The Secret to Understanding True Marketing ROI

Posted on: August 31, 2013 by in Uncategorized
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There’s a little known business calculation known as Lifetime Customer Value (LCV) that usually only the big boys pay attention to that may significantly help you improve your marketing efforts.

Lifetime Customer Value and How to Calculate It

The thing that is often overlooked when measuring the effectiveness of a marketing campaign is the lifetime value of each new customer. Not just the profit on their initial purchase but all of the repeat business as well. So lifetime customer value (LCV) is the total profit on average a customer adds to your company over the lifetime of their relationship with you.

The way to calculate LCV is to multiply the average gross profit on each purchase by the number of purchases per year. Then multiply that times the number of years they remain a customer. Of course you can substitute months for years if it makes the calculation simpler or helps you get a more accurate figure. Lets look at an example.

Gross profit per purchase: $100
X
Number of purchases per year: 5
X
Number of years they remain a customer: 2.5
=
Lifetime value: $1250.

As you can see this is a simple calculation. Now we have at least a good estimate of how much each new customer is worth.

One reason its so important to track your attrition rate (customer loss) is that it’s necessary to get the “number of years” figure.  Otherwise, you should estimate it and start tracking immediately.

Hopefully, you at least know how many sales you’ve made and what your gross profit on those sales is. If not, you obviously need to get those numbers before you can calculate LCV.

When Discounting Is Ok

A lot of business owners don’t like giving discounts and using coupons even in ads that are designed strictly to bring in new customers because it reduces profit. And if they get very little repeat business, that’s understandable. But in most businesses, a customer’s repeat purchases are worth far more than their initial purchase and the reduction in profit from a coupon on the initial purchase is insignificant.

And if a coupon or other incentive is going to have a big impact on the response to an ad (which it normally does), it’s usually a no-brainer. One reason understanding LCV is so important is that it helps you understand how that coupon or other incentive will affect your profits.

LCV Helps Determine Marketing ROI

The other reason having at least a good estimate of LCV is so important has to do with understanding the return on investment of your marketing.  You need to know how which campaigns are effective and how much you can afford to spend to bring in a new customer.

So for example, lets say you estimate that the avg LCV is $100. Then you run an ad that costs $100 and the ad brings in 2 new customers, that’s $200 in gross profit less $100 in ad spend equals $100 net profit. Since you made as much money as you invested, your roi would be 100%.  Actually to be completely accurate, you need to figure in the opportunity cost (eg interest) of having your money tied up as well but you probably don’t need to be that specific.

Customizing LCV

Many times when I go over the concept of calculating LCV with business owners, they don’t see the value in it because, they complain, “every customer is different”. Which of course is true. Some might have an LCV of $100 and others $500 and this is why you need to use averages.

That said, you may need to calculate individual LCV’s for different segments of your business or individual products and services since the LCV of customers who buy one product or service might vary greatly from another. And obviously marketing campaigns often drive sales of specific products or services.

You also may want track the LCV of customers acquired from different marketing campaigns as well since, as just one example, statistics show that customers acquired through referrals have a significantly higher LCV than from others sources.

For branding campaigns, knowing LCV will not be as valuable since its difficult if not impossible to know the true impact of a branding campaign especially in the short term.

Conclusion

It takes some work but I’m convinced, and hopefully I’ve made a good case, that if you really want to understand the impact and ROI of your direct response marketing campaigns, its essential to have at least a good estimate of average lifetime customer value.

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