Customer Lifetime Value (LTV) - Part 3 - Common Mistakes & Risks

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The majority of Direct-To-Consumer (DTC) companies recognize the importance of understanding what their customers are worth.  Many have also taken the step of calculating their Customer Lifetime Value (LTV) for their product or service.

It’s encouraging to see the industry recognize the importance of LTV as a metric to manage and optimize DTC businesses.  However, how LTV is calculated and applied to your business makes all the difference. Incorrectly calculating or applying LTV can put your business at serious risk.

This is the third and final installment of our 3-part series on LTV.   If you haven’t read the previous installments, click here for Part 1: LTV Definition and Part 2: Applied LTV

As a reminder, the definition of LTV is:

LTV is what a customer is worth, outside the cost to acquire them.

Customer Lifetime Value (LTV) can be applied in both subscription and one-shot businesses.

When I think about LTV the tagline from the board game Othello comes to mind “A minute to learn, a lifetime to master”.  While the overall concept of LTV can be easy to grasp, it will take years to truly understand all the nuances.  To help you on your path to mastering LTV, in this blog post we are going to cover Common Mistakes and Risks.

COMMON MISTAKES

There are countless ways where LTV can be calculated or used incorrectly. Below is a summary of 4 common mistakes we’ve seen across dozens of brands.

Mistake #1: Using the Wrong Inputs
Getting the base inputs correct is essential for calculating an accurate LTV.

LTV needs to be at the customer level. You achieve this by identifying a customer (or customer cohort) and connecting them to their associated orders. In doing so you are looking at the full behavior of that customer and not just singular orders.

LTV needs to be a projection (NOT revenue to date). The projection starts with actual performance to date and then forecasts this out, adjusting for known future variables.

LTV needs to account for all your variable costs. Correctly dialing in on both your Revenue and Variable costs will bring you to your Margin = the output of LTV.

Never try to use your Finance P&L as a replacement for LTV.

Mistake #2: Not Aligning LTV with Your Goals
Even if your LTV is accurately calculated, implementation can go sideways if you aren’t aligned to your business goals.

Start by getting clarity on those goals and get buy-in from the top of the org.  Then, using your LTV model, develop a media plan with CPO Allowables that support those goals.  Whether your objectives are growth or profit, your LTV model can be built with this in mind. Doing so correctly can avoid surprises down the road.

Mistake #3: Using Unrealistic Projection Time Frames
An important input for your LTV calculation is the projection for maximum Customer Life.

Most LTV calculations go out 2-3 years.  Avoid the trap of forecasting out to an unreasonable timeline. Amazingly, we’ve seen some go out 40 years. Will your business and current products still be around in 40 years? Or will it evolve or be disrupted? Plus, do you really want to wait that long for your projected return?  For most businesses going out beyond 5 years is a mistake. Additionally, the further out you go, the more you will need to consider the time value of money.

Base your LTV timing on a realistic time frame or you will be working with CPO Allowables that are overestimated.  Likewise, if you cut your time frame too short your CPO Allowables will be underestimated which will prevent you from growing at the speed that is right for your business.

Mistake #4: Hand Over All Thought to “A System”
In recent years some new companies have launched software platforms and dashboards promising to solve everything around LTV.  For example, calculating LTV every hour based on real time data feeds.

OK, that sounds cool, but is it helpful or actionable?  Is the expectation that decisions be made with that frequency?  Does the data and outputs change that often? If so, it seems like a surefire way to make your marketing team crazy and have management lose faith in the accuracy of any specific update.

In our experience, automating parts of the process is necessary to be efficient, but it can quickly be taken too far.  The best approach is to automate portions of data acquisition and then have experienced analysts (real people) reviewing these inputs, performing analysis, and making recommendations.

RISKS

When you first start using LTV, it can be very appealing to run with these new findings, increase your media CPOs, and push it.  Resist going too far too fast. Here are 2 risks to be aware of before you start.

Risk #1: Cash Flow
A huge risk to any DTC business is Cash Flow. This is particularly relevant to companies reliant on subscription or recurring sales. Cash Flow needs to be top of mind when you are scoping out your media plan.

Let’s say your brand has a $500 LTV.  That’s great. What you need to remember is that this figure is earned out over a number of years and your CPO is paid out today.  So, it is going to take time to earn back your CPO and then even longer before you hit your profit projections.

This is where Cash Flow issues are introduced.  A DTC business can be cash intensive, so planning is essential.

Risk #2: Razor Thin Margins
With a strong LTV, it can become very tempting to pour money in acquisition.  But, spending a fortune in media channels too quickly can introduce a host of new issues. Some of the big ones to look out for are higher CPO’s, declining customer quality, higher media costs, increased churn, running out of stock, more competition, and increased customer service costs.  Any of these can cause shifts that could erode your margins.

We recommend slow, gradual increases in media spend as you approach your CPO Allowable. Monitor your KPI’s at intervals that are insightful and actionable.

 

WHAT’S NEXT?

Regardless of your experience with LTV, Directade can help you avoid these common mistakes and navigate these risks to ensure you are set up for success.  How we work together is up to you. You can outsource it entirely to us or we can train your existing Marketing Analysts.

Let’s talk!

Customer Lifetime Value (LTV) - Part 2 - Applied LTV

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Everyone agrees that knowing the Lifetime Value (LTV) of your product or service is important, but there hasn’t been enough discussion on the many ways you can use LTV to improve your business.

Like Applied Math, LTV is just a number until you apply it to your marketing decisions.

