How to use customer lifetime value to inform your marketing decisions
Anyone running a retail business knows that not all customers are created equal. Some may only buy once, no matter how many emails, ads, or sales you throw at them. Others become loyal customers, buying frequently and telling anyone that will listen how great your business is. While getting those one-time or infrequent buyers certainly doesn’t hurt, it’s those brand champions that should be the bread and butter of everything you do. That includes understanding where you should be placing your marketing spend and the channels you’re using to acquire new customers.
Of course, that may sound simpler than it is. Here are some tips on how you can leverage the data you’re already collecting on your customers and use that to establish customer lifetime value (LTV) segments that can inform your marketing decisions.
Create customer LTV segments based on buying behavior
Customer LTV gives you a snapshot into the value of a customer over their lifetime. LTV is calculated by summing up the net revenue from all transactions by a customer and subtracting out the costs associated with those transactions. Costs typically include product costs and the cost to ship an order. You’ll also want to consider other factors that may or may not be unique to your business, like different cost elements or discount factors to apply to future sales.
Typically, LTV is rolled up into cohorts of buying behaviors, such as the month or quarter of their first purchase, their first product purchases, or the channel acquisition for their first purchase. Distinguishing these different cohorts will give you an idea for how different segments of customers perform based on different attributes of their first purchase.
By segmenting groups of customers based on these cohorts, it allows you to make comparisons between those segments to understand how your customers interact with your business and which ones are more valuable in the long run. For example, if customers that purchase product A have a higher lifetime value than customers who buy product B, then you may want to focus on featuring product A prominently on your website and throughout your acquisition channels.
Understand the value of customers acquired through different marketing channels
The cost of acquiring customers is commonly a key focus for e-commerce companies—and for good reason. Quite simply, acquiring new customers is much more expensive and can be much more difficult than getting repurchases from existing customers. Existing customers have already provided you with a wealth of information that allows you to create a more personalized approach to retaining them. On the other hand, attracting new customers to your site can feel like casting a fishing line into the middle of the ocean: the fish are there, but you have no idea if you are using the right bait, and there are plenty of other fishermen out there trying to find those same fish. A robust customer acquisition strategy usually requires innovative marketing techniques to try and attract customers and separate your business from a crowd. And because there are an ever-increasing number of acquisition channels—social media, display, paid search, and email to name the obvious—it’s important that you understand the value of customers you’re acquiring through each channel.
Once you’ve created customer LTV segments, it’s important to look at the value of customers acquired through different channels. Some companies spend equal amounts across all channels, assuming that a customer acquired through Facebook ads is just as valuable as a customer acquired through an affiliate program. This is rarely the case. Customers have preferences for certain channels just like customers have preferences for certain products, and you can often draw correlations between the channel through which a customer is acquired and their price sensitivity, or how much influence a discount has over their purchasing behavior. As we’ve already noted, customers shouldn’t be treated the same and, therefore, neither should marketing channels.
Use customer LTV to impact cost per acquisition
To put this knowledge into practice, say two customers, Customer A and Customer B, purchase the same product but are acquired through different channels. Customer A comes through a paid social ad while Customer B came through a paid search ad. Both purchases result in the same amount of gross margin because both customers purchased the same product. But without having an LTV model in place, the assumption would be that these customers are of equal value to your company. However, if you discover that Customer A only repurchased once but Customer B repurchased three times, it’s safe to say that you should be putting more spend behind acquiring Customer B.
Now assume that you have a whole bunch of Customer A’s and Customer B’s. Because you know that Customer B is more profitable to your business and that those same types of customers are more likely to come through paid search channels, you can set a higher cost per acquisition (CPA) target in your paid social channel and less in your paid search channels.
You now know that you receive less value from customers that are acquired through paid social ads because those customers don’t repeat purchase as often. To put it simply, you are getting more bang for your buck with the money you are spending in paid search.
Of course, you probably also want to investigate and discover why that group of Customer A’s are not repurchasing as often. It could be that the ads you’re running on social ads are giving those customers a different expectation for your product(s), so changing the copy or images could improve the profitability of those customers.
While it will take some time to dig into these possibilities and make changes to your advertising campaigns based on your findings, your newfound understanding of customer lifetime value and how to apply it will allow you to make more informed marketing decisions. Optimizing your marketing spend and redistributing it to the most valuable channels will have an immediate and dramatic impact on the bottom line of your business.