The Magic Formulas: Lifetime Customer Value and Customer Acquisition Cost

A customer by any other name would spend the same. At least that’s what Shakespeare would say if he were to try to sell his plays online. But that’s not always the case and some customers are better than others. Some customers are also harder to engage and sell to.

How do we differentiate and how can we make a good medium and long-term decision about customer acquisition costs and returns? The answer lies in using two indexes well known two marketers: Lifetime Customer Value (LCV) and Customer Acquisition Cost (CAC).

You can’t put a price tag on a customer. But you can assign a value.

Courtesy of http://gorillapodstrobing.blogspot.ro/
Courtesy of gorillapodstrobing.blogspot.com

Let’s take Lifetime Customer Value (LCV). The corporate world is often focused on quarterly and in best practices yearly results. That means that returns on investment have to happen quickly or they are useless. When short-term tactics prevail, customers are often mistreated. The innovation halts, marketing and customer relationship investments drop. Customer service is lousy. On short term executives may see a rise in profits but long term results are often slashed.

A lack of focus on LCV is often trouble for ecommerce companies and companies at large. Those employing the above mentioned short term tactics miss opportunities. The client base is often unimpressed, growing slowly or even decreasing. Let’s see why:

Say we get a new potential customer by encouraging him to visit our shop.  John Doe likes what he sees, registers for a newsletter, but he’s not yet convinced to buy. Later on, next month, a product on a weekly personalized offer catches his eye. He clicks, goes online, buys the product – he is now a customer. But wait. John will hopefully continue buying from us, won’t he?

[Read more about engaging customers with Omnichannel Retail]

He’ll keep coming back, buying something every month, say for a period of two years or so, until one day – something happens. He stops receiving his weekly personalized offer. Somewhere along the chain of command somebody decided personalized offer are too expensive. The overall operational costs dropped but so did mr. Doe’s orders. His Lifetime as a Customer is over.

In this scenario we can identify the following:

  • Customer Acquisition Cost (CAC): how much did we pay to get John Doe to a) visit our website, b) register to our newsletter, c) view the personalized offers until he decided to buy?
  • Lifetime Customer Value (LCV): the cashflow coming from John Doe’s purchases. In this case, if he were to spend an  average of $100, monthly x 24 month = $2400. But these are not all ours. Just the margin. Oh, and there will also be discount costs and other variables, but we’ll get to that, soon enough.
  • Shortsightedness: a long word to describe the fact that someone should have thought twice before deciding to cut out the personalized offers.

Customer relationship is an asset.

Any customer demands to be treated as a human being. That’s easy to say but when companies such as these handle millions of customers, that takes hard work to get done.

The Kindle Fire - both a loss and a huge win for Amazon
The Kindle Fire – both a loss and a huge win for Amazon

First, it takes a change in perspective. You have to understand and quantify probably the greatest asset any retailer has: the customer relationship. Ecommerce has made it easier for dissatisfied customers to jump boats. The leaders know this and they use it to their advantage.

For instance – Amazon is not making any profit when it sells a Kindle. The company supports costs so they can get more customers aboard. Those customers turn to happy customers and get to spend roughly $2400 during their lifetime as customers. So what Amazon loses in hardware sales, makes up in eBook sales and other product sales. Such a strategy is not possible without a clear understanding of Lifetime Customer Value and Customer Acquisition Cost, two of the most important indexes online retailers have to work with.

A formula for Lifetime Customer Value

Previously we had an example of Lifetime Customer Value and how we could better understand the concept and estimate the customer’s value. Those numbers being a crude model, we have to reevaluate and get a new perspective on this value. Here it is:

We have some variables (such as customer expenditure value or purchase cycle) and constants (such as retention rate or profit margin, which are less likely to change dramatically). But don’t worry, once you get the hang of it you’ll have a great and easy way to understand wether you’re spending too much or not enough on keeping your customers happy.

Let’s start with the variables. Feel free to adapt these to your own company metrics:

  • Customer Value / Week (a) – how much does a customer spend weekly in your shop?
  • Customer expenditures per visit  (s) – how much are customers willing to pay each time they visit your shop?
  • The purchase cycle (c) – how often do customers visit your shop each week?

These variables are defined here as weekly variables but you can change those to monthly values, if it fits your business model better. You will obtain the values above by estimating median values for all your existing customers.