This is the second installment of our 3-part series on LTV.  If you haven’t read Part 1 click here.  As a reminder, the definition of LTV is:

LTV is what a customer is worth, outside the cost to acquire them.

Customer Lifetime Value (LTV) can be applied in both subscription and one-shot businesses.

APPLIED LTV
Since there are endless ways you can apply LTV to decision making, we are focusing on our three favorite areas.

1) Media Allowables
How can LTV help with your media plans?

With analysis you can use your LTV to set CPO Allowables.  That’s how much you should spend per acquisition while still staying within your budget limits based on the value of that consumer.

Tracking your spend targets versus LTV will reveal whether you are spending too much or too little to acquire new customers.  Spend too much and you eat into your profit.  Too little and you miss out on potential sales.

2) Customer Cohorts
Through LTV, you can compare the value of each customer based on their profile - what Product/Service they purchased, what was the Source of their order, and what Offer brought them to purchase. 

Analyzing the LTV of these different clusters of customers can lead to strategic improvements in Product, Price, Churn, Conversion, and more.

Link this data up with your marketing objectives to develop a marketing plan.  For example, if your #1 objective is member file growth, then invest in the cohort that drove the most conversions which reach a minimum profit goal.  If profitability is your main objective, then focus on the customer cohorts which have the highest profit.

3) Marketing Costs
Since LTV considers your variable costs you can see how COGS, Customer Service, Fulfillment, and Shipping impact your LTV.

Regularly reviewing LTV data helps identify cost trends and can raise opportunities to be more efficient versus industry standard costs.

If you don’t have an LTV, or if you’re unsure that your current LTV is accurate, don’t be afraid to ask for outside help.  Directade provides marketing leaders with LTV models and analysis so they can be confident in their decision making.  Contact us to see how we can help your organization.

Customer Lifetime Value (LTV) - Part 1 - Definition

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With the rise of Direct-To-Consumer (DTC) and e-commerce businesses, there’s an increased focus on Customer Lifetime Value (LTV).  

Why should you care about LTV?
When used properly, LTV can be the backbone for Marketing decision making - including strategic planning, budgeting, and setting media/CPO targets.  This is why some DTC businesses seem to have endless media acquisition budgets.  They know and leverage their LTV.

Since everyone has their own interpretation of what LTV includes, how it's calculated, and how it should be used, we want to begin by offering our own definition of LTV.

LTV is what a customer is worth, outside the cost to acquire them.

But, of course, it is much more involved than that.  Let’s dig further by breaking down each word in “Customer Lifetime Value.”

“Customer”
You should be looking at the full relationship with a customer.  Not just one order, but a collection of all purchases the customer has made.

“Lifetime”
It is important to have a cumulative view of what that customer has purchased to date AND what you expect they will buy in the future. Revenue to date plus projections.  The projections are based on performance over a defined period of time - typically 3-5 years or more. When determining a timeframe that’s right for you, it’s key to line up your projection timeframe with your financial ROI goals.

“Value”
By value we mean margin, not revenue.  Margin is calculated by taking revenue and subtracting all contra revenue (returns) and variable costs (COGS, royalty, fulfillment, etc).  The result is your margin on a per customer basis.

In summary, LTV is the margin brought in per customer over a defined period of time.  A simple example:

A customer signs up for a $20 monthly subscription and they have been active for 3 months. Revenue to date is $60 ($20x3).  Based on similar customers you forecast they will stay active for 6 months. Lifetime revenue is forecasted to be $120 ($20x6). Your contra revenue & variable costs to service them for 6 months is $50. This brings you to a projected LTV of $70 ($120 projected revenue - $50 variable costs).

This LTV of $70 can now be used to set media CPO allowables, but more on that in our next blog post.

Having clarity on the customer, what’s included and subtracted to calculate margin, and the time period you’re measuring are all essential inputs into a successful LTV model.  This blog is the first in a series of three Directade blog posts about LTV - next time we will be exploring Applied LTV.

If you don’t have a Customer LTV, or if you’re unsure your current LTV is accurate, don’t be afraid to ask for outside help.  Directade provides marketing leaders with LTV models and analysis so they can be confident in their decision making.  Contact us to see how we can help your organization.

5 QUESTIONS YOU SHOULD ASK YOUR MARKETING TEAM

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How confident are you in your current marketing analysis?

Are you receiving weekly reports with a “Mad Libs” style fill-in-the-blank summary?  Are there regular meetings to review trends and agree on next actions?

Reporting and dashboards are important, but they lack the insight that reveals what is truly happening inside your business.

To understand whether you need to improve your marketing analysis, Directade compiled these 5 questions you should ask your marketing team.

  1. Do we know which is the most profitable product in our portfolio?
    Which is the least profitable?

  2. Do we know who are our best customers?
    a) Highest Customer LTV and Least Churn.
    b) Where did they come from (media channel, offer)?

  3. What is the separation between our current CPO and CPO Allowable?
    a) Are we spending too little and missing out on potential growth?
    b) Are we spending too much to acquire each order?

  4. Are we aware of the factors that most negatively impact revenue?  What are we doing about the following:
    a) Out of Stock products.
    b) Credit Card Billing Failures.
    c) Shipping Delays.
    d) Returns/Refunds.

  5. If we received $100K in incremental budget tomorrow where would you best spend it to meet our objectives?
    a) Media Channel investment.
    b) Improve back end efficiency.
    c) Buy more inventory.

How your team responds to these questions is just as important as the answers themselves.  Your marketing team should be able to discuss these topics openly and confidently.

Don’t be afraid to ask for outside help.  Directade works with existing teams to ensure business objectives are being met through strategy and analysis based recommendations.