LTV

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

LTV Part 3 Othello Vertical.jpg

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

Picture1.jpg

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

Picture1.jpg

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.

WHAT’S THE NEW DEFINITION OF A ‘SUSTAINABLE BUSINESS’ IN 2016?

Winter is coming this spring to Silicon Valley

Winter is coming this spring to Silicon Valley

By Rob Reynolds and Jason Solano

A ‘sustainable business’ has been defined as a green company dedicated to a minimal impact on the environment.

Now a second definition is beginning to circulate in Silicon Valley and other venture-centric hubs: a ‘sustainable business’ is one that can simply remain cash positive over time. This is somewhat of a pivot for The Valley, which was prone to shovel loads of cash at a business based on its speculative potential, not its P&L sheet.

One company taking pre-emptive, responsible steps is Optimizely.  Last October they received $58 million in Series B funding which brought their venture total to $146 million and a $585 million valuation.  Despite these impressive numbers, Optimizely laid off 10% of their workforce last week.  In a letter to employees, co-founder and CEO Dan Siroker tied the cutting of staff to the necessity of reigning-in costs and a promise for the company to be more profitable. Dan wrote “Destiny, which means controlling the path we are on as a company without having to depend on anyone but ourselves. In order to do that we must build a business that makes more money than it spends. We set a goal of getting to cash flow breakeven and we have made tremendous progress toward this goal.”

Companies in the Direct-To-Consumer and consumer subscription spaces are not immune to this emerging trend. In the first quarter of 2016 there are increasing media reports of layoffs at startups across the DTC spectrum including Birchbox, Sonos, Fanduel, Nasty Gal, Motiga and LivingSocial.

Outside of headcount reductions, what can today’s DTC and subscription startups do to build a sustainable business that will continue with steady growth and deliver responsible profits?

Directade has five suggestions:

1) Know your LTV at an offer (not just brand) level
Not only does LTV lay the foundation for your financial planning, it also enables brands to right-size their media spend to maximize new starts. It is essential that you de-average your LTV calculation at an offer level before you invest too much in an aggressive offer that doesn’t pay out on the backend.

2) Dust off and formalize your Business Rules
Subscription-based brands can protect as much as 18% of their profit by implementing optimized Business Rules in areas such as Credit Card recycling, billing and dunning processes, and guidelines for the velocity of claims and returns.  We love Business Rules and will cover the topic in depth in a new series of upcoming blog posts.

3) Protect your pricing strategies by not giving away the farm
Continuity businesses should offer trials and coupon codes to get new starts, but an overreliance on these offers to drive growth can destroy overall brand value. Challenging your teams to innovate through fresh creative, offers featuring new products and gifts, and new emerging media channels should take priority over the “Free Trial” easy button.

4) Balance retail one-offs vs a direct relationship
Consumers should have many compelling reasons to buy directly from your website.  Not just one, but many. Make sure your direct customer is sacred and preferred. Fostering an ongoing relationship with your customer is more valuable than any retail one-off sale.

5) Buy Flow Optimization
You’ve invested a small fortune on advertising to get people to visit your website.  Advertising may even be your largest expense.  Reap the full return on that investment by making sure you follow two deceivingly simple objectives.  

You’re most likely already focused on the first objective: conversion rate optimization. Capture every potential customer.  Easier said than done? Sure.  But, there are tried and true approaches which many websites don't follow.  The majority boil down to creating a low friction buying experience.

Fewer companies focus on the second objective: maximize your customer's LTV (Lifetime Value) starting with that first sale.  Retention marketing has it’s place, but in our experience we’ve seen the biggest boosts in LTV by changing the approach at the point the customer starts. How to do that? Not all customers are created equal. They often have different needs. Some potential customers are more engaged with your brand, have specific motivations or have more disposable income. Develop and offer them product configurations that meet those needs. They will be happier customers (who will stick around longer) and often those new products will increase how much they are spending.

In Summary
On the surface these five suggestions are simple to follow.  But they also take years of experience to master.  It’s also good to keep in mind that some of these approaches can work against each other.  That is why it is so important to manage your business with a testing mentality and go heavy on the analytics. Taking the time to find the right balance is always worth the effort.  Invest resources behind these approaches and you’ll go beyond being a ‘sustainable business’. You’ll bring your company to new levels of profitability.

Reach out to Directade for more detail on these ideas, and others, to ensure the stability of your DTC business.