When you have estimated your variables you will have to take into account some constants. They will help you predict your estimated customer lifetime value. These are:

  • Average customer lifespan (t) – how long, based on your experience, do you expect customers to remain your customers?
  • Discount rate (i) – no, this is not your customer’s discount. You are projecting a value, into the future, but you’ll have to adapt this value to present tense. Simply put – the value of a certain good in the future is lower than that of one you are holding in your hands today. You can study more about this topic starting with the Annual Effective Discount rate and than heading over to Intertemporal Choice. Puzzled? Maybe you’ll want to go with something like a (0.1) value.
  • Customer retention rate (r) – how many of your customers come back to your store and purchase from you, compared to the previous, equal amount of time?
  • Profit margin (p) – pretty self-explainatory
  • Average Gross Margin per Customer Lifespan (m) – the gross profit per customer expected in the given average lifespan (Profit Margin x Expected customer lifetime expenditure)

So now we have the variables, we have the constants, let’s get busy with the equations, from simple to complex.

1. Simple Lifetime Customer Value Formula

We will be using 1 year as a reference timeframe and we will be estimating how much will we be making in a year on any given customer. There are two main variables involved – the average customer value / week (a) and the average customer lifespan (t), expressed in years.

Limitations: this is a pretty crude estimate so it will only serve as a base for further examination. It does not take into account the retention rate and attrition (loss of customers), the discount rate, not even the profit margin. It just tells us – how much would we be expecting our customers to spend with us, during their customer lifetime.

The formula is:

Basic Lifetime Customer Value Formula
Basic Lifetime Customer Value Formula

2. Extended Lifetime Customer Value Formula

So now we know roughly how much will our customers will be spending with us. But that’s not actually our money, isn’t it? That’s the revenue, not our profit. So let’s step a little further and take into account our profit margin and double check the figures, by using the Customers expenditures per visit (s) and the Purchase cycle (c) value.

Remember – this is the not the final form – we will still have to think of a future projection of our lifetime customer value. However, the second formula would be this:

Extended lifetime customer value
Extended lifetime customer value

3. Projected Lifetime Customer Value Formula

This formula has it all – Gross Margin per Customer Lifespan (m), discount rate (i), retention rate (r). It is also one of the oldest and simplest ways to estimate customer value (well, as simple as it can be).

Let’s have a look at it:

Projected Lifetime Customer Value
Projected Lifetime Customer Value

You can see there that this is directly proportional with two of the values. First – Gross Margin per Customer Lifespan (how much will you profit from your customers during their lifespan as customers). Second – retention rate. So do what you can to extend your customers lifespan and the retention rate.

So now we have three formulas. Each outputs a different value. Which is the right one?

Answer: all. And none. Remember – this is an estimate. The best you can do with these three is find an average and try to stick with it. Once you have a number you now know how much should you be spending on your customers. You want an example? Head over to this info-graphic and see these formulas in action with a fine aroma of roasted coffee. Starbucks has a Lifetime Customer Value of $14099 so as long as its spending less than that to turn you into a customer and keep you one – they’re profitable.

What do I do with these figures and formulas?

What is LCV good for? First off – telling you which customer to keep and which not. When it comes to ecommerce data is anything but scarce. You have the info – now use it. Find out who are your best customers. Analyze your data, split customers into marketable groups and … action! Drop the marketing on unprofitable customers (that doesn’t mean you should treat them worse – just spend less on acquisition). Engage your profitable customers.

But be advised – you have to have a long enough timeframe to analyze data. Sometimes those negative LCV’s might turn out to grow in time. Use predictive analytics and extend your search to see where are your customers going, not just where they are right now.

If you enjoyed reading this post as much as I’ve enjoyed writing it go ahead and share it with those you know might want to read it. Comment on it. Like it. Anything as long as you can show me you wan’t to know more about it. Next stop – Customer Acquisition Land. How much, where and how would it be better to spend on new Customers.

Tracking customers in-store. Where is the Privacy?

Did you know that stores use smartphone WiFi and Bluetooth connections to track your movement? Turns out that’s kind of a growing trend right now. Showrooming is ever on the rise so traditional retailers need to act on understanding customers better. Tracking phones is one way to do it.

privacy

There are some companies out there (their number increasing) that provide tracking technologies. One of them is Shopper Trak and I had the pleasure of meeting one of their representatives this week. The company uses a combination of WiFi and Bluetooth signal detection to count, profile and report on customer behavior. How do they that? By registering the smartphone’s MAC address.

What are MAC addresses? Good thing you asked. These are unique identifiers for your smartphone. Kinda like your IP, except they don’t change. That’s one great feature if you’re going to track returning customers. Of course – all of these informations are anonymized and encrypted, as Bill McCarthy of Shopper Trak convincingly told me a couple when I had the pleasure of chatting with him.

Working in tech for some time now – i’m not really so sure about anonymous data but the technology is pretty interesting and its applications can work wonders for multichannel retailers.

Being a online-first type of guy, I was surprised to see the kind of tracking you get with Google Analytics in brick and mortar stores. The first question that popped into my mind was – “Can you compare store tracking data with online analytics data?”. Apparently most of the companies that provide such a service do provide a form of data export that can be used to understand online-offline behavior.

