The full skinny on how to build your own customer lifetime model
In Parts 1 & 2 of this mini-course I went through the essentials of why knowing your customer lifetime value is vital to your business growth and what’s involved with establishing what it is for your business. In this third and last part I want to show you how to build your own customer lifetime model.
Download Your Master Files
Please download the Lifetime Value zip file (right-click and choose Save as) and extract the contents to your computer. Inside is a PDF (containing these 3 articles) and two Excel spreadsheets; one is a ‘master template’ that does most of the work for you.
Not all, but most! It isn’t complete until you input your own data. The hard work is done by the spreadsheet and the formulas it contains.
The other spreadsheet is a working example for you to study.
STOP!
Before you do anything else, create a template-master file of the spreadsheet then use it to open a second file to create your ‘what if’ or personal working file. Only enter your own data into your working file. That way you always have the template-master to go back to.
Please open your work file. Inside you will find two worksheets labelled ‘Detail’ and ‘Model’.
The Detail Spreadsheet – Assembling the Information
Here you have a basic checklist of the factors that you may want to include in your own LTV model. Where these factors have a cost, the more precise your definition is, the more accurate your LTV model will be. You can add or delete data rows above the ‘Total’ without affecting the addition formula.
In my experience it is also the area where direct marketers get things wrong. Despite their interest in getting their metrics right, they often seem to run away when they see the £ or $ signs. Of course they are different, but they’re not difficult. Plus you’ll be able to defend your results when others ask questions.
The important idea to remember is to be consistent in the elements you include so that all versions can be comparative. For example, if you have a telephone response option then including those costs in one version and not in another must affect the end result and any comparison between those results is not viable.
You also don’t need to go overboard in the costs you include. You’ll have set your product prices to cover your overheads so there’s no need to consider them.
What must be included are the extra costs associated with the specific segment you are modelling. For example, the costs of recruitment, subsequent costs of communication and handling promotional costs – except discounts as they are already accounted for in the sales value.
There’s one factor that is a bit more of a challenge to deal with. You’ll remember from Part 1 that I wrote about needing to account for inflation. This is done by applying a discount rate but, where do you get this from? Some will try to tell you that the discount rate is equivalent to the prevailing interest rate. It’s not!
Sure, if you had to borrow the money you’d pay a bank’s lending rate, but that’s only a start. You also need to allow for risk and more which I would need another course to describe.
So use these ‘rules of experience’ – if the bank rate is:
° less than 5% use a discount rate of 10%
° from 5- 10% double it to establish the discount rate
° over 10% add another 10%
° if it is over 10%… then god help us!
The Model Spreadsheet – Making The Maths Simple
The major formula in the spreadsheet is shown below and it’s not that simple to understand! That’s why the model worksheet takes care of the mathematics for you.
But there are two issues with this formula of much greater relevance:
1. You want tools to help you make better decisions. You don’t want to become a mathematician. This LTV model is one of the most useful marketing tools you can use.
2. The formula gives you a single figure result. In the example I’ve given the Customer LTV is £98.22 based on net cumulative sales over 5 years. When we refine the calculation based on profit earned over 5 years the Customer LTV is £39.29. Of course those are results we set out to establish but they hide too much essential information.
When you look at the example spreadsheet you’ll see the impact of the retention rate on the decline in the customer numbers year on year. This may be a factor that you may not have appreciated in hard numbers before. And there’s much more to review besides.
Run spreadsheet tests to examine what you would need to do to increase Customer Lifetime Values. If you use realistic alternatives and the results are positive then you have removed some of the risk before you organise a live test.
Please go through the spreadsheets to familiarise yourself with the information they reveal. There’ll be a surprise or two for you I’m sure
Questions? I will do my best to answer any questions left in the comments below.
If this mini-course has been useful, and you think that another article at a later date to build on how to get the best out of your customer LTV would be helpful, please let us know by adding a comment below or sending an email to carol@carolbentley.com.
