I have written many times about the importance of customer lifetime value (LTV), about its central role in determining a company’s success and how to impact it. In this post, In this post, I will address how to manage users (customers, players, etc.) based on LTV.
Profitability, success and LTV
The success and growth of your company comes down to one basic principle, your customer LTV needs to be greater than the cost of acquiring and servicing the customer. The larger the difference between the value you get from a user and the costs associated with that user, the greater your profits. The greater the difference, the more resources you can devote to user acquisition. The greater the difference, the more someone will pay for your company.
The key to optimize the value of a customer versus their costs is not treating all customers the same. Each customer has a different LTV, which can be estimated from everything nearly all the data you are collecting, including from how you acquired the user, their demographic, their initial behavior, etc. The first step to optimizing your business is to determine your different customer segments (VIPs, heavy spenders, occasional spenders, one time spenders, social whales, browsers, etc.). You then put all of your users (hopefully automate this process) into these segments.
Managing a customer portfolio
Once you have segmented your users based on their behavior and predicted lifetime value, you need to manage actively this portfolio of users to optimize your profitability. For each segment, you need to build a strategy that maximizes the difference between the LTV and the costs. For users who spend frequently, you may want to give them enhanced customer service and free gifts so they come back (and spend) even more often. The costs of this additional service and gifts are more than offset by the additional revenue you generate. Conversely, for the one-time purchasers, you want to minimize expenses tied to them. Since they have a low lifetime value, you do not want to devote any resources (costs) to them. By allocating resources only where it increases the difference between LTV and costs, you optimize your profitability.
Role of pricing
Pricing is also critical in optimizing the yield of your users. For players or customers who will only make a couple of purchases, you want to maximize those purchases. You can do this by charging a higher price. For users who will use your product regularly, you probably want to maximize the volume of the purchases, get them to buy more frequently. Again, you can impact this metric by price, offering them discounts for multiple purchases, lower prices, etc.
Price discrimination is easier said than done, however, there are techniques to enable it without upsetting your customer base. If a user learns someone else paid a lower price, they are frequently upset and may voice their displeasure by abandoning your product or complaining (either to friends or on social media). There is never a value to upsetting a customer so it is important to mitigate the risks while still using price to optimize the profitability of different customer segments. Discounting is a great way of offering different prices to different segments. You can give regular customers a standing discount (which effectively is just a lower price) or offer them specials or sales that you do not offer other segments. You can base discounts on the segments, using different discounts that maximize the value of each segment. What I have found is that customers rarely complain about other users getting a sale, while they would be irate if it was positioned as them having a higher price than the other user.
Service and support for customer segments
On the cost side, you need to minimize expenses for users with a low LTV while devoting resources to other segments as it should further improve their LTV. You want to devote substantial resources to your users with a high lifetime value as there is a tremendous cost in losing them. This could come in the form of better customer service (local versus off-shore reps, more ways to reach them, etc.), a dedicated sales rep, a special VIP department, etc.
If there is a small delta between LTV and costs, then you need to minimize any costs that make that delta smaller. Give these users minimal support, direct them to forums or FAQs and only allow them to communicate through the most cost effective channels.
Selective user acquisition
One of the crucial elements to optimizing profitability is focusing on acquiring the most profitable users. Although you or your management may be looking at high-level metrics, such as DAU, ARPDAU, D1 retention, at the end of the day profitably is the key to success. Having 20 million users that cost more to service than they generate does not demonstrate a successful company. Also, get a million users with the highest lifetime value but a customer acquisition cost higher than this value is not prudent. Instead, you want to acquire the users who have the greatest difference between their costs (cost of acquisition and costs to service) and their LTV. By focusing your user acquisition efforts on these customers, you optimize the long-term profitability of your company.
I have written before about the importance of understanding that LTV is a prediction, not a value. As a prediction, it could end up higher or lower, thus a potentially profitable customer might actually represent a net loss. There are two implications of this situation
- You need to incorporate this risk into your strategy. If a segment has a relatively low positive gap between LTV and costs , you want to minimize the resources you devote to that segment until you are confident it is LTV positive.
- Some segments will have less risk than others. Just as with stocks or other investments, you need to expect a greater return if you take a greater risk. If one segment has a larger chance of having a high variance in its LTV, the expected profit from that segment needs to be larger than a more stable segment to warrant dedication of resources.
The important point is to adjust LTV based on the expected value of the user, where expected value incorporates risk.
- It is important to not only understand the LTV of your customers, but to place them in segments based on the expected LTV of each segment.
- You should match the resources you devote to each segment to their expected return.
- User acquisition efforts should target those customers who have the biggest difference between LTV and costs.