Achieving Sustainable Growth by Balancing Cost of Acquisition and Customer Lifetime Value
Despite concerns about the ongoing decline of iconic brands here in the U.S. and abroad, things aren’t nearly as bad as they seem for the retail market. Look back at the 2018 holiday season, for instance. According to the National Retail Federation, U.S. retailers managed to pull in more than $707 billion in the last two months of the year. Spending doesn’t seem to be showing any significant signs of slowing down in 2019. If that’s the case, though, why are so many brands suffering? The disconnect between these two realities is that more and more consumer spending occurs online, rather than in-store.
E-commerce presents incredible opportunities for retailers, as well as a host of new challenges. Online sellers must consider new expenses and complications that impact the eCommerce market in ways totally different from brick-and-mortar retail. Site design, customer verification, cart abandonment…they’re variations of problems that existed for brick-and-mortar. However, they have a much more dramatic impact in the online market.
The act of managing these considerations is important. To be effective, though, you must also think about the amount of energy and money it’s reasonable to spend. This is where two key indicators—customer lifetime value and customer acquisition cost—come into play.
What is Customer Lifetime Value?
Customer lifetime value, also known as LTV, is the total value of all revenue you can expect to generate from an individual customer over that person’s entire lifetime. To calculate this figure, start by tallying the total amount spent by that customer, plus any additional revenue generated, such as referrals, membership fees, etc. Then, subtract from that amount the customer acquisition cost (CAC), or the sum of the time and resources invested in acquiring and retaining that buyer.
It’s surprisingly common for merchants, especially those who are less experienced, to overlook certain facets of CAC. Too many sellers invest massively upfront, hoping it will help their products go viral. They’re essentially playing the lottery with this approach. And, if there’s one thing you should know about that…it’s that the odds are always against you.
CAC isn’t just immediate costs like advertising, for example. You must account for the time and resources directed toward developing campaigns, researching customer interests and wants, fulfilling orders, and providing post-transaction support.
Calculating LTV and CAC enables informed decisioning regarding how you allocate resources. After all, you should have a significant margin between the amount spent and the amount of revenue generated. Otherwise, it’s not worthwhile to acquire and retain the customer in question.
This calculation plays into other aspects of customer relations beyond the immediate, transactional interaction, too. LTV serves as a guideline for how much you should allocate to discounts and loyalty programs. It helps you make decisions about scaling and expanding into new markets or sales channels.
Operating without insight on how much you can expect to make from a single customer is like flying blind. You have no idea what’s reasonable to spend relative to what you can expect to make. It’s a vitally important indicator that no merchant should ever overlook.
Calculating LTV
Beyond customer acquisition cost, you need to account for a few more fundamental variables to get a good impression of your average customer lifetime value. Most importantly, you need to know:
- Your average transaction or order value.
- Your total number of annual purchases.
- The number of unique customers you serve each year.
- The average span of time a buyer will remain your loyal customer.
Once you have those variables, simply follow this formula:
[Average Transaction x (Total Annual Purchases ÷ Unique Customers) x Time] – Acquisition Cost = Customer Lifetime Value
It’s never going to be an exact impression. That said, this formula should give you a reasonable impression of how much revenue you can expect to generate from an individual customer. You can then adjust your strategy to develop a systematized method for managing customer interactions. This way, you can see generally higher customer value and satisfaction, while simultaneously minimizing costs.
You should remember to account for many different variables when interpreting LTV. The rate at which customers return items, the amount of inventory you need to keep on-hand to provide optimal service, your product vertical, and your responsiveness are all important considerations.
Lifetime Value is a Guide to Sustainable Growth
It pays dividends to retain customers. In fact, the cost of acquiring a new buyer is five times higher than the cost of retaining an existing one. Ultimately, the key to retention is simply providing excellent, fast service and quality products. This works because, on one hand, pleasing existing customers keeps them coming back over and over. However, there are many ancillary benefits of top of that, too.
You can essentially turn happy customers into brand ambassadors, helping bring-in new customers with little-to-no added acquisition cost on your part. On average, a pleased customer tells nine people about her experience, while a dissatisfied buyer will tell 26 people. You also instill confidence in your customer service operations, which can significantly reduce your chances of experiencing friendly fraud.
This approach to developing your brand—one which keeps customer lifetime value as a central concern—isn’t as flashy or impressive as overnight viral success. It’s also not as energizing as driving in a boatload of new traffic. But, by not overspending on acquisition or marketing, you build a much stronger foundation for a lasting organization. It’s a more sustainable approach that sets you up for consistent, strong growth.
Written by Monica Eaton-Cardone.
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