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.
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.
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.
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.
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.