WiFi / Bluetooth tracking is not that popular, due to privacy concerns.

The second question was “Isn’t this thing a little intrusive?”. Probably.

Comments on Nordstrom's decision to track shoppers behavior.
Comments on Nordstrom’s decision to track shoppers behavior.

Last year Nordstrom decided to find out more about its brick-and-mortar store shoppers. They thought they can get valuable intel by tracking who comes in the shop, which products customers buy more, what’s the return rate and others. You know – the kind of stuff all online shops track so they can improve customer experience and increase sales. Except they did this by tracking customer’s smartphones.

But Nordstrom did something that online stores don’t usually do – they posted a sign announcing shoppers they were being tracked. And the shoppers were not happy at all. You can see in the image on the right the kind of feedback they received.

Fearing increasing frustration with their tactics, Nordstrom discontinued the program.

Tracking in-store traffic with video cameras

Some of Brickstream's graphics are definitely not intended to address privacy concerns
Some of Brickstream’s graphics are definitely not intended to address privacy concerns

Atlanta based Brickstream uses a 2d /3d type of cameras to track shoppers inside stores, reporting on queue length and customers behavior.

Brickstream uses path tracking to understand and report customer routes. It also uses height splitting in order to differentiate between different demographics (male, female, child) and 3D technologies to “see behind obstacles”.

Their video intel is, of course, pretty efficient. Used together with mobile tracking- even more so. It is also a little scary for customers inclined to privacy concerns.

Are you are one of those customers? Than you may want to scan through info on the 8 major players in this growing market, Brickstream being one of them:

Companies providing in-store customer tracking technologies

In-store traffic traffic tracking is an industry lead by these 8 companies, with other minor companies quickly growing. The list is provided by “Future of Privacy”, a think tank based in Washington DC, focused on “advancing responsible data practices”.

Nomi tracks customers online and offline
Nomi tracks customers online and offline

One of the younger companies providing in-store analytics, Nomi, which recently received a $10 million funding, mentions the length they go to in order to insure customer privacy. The privacy principles they list on their website are:

  1. Collect, use, and share anonymous information only.
  2. Allow you to opt out of Nomi’s services.
  3. Use industry standard security practices to protect the data we collect.

So everything is cool right? Well…

Good thing you can turn of your Bluetooth and WiFi, if you’re concerned about privacy. Oh, wait…

So far there have certainly been some concerns regarding privacy. Retailers usually addressed them as quick as possible. And when that was not the case – customers could just turn off their WiFi and Bluetooth connection so they won’t be tracked.

As mentioned earlier the technology only works when there is some type of WiFi or Btooth connection that beacons can track. Without it – smartphones are basically invisible. But than Apple thought – hey, let’s change that.

One of the often left out features when it comes to Apple’s new iOS 7 is the iBeacon. The iBeacon is Apple’s response to NFC (near field communication). When an iOS 7 device comes within range with an iBeacon it emits a BLE (Bluetooth Low Energy) response. It becomes trackable even when the above mentioned connections are turned off.

And Apple is really committed to using it:

Apple will track iOS users with iBeacons

The Apple Store Visits you
The Apple Store Visits you

The technology laid dormant during the past months since it was announced. Now Apple will instal iBeacon transmitters in its stores. When walking past such a device, iOS users will be notified of additional information they can read and save on their mobile devices.

The technology will offer in-store analytics to Apple, push ads and info to customers, assist in queue lines at the genius bar and of course help with purchases and payments.

Numerous other possible uses come to mind, mostly location based enhancements… Things like door opening for the blind, customized ads, personalized offers and many others will act as an usher in a new age of technology.

This new age, however, does not leave place for privacy.

Flipboard Becomes an Ecommerce Gateway with its New Catalogue Feature

flipboard

 

Flipboard, famous for making it easy to read webclips and magazines on mobile devices, flips over to ecommerce. In a recent blog post the team announced it will allow brands and users to create virtual product catalogues.

For starters the company allows users to flip through curated content with v-magazines such as “Modern Man,” “Beauty Bar,” “Home Sweet Home,” “The Pantry” and “The Active-ist”.

Several brands have also taken up the opportunity and have launched brand magazines. The thing is – these magazines allow users to browse through holidays offers and than shop. It’s safe to assume that Flipboard aims at something more than just content browsing.

Right now the company has enlisted Banana Republic, Birchbox, eBay, Etsy, Fab and Levi’s. Soon others will  join given the fact that Flipboard has more than 85 million users (a rather interesting market), with 1 million of them actively creating and curating magazines.

