Customer lifetime value has been an interest of mine for several years: cohort and survival analysis, revenue models, unit economics, and innovation through experiments. It is a fascinating space populated by smart people publishing new findings built on decades of research originating, in part, from database marketing thought leaders.
But while the academic research is intellectually interesting my passion is centered on how models are adopted in the real-world and less concerned with accuracy. How do companies manage lifetime value? How transparent are models to key stakeholders? What insights exist into high-value customers? What tools are made available to acquisition and retention teams? Do value-based KPIs exist across silos? Does lifetime value carry hidden risks and how should we mitigate them? Let’s explore some of these questions.
Bill Gurley has been around tech and venture for a while and brought some wisdom to this debate several years ago in a long post titled The Dangerous Seduction of the Lifetime Value (LTV) Formula:
As long as the sum of the discounted future cash flows are significantly higher than the SAC [Subscriber Acquisition Cost], then people will argue it is warranted to “push the accelerator,” which typically means burning capital by aggressively spending on marketing… The LTV formula, when used correctly, can be a good tactical tool for monitoring and comparing like-minded variable market programs, especially across channels. But like any model, its proper use is entirely dependent on the assumptions used in that model. Also, people who have a hidden agenda or who confuse a model with reality can misuse it… Seduced by the model, its practitioners often lose sight of the more important elements of corporate strategy, and become narrowly fixated on the dogmatic execution of the formula.
Amen! While I am one of the lifetime value loyalists Bill mentions, his skepticism is met with open arms. We could spend days better understanding his entire post so I’d like to focus on one key point around how the drivers of lifetime value “tug” at one another and what that means for marketers:
This may be the single most important issue and it lies at the heart of why the LTV model eventually breaks down and fails to scale ad infinitum… If you try to raise ARPU (price) you will naturally increase churn. If you try to grow faster by spending more on marketing, your SAC will rise (assuming a finite amount of opportunities to buy customers, which is true). Churn may rise also, as a more aggressive program will likely capture customers of a lower quality. As another example, if you beef up customer service to improve churn, you directly impact future costs, and therefore deteriorate the potential cash flow contribution.
Many marketers approach growth and profitability from the perspective of opportunity costs, as two ends of a spectrum with trade-offs to be accepted and managed. Does quality (“profitability”) always come at the expense of quantity (“growth”) though?
Margins of safety in marketing allow us to exploit the spread between price and value
Price is what you pay, value is what you get. Smart marketers can learn from smart investors. Past performance is no guarantee of future success but each individual customer can be framed as a unique investment, taken with a reasonable margin of safety in the same way value investors approach stocks and bonds.
We have been taught there is a fundamental tension between growth and profitability — that decreasing marginal returns are a fixed assumption between volume and efficiency— but analytics gives us the power to find quality without sacrificing quantity. Two assumptions underlie this opportunity:
- There’s no such thing as the “average customer” and since all customers are unique we assume value is highly variable. Said another way, thePareto Principle holds for customer value.
- For a variety of reasons — some technical, others political — marketers today rarely use lifetime value effectively. Almost 60% of marketers admit an inability to calculate lifetime value and less than 40% of marketers use revenue-based measures lifetime value as their primary success metric. Even fewer segment “below the average” to cohorts; let alone individual customers.
From the perspective of acquisition marketing, it follows from these assumptions that the spread between price and value is highly valuable. When we say “quality of quantity” we only mean the shift in mindset that, as a marketer, your goal is to maximize this price-value spread across a set of customers, influenced through different marketing channels during their consumer decision journey.
While Gurley challenged executives against worshiping at the altar of lifetime value, he also acknowledges that, from an investor point of view, not all revenue is created equal. From an operator point of view the lens of quality is similar: predictability, profitability, and diversity all matter to profitable growth.
… and how should you actually do all this? Every business will have nuances but the foundation is a persistent connection between your data warehouse and digital analytics platform. Confidence in your data goes a long way too!
With this link in place you can explore the digital predictors of customer value, build expected value models, export data to data management platforms, activate using different marketing channels, and more. Easier said than done so in my next post I’ll explore how you might size the opportunity for your business as well as some lifetime value “hacks” you can quickly implement to increase quantity of quality!