The following article is from the advanced topics section; you might want to take the tutorial Comparing the Potential Value of Customer Groups before reading it. If you would rather see a general description of the Drilling Down method and specific benefits first, go to the home page.There are several ways ROI thinking is used in marketing. Some people look at the ad spend versus the visits or clicks created, and reallocate spending to the highest ROI (lowest cost) areas, as measured by cost per visit or cost per click.
Others may be able to take it deeper, and turn an action directly into a monetary value using ad sales or purchases, calculating ROI on dollars spent versus profit generated for the campaign.
These “campaign management” applications of ROI thinking, while a good start, are very front-ended and representative of the Web’s early focus on customer acquisition. They are short-term oriented and don’t include the future value of the customer to the company in the thought process. Return on Investment is not a place in time; the notion of a “Return” almost always implies a longer time horizon.
Here’s what can happen with the campaign management approach to ROI. Let’s say one media/creative combination generates
a low cost per action, but these customers fail to repeat the action. They’re “one-timers.” Another media/creative combination generates a high cost per action, but the customers repeat this action over and over, generating additional profits with no additional costs.
If you are using the campaign management style of calculating ROI outlined above to administer this campaign, you could actually be responsible for ultimately decreasing the future value of your company. You would be allocating campaign resources away from the most valuable repeat customers, just because they have a higher initial cost per action!
The next step towards accurately measuring ROI comes into play when the Web starts to focus on customer retention.
With a customer retention marketing perspective, ROI takes into account the LifeTime value of the customer, that is, the net profit to the company from the customer as long as the customer remains.
A High-ROI campaign starts off by acquiring the right customers, customers who will continue to contribute to the profitability of the company after the initial acquisition. ROI is the LifeTime Value of the customer divided by the acquisition cost. This is the definition of ROI most customer retention oriented companies use. It is a sequence of events and measurements over time, ultimately resulting in a marketing campaign being deemed High-ROI or Low-ROI.
The sum of all the LifeTime values of customers represents the future profits of a company. Understanding these metrics allows for accurate predictions of future profits and thus the valuation of the company as a whole. This kind of ROI thinking can be very similar to the financial idea of cash flow, with each customer contributing their own cash flow to the company over time.
So creating a high-ROI marketing campaign starts with understanding the LifeTime values of the customers the campaign will generate. You have to analyze the current customer base, look at customer LifeTime Value relative to how and where the customers were acquired, and target appropriately.
Customers coming from RON banner ads may have a lower LifeTime value than customers coming from newsletter sponsorships. If true, you would move most of the marketing budget out of RON banners and into newsletter sponsorships. ROI thinking, when applied to retention marketing, means a migration over time from acquiring low LifeTime Value customers to acquiring high LifeTime Value customers. In this way, a marketing budget can remain flat or even decrease over time even as the value of the customers and business rises.
Let’s say you just don’t have the time or resources to do a LifeTime value analysis. Maybe you never tracked customer source and just can’t do the analysis. What are some of the keys to organizing campaigns along LifeTime Value ideas, given the lack of ability to determine LifeTime Value?
There are two issues: targeting the campaigns and measuring success.
Targeting on the Web, because of roots in the publishing business model, has been dominated by demographics. High-ROI marketing is about ongoing customer behavior, not demographics.
The reality is, you want people to behave in a certain way: to buy, click, or visit. Outside of some narrowly focused pure publishing plays, if customers behave as you want them to, how important are their demographics? You would probably be surprised how many of your “best customers” are outside your “core demographic.” Demographics should play second to behavior when targeting for high-ROI marketing campaigns.
People tend to continue behavior they have established in the past. Using behavior to target implies finding people who do what you want your future customers to do. If you want them to click, find places to advertise where click-through activity is high, and address demographics secondarily. If you want them to buy, seek media known to be heavy on actual buyers, and address demographics secondarily. And this time, track the acquisition source and ongoing patterns of behavior for the customers you acquire.
The measurement of success, if you don’t have the time or resources to do a full LifeTime Value analysis, can be looked at in two ways:
1. Use proxies for LifeTime Value. The simplest is repeat buying / visiting. Do the customers coming from RON banners have a higher or lower repeat rate than customers coming from newsletters? For examples of other proxy metrics you can use without actually measuring LifeTime Value, see the article Tracking the Potential Profitability of B2C CRM Implementations. It’s based on this idea of proxies for LifeTime value and explains the approach in more detail.
2. Just pick any time period, say the past 30 days, and start tracking behavior. Customer value is relatively constant in the short term. Customers who are the most valuable at 30 days tend to be the most valuable at 60 days; customers who have low value at 30 days tend to have low value at 60 days. Just start tracking and readjust your horizon as you move along. As you’re doing this, you will begin to discover exactly what a LifeTime is for customers acquired from different sources. Want a hint? It’s shorter than you think.
Here’s the point, folks. You don’t have to overcomplicate any of this. There is no absolutely right way to do it. The idea is to start doing something, anything, regarding measuring ROI over a longer timeframe than the point of acquisition of the customer.
You’re already doing a good job with campaign optimization. Just follow through and tie acquisition source back to the customer behavior over time, using any metric you consider valuable to your company. You will end up driving an increase in revenue while reducing the overall cost of acquiring and retaining customers.
The future value of customers can be predictably determined by looking at media source, product of first purchase, time of day, affinity profiles, and many other “triggers.” This is the first step towards improving customer retention – measuring the value of customers acquired by source.
After measuring customer group value, the next step is to manage customer value – to make money by creating very high ROI customer marketing campaigns and site designs. The Drilling Down book describes how to create future value and likelihood to respond scores for each customer, and provides detailed instructions on how to use these scores to continuously improve profitability.
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