To your planned success
Terry Savage
© 2010 : Terry Savage, Savage Advertising Services Ltd
Terry Savage has been advising, training and mentoring direct marketers successfully for more than 35 years. From individual addresses on metal to highly complex online applications he’s managed them all and helped develop a few of them too.
His consultancy continues to work with major direct marketing companies in building new online strategies and resources. Now he’s distilling his skills and experiences via online products and services for everyone.
People seem to think he knows what he’s talking about (I certainly do!)
Terry Savage: BA, DipM, FCIM, FIDM, FISMM, AMRS, Cert Accy
I now know some of ‘that’… I need to know more
We looked at many of the basics in Part 1 of this mini-course. What I didn’t do is give you a clear idea of what a customer lifetime is.
So what’s lifetime?
First we are talking about customers and the length of time that they buy from us before they stop. That period, be it 1 year or 25 years, is their lifetime.
Let me expand on that. No individual will continue to buy from you. Your customers will fall away year on year until you have too few for planning purposes. I set that minimum at no less than 10% of the original volume, unless dealing with mega databases.
A phrase you’ll also hear is the ‘retention rate’. That’s the proportion of the customers who continue buying year after year after year. If you have 3,000 customers at the end of year 1 and 1,890 buy again in year 2 you have a retention rate of 63%. Obviously you want to use tactics that increase that retention rate to as near to 100% as possible.
So the length of a customer lifetime is dependent upon the retention rate – sometimes also called the ‘churn rate’. So again you may ask, “Just how long is that lifetime?”
I wish I knew too!
When you begin to build your permission database* you don’t know how long your customer lifetime is. There is no magic formula to tell you. Experienced marketers have data to analyse that gives them a clear guide to a precise estimate; for the rest of us we have to estimate based on experience.
[* Permission means you are legally entitled to market to your customers until they or you decide to stop. I also use ‘database' rather than ‘list'. A list has contact details, a database has so much more e.g. transactional histories, profiles of behavioural data, channels used and more that help us to market to them with knowledge of their wants and needs.]
From my experience a retention rate of 50% is common. It’s not a certainty as I’ve seen both stronger and weaker rates. This is just a fair estimate to use. If you do the maths you’ll find that between years 4 – 5 your database falls below the 10% limit described above. For the sake of simplicity, the average person on your database probably buys from you for an average of 2½ years.
To calculate lifetime value, however, we consider the actual customers, their actual cash transactions and the actual number of years they continue to buy.
Does that mean riches to rags in 2½ years?
No! We were only looking at your customers at the end of year 1. In year 2 you attract more customers, and in year 3 more… and so on. They haven’t been included in the calculations – yet.
As your business continues you re-evaluate lifetime and lifetime value estimates, establish your own retention rate and improve the quality of your analysis.
If you’re with me so far, let’s look at improving the quality as your basic knowledge grows.
1. Not all of your customers are the same. Gender could be important or age or lifestage or geography or any of many profiling characteristics.
2. Not all of the items they buy are the same. Some buy the same product or selection of products each time; others buy across the range and do not repeat purchases or upsell or cross-sell between ranges.
3. Not all of the prices they pay are the same. Some may favour special deals, others unit price yet more buy in volumes only.
4. Not all of your customers have the same buying pattern. Some buy annually, others irregularly or seasonally.
5. Not all of your customers are individuals. If you’re fortunate to have business or public organisation buyers as well as individuals you have yet more to consider.
You can’t be expected to know any of this when you begin trading. Your previous experience may give you a head start as to the buying characteristics of your ideal customers, but you can’t be sure and you won’t have worthwhile numbers for some time.
So don’t let this checklist overwhelm you, just be aware that the data you gather becomes more useful over time.
In Part 3, the final part of this mini-course, you get the last of the building blocks, a worked example plus a worksheet template you can use immediately for your own calculations.
To your planned success
Terry Savage
© 2010 : Terry Savage, Savage Advertising Services Ltd
Terry Savage has been advising, training and mentoring direct marketers successfully for more than 35 years. From individual addresses on metal to highly complex online applications he’s managed them all and helped develop a few of them too.
His consultancy continues to work with major direct marketing companies in building new online strategies and resources. Now he’s distilling his skills and experiences via online products and services for everyone.
