Jim’s Note:  It is not essential to figure out the exact monetary LifeTime Value of a customer.  What you want to really know is the relative LifeTime Values of your customers.

Let’s talk about one of the most confusing and misunderstood parts of customer marketing, LifeTime Value.  The LifeTime Value of a customer is the net profit the customer generates over their LifeCycle.  

People tell you not to spend more to get a customer than their LifeTime Value, or you will lose money.  This is true on the face of it, but actually figuring out what the LifeTime Value of a customer is can be a difficult task, especially if you don’t have the right tools.  Besides, what if you are a new company, or have never tracked the data you need to calculate LifeTime Value?  Is the concept useless to you?

Not at all.  LifeTime value is used to make decisions about allocating marketing to ideas that generate high potential value customers, and away from ideas generating low potential value customers.  And to do this, all you need to know is the relative LifeTime Value of the customers generated by each idea.  Recall LifeTime Value is the net profit the customer generates over their LifeCycle.  So if you know what the LifeCycles looks like, you should be able to do a pretty good job of determining who the highest LifeTime Value customers are, relative to each other. 

If you do your Recency tracking on ads, PPC keywords, newsletter links, and so on, you should be able to compare the relative potential value of the customers generated by each approach and easily decide where your ad budget is most profitably spent.

Let’s say you have run 20 campaigns and you know your cost per new customer from each of them.  You want to run the top 10 (lowest cost per new customer) but you only have the money for 5 campaigns.  With Recency and LifeCycle tracking on the 10 campaigns, all you have to do is choose the top 5 campaigns generating customers with the highest potential value based on Recency.  If you allocate your budget to those and away from the bottom five, you are maximizing your budget ROI, regardless of the actual LifeTime Value in dollars of the customers generated.  What else could anybody ask for?

Continuing with our Ad #1 and Ad #2 example, based on the LifeCycle chart you just saw, can you make a judgment about which ad generates customers with higher potential value?  Looks like Ad #2 to me.  Ad #2 appears to generate customers with a longer LifeCycle, so their relative LifeTime Value is higher when compared with Ad #1 customers, given the costs of acquiring and maintaining customers from both ads is roughly the same.   Period.

And by the way, with the LifeCycle information in hand, is cost per new customer really the issue?  Probably not, because you have to weigh the cost per new customer against the length of the LifeCycle.  Customers who are the cheapest to acquire may have the shortest LifeCycles, and customers who are expensive to acquire might have very long LifeCycles.  So you really need the potential value and LifeCycle tracking to get the whole picture.

The problem people run into with LifeTime Value is the whole question of determining a LifeTime.  There’s no easy way to do it, and so the whole idea gets tossed.  People get frustrated because there’s nothing to grab on to, and no easy way to make comparisons.

But when you track the LifeCycle, you know for a fact one group has a longer LifeCycle than the other.  Who needs the absolute LifeTime Value number in dollars and cents?  As long as you allocate money towards higher potential value customers and away from lower potential value customers, you are maximizing your resources in everything you do.  And that is the reason people want to look at LifeTime Value in the first place.

If you really need a hard number, don’t be afraid to call an end to the LifeTime.  They’re much shorter than you think.  When you are tracking your LifeCycles, and they start to approach 0% of customers making a purchase in the past 30 days (or whatever standard you’re using), it’s over. The LifeTime generated by these particular ads is over. Don’t hope customers will magically come back; it usually doesn’t work like that.

Once you call the end to the LifeTime, subtract your costs (cost of products sold, ad costs, an allocation for service costs) from the revenues for both Ad #1 and Ad #2 customers, and you’ll have your LifeTime Value.

Next in Tutorial: Fun with ROI

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LifeTime Value issues and models are covered in more detail in the Drilling Down book.