Flipboard closing into Pinterest

Remember when we talked about how Pinterest is killing it in terms of ecommerce referral traffic? It seems that Flipboard has also taken up the model and lets users collect products using this handy-dandy little bookmarklet that allows users to collect and share their favorite products.

A mobile commerce gateway to lovable goods

Flipboard is one of the most popular mobile apps around  and not just in terms of number of users. Its 1 million personalized magazines has led to change in user behavior. Almost 50% of all users now read personalized magazines created by less than 1%. The time stamps are interesting also: most reading is done in the morning (9 AM – kinda like a morning newspaper), magazine updating is done in the afternoon and most sharing is done in the evening.

So far their unpaid editors were not able to make an actual living curating the magazines but who knows – The new commercial magazines might change the way we look at Flipboard.

With over 1 million editors, 85 million users and a lot of nice products out there Flipboard can maybe become the mobile Pinterest. There is a need for socially curated ecommerce stores, Pinterest is a success so far in terms of ecommerce interest and mobile is on the rise. Say hello to the new Ecommerce Gateway.

Choosing The Right Products For Your Online Store

Say you’ve decided you are going to start the company you’ve dreamed of – an ecommerce business. You’re ready, motivated and you’ve already read anything there was to read about it. And now I picture you there, in front of your computer, searching for an answer to the big question: What am I going to sell?

Of course – there is no absolutely right answer to that question. There are, however several things you need to take into account when choosing the right product(s).

1. Market size AND competitors

You will first be faced with a need for information regarding:

  • Market size
  • Competitors
Book Market Evolution - Source: http://paidcontent.org/
Book Market Evolution – Source: http://paidcontent.org/

The trick is those two need to be thought of together. There is a strong connection between them. Your ideal market is big enough to make it worth your effort and small enough to have manageable competitors.

Say you’re looking into selling ebooks. Supposedly you’d try that in an established market like the US. The book market is huge (est. $15 billion) and ebooks amount to 20% of that figure. Unfortunately you will be faced with some fierce competition: Amazon, Barnes&Noble, Sony Bookstore and Apple iTunes. Tough luck, you are probably not going to make it in the big fish pond, baby.

Say you’d try some smaller market, but big enough to have a say in it. Something like kids ebooks. You would have less competition from the big guys (as you can see in the graph above the kids ebooks is the smallest category yet the fastest growing). Secondly – there is still a big enough market to make it worth your effort (approx. $500 mil).

Key take aways:

  • choose a market that’s big enough to make it worth your effort, but small enough so you won’t be crushed by your competitors
  • be careful with small markets – unless you have the financial stamina to grow your market into something solid it can be too risky to stick to small markets. Ex.: Selling products such as a dog GPS-connected collar with MP3 player and iPhone connectivity. It might be the bomb in 10 years – but isn’t this market a little risky?
  • competition is a great thing to have – it means you have a viable market. Growing competition is even better – it means your market is evolving. You should only worry when your growth is outpaced by the market’s.

2. The right suppliers

Suppliers are key factors when determining the future of your online store. You need to make sure that your suppliers are:

  • Reliable – you will not be manufacturing your own products. As such – you need to make sure that your suppliers are reliable in terms of product quality, delivery time and financial stability. You wouldn’t want them to sell you broken products, delay shipments or go bankrupt.
  • Cheap enough – don’t forget – you need to make a profit to keep your business afloat. To do that you will need to search for those suppliers that will allow you to have a decent margin.
  • Able to fulfill your orders – say you’ve ran a successful Black Friday promotion. Your sales went through the roof. Now it’s time to start delivering those orders. Is your supplier up for the job?

3. Can you actually ship your product ?

Think of this: most shipping companies will charge you by the distance and by the pound when shipping your orders. Let’s say you’ve decided on the right products, your market size is big enough, competitors don’t seem to be too threatening but there is a small issue: The product is too heavy.

Can you ship this product and still keep shipping costs at a decent level? If not – you might want to rethink your choice.

4. Recurring sales and upsell strategy

Most of your marketing will be focused on two things: 1. acquiring customers and 2. making sure those customers keep coming back. You need to keep that in mind when choosing what to sell online.

You need to sell products that customers can:

  • understand (remember the GPS dog-collar with MP3 player features – it may not be so easy to convince people to buy it)
  • get informed about, preferably on your website
  • need to be bought periodically (books, electronics, airplane tickets – they are all products that are sold recurrently). This means you can build upon your previous customer acquisitions.

Now that you’ve decided on the right kind of product, the kind that is bought not only once but many times – add something to the order. Upsell. Say you’ve decided on selling fashionable clothes. You might also want to add accessories or cosmetics to your product assortment as they are likely to be bought together.

As you are likely to find it it hard to sell all those products right from the start – just focus on your best sellers. However – do outline your up-sell strategy straight from the beginning and follow up on it.