People seem to think he knows what he’s talking about (I certainly do!)
Terry Savage: BA, DipM, FCIM, FIDM, FISMM, AMRS, Cert Accy
If only I knew… (this), then I could do… (that)
Every business owner or marketing professional has asked themselves that question at least once in their career life. For some of the most successful it’s almost their daily mantra.
In this 3-part mini-course I want to help you answer an important lifetime question; “How do you value a customer lifetime?”
Why bother, isn’t it just another nice to know idea?
No! It’s a need to know tool. I’ve been a direct marketer for more than 35 years, both as client and consultant. In that time I have not found any tool as valuable to the future of a business as knowing the customer lifetime value or LTV. And for many reasons… these are the most important:
1. To know the worth of my database should I want to sell-up. Even the dreariest of bankers and accountants value and respect the calculation.
2. To know how much to invest to recruit a new customer. And what medium or channel to use, if your database gets big enough to provide that insight.
I know of major airlines who willingly spend £2-3,000 to get a prospect into the top tier of their loyalty scheme. Those individuals are worth in excess of £200,000 in ticket sales over their ‘lifetime’.
3. To know how much to re-invest in retaining that customer each year.
Major catalogue companies can forecast to the penny how much they have to pay to incentivise repeat sales.
4. To know the results of initiatives to extend every customer’s LTV with up-sell, cross-sell and innovation strategies.
5. To know which project is the most likely to give the best return. Management is about choices; choosing the route with the greatest potential for financial success makes sense to me.
I’ve helped several companies who were considering changes to their marketing strategies to promote to new audiences through new media sometimes with new products too. Creating simple LTV models enabled us to prioritise the options available.
6. To know that I can set targets of features within campaigns, assess performance and modify plans if necessary. What’s more, once the plan is on a spreadsheet you can ask ‘what if’ questions to aid decisions at all times.
Are we talking about return on investment (ROI)?
Isn’t that something accountants handle?
Two questions, two answers – both are “No”.
OK, there some similarities between LTV and ROI. They are both concerned with how money changes in value over time – more below* – and use the same arithmetical formula to calculate it. [The calculation can seem too complicated for many people... stay with me to Part 3 and I'll give you a spreadsheet that does it all for you.]
More particularly ROI versus LTV is an issue of focus and use. ROI covers any project of any kind that involves the allocation of resources for any member of the management team. LTV is about people; our customers, who they are, where we find them, how we get them to spend money, for how long and the costs of doing all this… while making a profit.
So No it’s not something for accountants to handle – they don’t know people like we know our customers.
*Money really does change in value
It’s called inflation – if we leave aside international exchange rates.
Let me give you a simple analogy. Say that last year a loaf of bread cost £1 and this year £1.10, the loaf hasn’t changed but the price has gone up 10p. Money has lost 10% in value from the first year to the next.
This is important because we can’t compare money amounts over 2, 3 or more years with discounting for inflation. And this is the norm in LTV calculations. One client of mine had a LTV of 25 years.
Just think how the price of his bread might have changed from year 1 to year 25!
Let’s start with an example of a simple LTV
(This is the example Carol uses in her book ‘I Want To Buy..’).
Suppose you sold an electronic gadget that normally retails at £50. It costs you £20 to buy. When someone purchases that gadget you make a gross profit of £30.
Having purchased that one item you keep the customer informed of similar products. They buy another piece of equipment at £150, which costs you £80 to buy. That gives you a GP of £70.
So far you’ve made £110. Now, let’s say he purchases an item for £230, which costs you £110 to buy in. That’s another £120 to add to your GP from that one customer.
Suppose he only buys one more item from you at £320, which costs you £180 at source. That’s another £140 in GP profit. Your overall GP from that customer’s four transactions is now:
£30 + £70 + £120 + £140 = £360.
Now that you have this information you can make an educated decision on how you’ll encourage a prospect’s first purchase. In fact you could afford to offer the first electronic gadget at a ridiculously low price, i.e. cost or even just below, knowing that your follow up marketing methods encourage more sales on which you can make additional profits.
