As this is my nineteenth post about customer lifetime value (LTV), I obviously think it is very important, but I wanted to take some time to provide examples of how it can impact almost any business. Even if the examples do not cover your initiative, they will hopefully help you see how understanding, marketing and designing for LTV is crucial to any company’s success. Examples range from tech companies to business types that have been around longer than the United States. The breadth of companies that LTV is critical for shows its central importance.
Mail order catalogs
Catalog companies, from the days of Sears and Montgomery Ward, to the current heavyweights like Restoration Hardware and Crate & Barrel, have always needed a deep understanding of LTV to succeed.
With the cost of printing and mailing catalogs, these merchants need an LTV higher than the shipping/printing costs. Thus, they have to first understand different customer segments (e.g., location/postal code, sex, age) and only send catalogs to those people who will have a higher LTV. If they sent their catalog to everyone, the average LTV would decline and make their efforts unprofitable. In addition to understanding the LTVs of each segment they have to optimize along the three key LTV variables: Retention, monetization and virality. If a person reads through the catalog once, makes an order and never picks up the catalog again, it is hard for their value to be higher than the costs of shipping them the catalog. If they, however, keep the catalog and place ten orders in a six-month period, the LTV is likely to exceed to costs of sending them a catalog. Monetization is also critical. If they love the catalog, keep it on the coffee table, but never make a purchase, the merchant loses. Even if they make very small purchases the merchant proposal loses. Successful direct marketing companies succeed by getting larger shares of wallet from their customers. Finally, virality is important even for a non-digital good. If the person shows the catalog to ten family members or friends (who have an equal potential to buy), then the costs of sending a catalog are effectively one tenth as you are reaching 10X people.
Casinos (the land-based ones you find in Las Vegas or Monte Carlo) are masters of using LTV to generate strong profits. Casinos were one of the first industries to embrace analytics, back in the early 1990s Harrah’s was the top case study for SAS (the privately held statistics software company). What casinos realized is that by understanding and estimating each player’s lifetime value, they could focus their efforts on those who would generate the highest profits. Rather than just using intuition to find good customers, they would look at gambling patterns (frequency, size of bets, favorite games, et al.), credit scores, location, etc., to calculate the expected LTV of everyone entering the casino. This capability is enhanced by their rewards programs, which allows them to track almost everything.
Once they have an expected LTV for a customer, they then use that information to focus their marketing efforts. They will offer these players special perks to visit their casino (ranging from free hotel rooms to use of their private jets) and discounts on their gambling, all intended to increase their LTV (either through better retention or more monetization). They also use this data for their player acquisition efforts, since they have a profile of their most valuable players they can then reach out to others who look like those profitable players.
I have spoken ad nauseam on the importance of LTV to social and mobile game companies (think Candy Crush Saga from King.com) but would be remiss in not including them in this post. For a social or mobile game company, LTV is critical because we rely on performance marketing, such as cost per install (CPI) and cost per click (CPC) advertising. Given that LTV provides the total value of a customer, as long as you can acquire new customers for less than their LTV, you should continue to use your current methods of customer acquisition (in a future blog post I will discuss how customers from different sources have different LTVs). Once the cost of an acquisition exceeds the value of the new customer, it is unprofitable to acquire that customer. The difference between the LTV and CPI is the long-term profit—or loss—from the new customer (including revenue they bring in by acquiring other users for free).
LTV tells you if a new customer or player is worth more than the cost of acquiring them. Simply put, if bringing in new customers is not profitable, there is no reason to bring in customers. If there is no reason to bring in customers, you have a game without players. If you have a game without business, you do not have a game, at least not for long.
E-commerce is a space where LTV is critical to success. With virtually limitless options available to consumers, e-retailers must be able to both acquire and retain customers. User acquisition is central to LTV, since the lifetime value of a customer always has to be higher than the cost of acquiring them. If you look at a company like Harry’s, the men’s shaving retailer, they could only afford to advertise their brand in your Facebook feed and everywhere else because their projected lifetime value of a new user is more than the cost of the ads. If they were not able to generate as much from customers, nobody would have heard of them and they would just be another start up with a website.
The plethora of options to online shoppers also points to why it is so important to optimize all three elements of your LTV, retention, monetization and virality. In particular, virtually no online retailer could stay in business if users they acquired just purchased once and never returned. Thus, would have constant churn and would have to have incredibly high margins to justify getting a new customer. The inverse is Amazon who, through programs like Amazon Prime, keeps customers year after year and has become their primary shopping outlet. The Amazon market valuation of over $150 billion reflects the high LTV they get from customers.
A few weeks ago, I wrote about Groupon, and how a restaurant needs a good LTV to use it as a channel. This argument can be extended to the entire restaurant business. The key to a restaurant’s survival and profitability is LTV: virality, monetization and retention. Virality is important as word of mouth is one of the largest drivers of new users. If customers talk about a restaurant, then they get more customers with no additional marketing expense. Retention is always important, virtually no business can afford to only have a user visit once or twice. And finally, monetization is crucial; you must make enough from customers to not only cover all your expenses but also earn a profit.
The key to being an attractive franchise is the lifetime value the franchise model creates with customers. Potential franchisees are paying for a business template that acquires customers whose lifetime value is greater than the cost of acquisition.
There are thus two key elements to a franchisor’s success. The first is the ability of the franchisor to generate customers at a low cost. They will often achieve this through national advertising campaigns or because they have built a strong brand. The second part is having a product that has high LTV, either overall for the franchisor or for the individual franchise owner. If it is a food product like McDonalds, the fact that people will return multiple times in a week provides value to both the individual restaurant and the franchise in general (as customers may go to different franchises within the network). This retention helps keep LTV greater than the cost of acquisition and leads to profitability of the franchises which leads to more demand (and revenue) for the Franchisor.
Software as a Service (SaaS)
Software as a service experiences virtually the same dynamic as a social game. Examples of software as a service (SaaS) include Salesforce.com, Dropbox, Workday and LogMeIn. For all of these companies, they must generate more value from a new user—who may start as a free user—than the cost of acquiring that user. As with the free-to-play model, value from the user comes from monetization (though more often from a subscription model for premium service than virtual goods), retention (the longer they subscribe) and virality (how many co-workers they sign up). Although user acquisition may come more from a sales team (though not with all SaaS), you still need to generate more from these users than the cost of the salesperson. The higher the difference between LTV and cost of sales, the larger the sales force you can afford and the quicker you scale.
One of my favorites examples of the importance of LTV is an industry that is the opposite of the tech space most of my readers are in: The automotive industry. In particular, the failure of the US auto industry is largely a result of not understanding and focusing on LTV. US automakers created a weak product but for many years enjoyed good profits by covering a weak product with an attractive façade and having great transactional marketing. Through rebates, billions of dollars in advertising and high-pressure sales people, they were able to sell large numbers of cars. These cars, however, provided many customers with a bad experience, so retention became low. For example, after buying a vehicle, Cadillac and Dodge customers would not buy another and switch to a Japanese or European car. Virality became a negative, as people would tell others about their bad car experience. Thus, even though monetization was high, the other elements of LTV were so weak that it almost destroyed the US auto industry.
While I normally list three key takeaways from every post, there is just one from this post: No matter what business you are starting or career you are entering, understanding and using LTV is crucial to your success.