, and what type of answer do you think you’d get?

LifeTime value of a customer (LTVC) is a technique that has been used for years to guide marketers, providing profitability views of a customer over time. The academic research on this topic is extensive and deep, and the more sophisticated formulas would make a particle physicist jealous. They include a range of components such as NPV (net present value) stochastic models and Iso-value curves (a way of graphically depicting customers and their future values despite past behavioral differences).

Even with the more sophisticated modeling involved, you should know one thing: Your customers simply will not behave according to your predictions! LTVC modeling is a guide at best if used in the traditional sense, as it can’t adequately reflect the nuances of day-to-day consumer behavior.

So, how do you really know what customers are worth, how much to spend on them, how much to discount, when to discount in the lifecycle and which channels to spend the most on? LTVC only gets you to a certain point of decisioning.

For years, my approach to “email, social, mobile, display, search” and LTVC was that there was a channel proxy that goes into this model -- the only way to show the long-term value of the activities that you handle day in and day out. I also believed you must be able to tie back to LTVC, even if your measurement is proxy-driven (e.g cost of sale, CPC, CPL ). I also did this to show that many companies didn’t accurately reflect the front-end costs of acquisition or project these out long enough to understand the value of channels at a point in time.

I tried to simplify the formula for a single purpose: to show the original value of an email address. This was easier to justify when it was a variance between sending a piece of mail vs email. If I’m ever confused about attribution or the chaos of marketing in general, I refer back to this model and build my logic from there. When I look at this today, I am challenged by two primary issues:

1. How has the “referral” value in a LTVC model changed with the dynamics of social and mobile?

2. How do we apply this within this model based on new measurements available?

Many apply RFM (recency, frequency, monetary), yet in reality we operate in a world of profit and bottom line.

What’s really cool about tomorrow is, we now have mainstream buy-in to customer word of mouth and referral and ability to measure in many forms. This in itself brings new life to channel proxy values to a LTVC model, and the rationale to apply it more than once a year at budget time.

I’ll leave you with this thought. If you’ve never calculated or don’t understand the merits of

LTVC= [(M-C) x (PxY) – A + (A x N)] X F -- you’ll have difficulty showing the incremental value of new emerging channels on what a customer really means to your business. Learn it and translate it for your efforts.

6 comments about "Lifetime Value Of A Customer".

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Jaffer Ali from PulseTV, June 4, 2012 at 1:02 p.m.
Dave, pretty good article. You realize that LTV really is a moving target based upon variables completely out of one's control. So if you are selling goods made in China and suddenly we go to war with China...and your supply lines get crushed, your LTV is affected. Fukushima also comes to mind as all of the businesses in that city have all learned of the tenuous nature of LTV.
The tenuous nature of LTV may be the most misunderstood notion for DR folks. The predictive models have at least 2 orders of uncertainty compounding the problem.
Reply

Karl Murphy from Carolina Auto Spa, Inc, June 4, 2012 at 1:20 p.m.

Dave, good article. I talk LTCV to my team all the time. There is a lot of nuance but it's a great tool. Can you give me the values for all the variables in your formula. I think your formula is more complex than mine.
Karl Murphy, Owner, Carolina Auto Spa, Inc.
karl@carolinaautospa.com

Mark Walker from aka Media Mark, June 4, 2012 at 2:26 p.m.

Karl, I was thinking the same thing. My Google search yields nothing reasonable either.

Ron Kahan from Dovetail, June 5, 2012 at 5:30 p.m.

Here's a link to Arthurs Hughes' equation: http://www.dbmarketing.com/articles/Art251a.htm

Ruth J Clark from Fashion Moves Inclusive Designs, June 7, 2012 at 4:35 p.m.

This detailed outline of LTVC is very interesting and I would like to add to it a wee bit.
The Disabled community is one of the largest niche markets, World Wide, yet very few service/product providers do any target advertising to this community.
Using your Hotel example. The property has already spent 50 - 100% more on making that ADA compliant room so lets get some of the target guests into the room.
If that same Hotel were to put a Terry Dressing Gown, designed for someone who uses a wheelchair full time, into the closet of their accessible rooms, this would show genuine interest in their guest. Individuals with disabilities are often travelling with at least one other person and perhaps with their whole family.
That (those) guest(s) will now tell 50 of their friends and maybe put it on their blog or other social media sites. There is a good chance that the trickle down % of new guests will be higher than the general numbers.
Individuals with disabilities are Business owners, Teachers, Dr's and Nurses, Artists, Wounded Warriors and family members. They all travel for work, for medical purposes and for pleasure. They all stay in Hotels, buy clothing, eat in Restaurants, etc. If you cater to them you will generally see a much higher LTVC
Ruth Clark
www.fashionmovescompetition.blogspot.com

David Baker from Cordial, June 13, 2012 at 11:25 a.m.

Thanks for the response. Sorry to be so late to reply.... I realize there are several ways to go about this and as Jaffer says, LTV is a rapidly changing dynamic that in its purest sense may not be practice to some.. I used it to illustrate a different way to look at things for this audience and the nature of this publication.

The variables are:

M= Average amount of money spent per purchase
C= Average cost to service each purchase
P= Number of purchases per year
Y= Number of years you expect to keep the customer
A= New customer acquisition cost
N= Number of new customers referred by original customer
F= customer adjustment factor, which is applied to the period of time ebeing evaluated.... (it essentially captures the changes you expect or consider likely to happen over a period of time)..