So, if you offered your gadget at £21 instead of £50 as a ‘special offer’ you could have a higher number of people purchasing than you would if you tried to retain your profit margin on the first sale.
Arguably this simple LTV calculation is sufficient if you maintain the same strategy year on year. However, it’s not really precise enough in a dynamic environment for business people like us.
In Part 2 we’ll go further into building your knowledge of LTV.
To your planned success
Terry Savage
© 2010 : Terry Savage, Savage Advertising Services Ltd
Terry Savage has been advising, training and mentoring direct marketers successfully for more than 35 years. From individual addresses on metal to highly complex online applications he’s managed them all and helped develop a few of them too.
His consultancy continues to work with major direct marketing companies in building new online strategies and resources. Now he’s distilling his skills and experiences via online products and services for everyone.
People seem to think he knows what he’s talking about (I certainly do!)
Terry Savage: BA, DipM, FCIM, FIDM, FISMM, AMRS, Cert Accy
You will receive a valuable gift from Terry Savage who, like you, reads this blog.
Was my definition wrong? Well, it is more a case of over-simplifying… here’s what happened:
Terry contacted me after reading chapter 3 of my book – you can see it in the download offered in my post… ‘If An Opera Singer Can Do It… So Can You‘
In his email he said:
Hi Carol,
I’ve been looking at the downloads you offer to new subscribers and following through onto your website.
I totally agree with your assertions in the Profit Mastery interview about the failure of many to understand true lifetime value. What I take issue with is your formula for calculating true lifetime value on page 16 of the sample chapter from your ‘I Want To Buy…’ book.
I’m a 35 year veteran of direct marketing and have lectured students sitting the admission examinations for the CIM and IDM. Had any of them used your formula in those examinations they would have failed.
At best, your formula calculates gross sales value and nothing more.
There is no consideration of inflation and its impact on money. Without it there is no basis for valuation over time. This matter is even more important when considering Internet sales where foreign currency fluctuations add another dimension.
In turn that raises the matter of segmentation and the possibility that there can be more than one lifetime value.
Different segments of a database may have different lifetime values of which the item(s) purchased, how frequently and at what price/currency, and more, may influence the lifetime value calculation differently. Yet all segments may be profitable.
That being the case, the nurturing you refer to may be organised differently for the different segments. So the costs of that nurturing or CRM in the jargon must also be factored in.
This is a long way from your simplistic formula.
So why have I bothered sending you this email? Well, like your answer to the question posed to you about giving information away I too believe that there is value in giving information away. Also because I have obtained useful value in your articles it’s right to give feedback.
Kind regards,
Terry Savage
Managing Director, Savage Advertising Services
And he’s right… I described a very simplistic way of checking the lifetime value of your customers… my prime intention is to get business people to consider the long term relationships and frequent transactions that a new prospect represents so they make sensible business decisions about their marketing spend and activity.
Terry has a valid point though (and he should know because, as he mentioned, he has a long track record in direct marketing).
So I invited him to do a guest posting to explain, in more detail, exactly how this important element of your business, should be gauged.
Generously, he not only agreed… he went one step further (actually quite a few steps further!) and created a mini course – yours for the taking.
It will be released as a series of 3 short articles next week. He also decided to make life extremely easy for you… he’s created an Excel worksheet that calculates your life time value taking into account all the additional considerations he mentioned above. A master template of the spreadsheet, an example model spreadsheet and a PDF containing all 3 articles will be available for download with the final article so you can easily print, read and keep them for future reference.
We’re just finishing the editing and preparation ready for publishing. Look out for a post next Tuesday titled ‘Getting to grips with the Real Customer Lifetime Value – Part 1′… that will be your first valuable insight to this important know-how.
BTW – this is crucial knowledge for anyone who owns a business... please use the share buttons below to let other business owners you know have advance notice of these valuable articles or email your colleagues and suggest they visit www.copywriting4b2b.com. I’m sure they’ll appreciate your thoughtfulness. Thanks 
~ Carol Bentley
In the late 1990s and early 2000s businesses were told “If you don’t have a website you’re risking annihilation by your competitors who are embracing this technology!”
Now the trend is to deliver, online, as much information and instruction by video as you can and encourage discussion and social participation in comments or forums if you want to stay ahead of the game.
And, although I understood the sense of this, the challenge for me was how to bring all these different aspects of modern Internet Marketing together without a technical team or having an IT degree! You had to find solutions like how to deliver video content without without overwhelming your web host service provider (they don’t appreciate a ‘meltdown’ when you get high numbers wanting to take a look at the same time!) Then there’s organising forum style websites (I appreciate WordPress is a good starting point); setting up a support helpdesk for answering questions and, of course, making sure you (or your IT team) are not completely tied up maintaining it all!
And then there’s the cost to put all this together…
That was – until now.
Have you heard of Kajabi? No? Neither had I until the end of last week.
It is a complete content / marketing platform that delivers all the elements – and more – that I mentioned above. I’ve taken a close look and I have to say I’m impressed. It makes marketing your business with the latest technology stunningly easy and – amazingly – inexpensive! It really is set to be an affordable solution for any business, regardless of size. (That’s what I discovered when I took a ‘peek behind the scenes’! )
So I plan to grab it, just as soon as it goes live (14th Oct is the scheduled date).
Actually my little rambling here doesn’t do it justice. You can check it out for yourself, without even giving your email address for ‘more information’, check the video introduction at Kajabi Stuns
If nothing else it is a great case study of how to promote your business with a video. Then get the free 30-page report that reveals:
- The 4 Fatal Frustrations that lead to crippling inaction or downright failure in a business…
- How to conquer the 4 Fundamental Forces that shape a business from outside…
- The 4 Pre-Flight Factors that help build a better business that can be taken to the “next level”…
Collect the report at The Need For N.I.C.E.
Even if the Kajabi platform is not for you, I think you’ll find some interesting, thought-provoking points in the video and report.
P.S. Those links above are affiliate links – that’s how I got the sneak preview on content and price!
P.P.S Some of the high-players on the Internet have beta tested the Kajabi platform and, as a result, I’ve experienced it as an end-user and it certainly delivers all it promises. Take a look at it: Kajabi
~ Carol Bentley
I read a lot of different blogs to get ideas from other professional copywriters and marketers. Clayton Makepeace is one I like to follow, especially because he has some very good guest writers. Bob Bly recently posted a great article on there called ‘The 12 Most Common Direct Mail Mistakes … and How to Avoid Them’.
You can read the post at 12 Mistakes To Avoid
Every one of those mistakes he describes is spot-on. And each is relevant to both commercial and business audiences. However, I do think that number 11 needs updating…
Mistake No. 11: Failing to appeal to all five senses.
He suggests using other media to reach your audience, including audio-cassettes and video-cassettes. I would suggest replacing audio-cassettes with CDs and video-cassettes with DVDs.
But what else could you use to appeal to your audience’s audio and visual senses?
How about:
- Sending an MP3 player with your message recorded? The player could be branded with your company logo.
- An MP4 player, containing an exciting and informative video clip, might hit the spot for your prospect.
- A memory stick - again branded with your company logo – containing audio, video and a PDF delivering your sales message
- If your product or service is a very high value and you are OK with spending more, how about an Amazon Kindle with your full sales message as an MP3 and / or PDF? You could even gift a copy of a relevant book with it too.
What other, more modern, alternatives do you think are viable for appealing to these senses?
Share your ideas below.
~ Carol Bentley
If you get a personal email from a good friend who seems to be asking for your help, you would respond – wouldn’t you? And maybe it would not occur to you that the email didn’t actually originate from where it was supposed to.
Perry Marshall had that experience and he nearly fell for it – he described it as The Cleverest Email Scam.
You can see what he’s talking about at Perry nearly fell for this
We all know about other email scams from ‘messages from your online bank’ to the ‘Nigerian Minister’ to your ‘unexpected inheritance’, but this one really does sneak up on you, so please be vigilant.
~ Carol Bentley
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