To profitably grow a business, you need to invest the right amount in prospecting. But what is that right amount? It varies by company based on several factors including sales goals, profitability targets, short- and long-term strategic plans, and how customer lifetime value (LTV) compares with acquisition costs.
The LTV equation
Many companies struggle to calculate the customer lifetime value; they feel they do not have visibility to every sale, return, and marketing and fulfillment cost for each buyer. Happily, the reality is that you can calculate an LTV to use as a yardstick to guide decision-making in the right direction.
This LTV is actually a 12-month “lifetime” value. That sounds like an oxymoron, but in this day and time, companies need to get a return on their investment within 12 months. If you strategically decides to invest further out, then you could calculate LTV for two years or more.
To determine the 12-month LTV, start with segmentation, mailing strategy, and matchback results. While using discrete time frames in segmentation, such as January-March 2006 makes for the easiest and most accurate quick LTV calculation, you can also get there with rolling frequency segmentation, such as the more traditional 0 to three-month recency.
By using segmentation, you can calculate the number of 12-month buyers. The mailing strategy will provide number of contacts and overall marketing costs for each segment, and the matchback analysis will provide gross sales by segment. By adding those for a 12-month period, you will have calculated gross sales. Simply factor in returns and cancels as a percentage of sales, as well as cost of goods, and fulfillment costs also as a percentage of goods. Fulfillment costs should include any costs associated with taking and fulfilling the orders, including customer service, phone expenses, and pick, pack, and shipping costs.
The quick reference 12-month lifetime value formula is:
(Matchback sales results for 12-month buyers) minus (returns and cancels) minus (cost of goods) minus (marketing costs) minus (fulfillment costs) divided by (number of 12-month buyers)
This yardstick will provide a frame of reference for how much your business can afford to invest in prospecting to at least break even in the next 12 months. But that still doesn’t answer the question of how much prospecting is the right amount. Now a quick calculation on acquisition cost should be done.
Calculating acquisition costs
To determine the cost of acquisition, again start with the prospecting mailing strategy and matchback results. By calculating the total prospecting quantity and cost per catalog, you can determine the total marketing cost. The matchback analysis will provide gross sales by list.
At the same time, by calculating the total number of orders from the prospecting list, you can determine the number of buyers acquired. You can use the same figures for returns and cancels as a percentage of sales, as well as cost of goods and fulfillment costs that you used in determining the 12-month LTV.
The quick reference acquisition costs formula is:
(Matchback sales results for 12 months of prospecting) minus (returns and cancels) minus (cost of goods) minus (marketing costs) minus (fulfillment costs) divided by (number of new 12-month buyer)
Putting it together
To profitably grow a business, a typical company must maintain a robust 12-month house file. This is where the bulk of the sales and profits will be generated. Customer attrition forces everyone to prospect, but to different degrees. By knowing the 12-month LTV and the current acquisition cost, you can determine whether your prospecting is as deep as is financially sound or if you should reduce your prospecting efforts.
For instance, if you have a 12-month LTV of $125, your prospecting can go pretty deep and still pay off by the end of the year. A mailer with a very low 12-month LTV of $35, however, must be very selective when prospecting.
Michelle Farabaugh is a partner with San Rafael, CA-based Lenser. She will be presenting “Maximizing Lifetime Value: The Promise of Multichannel Marketing” at MCM Live, a two-day intensive session presented by MULTICHANNEL MERCHANT, Oct. 5-6 in San Francisco. For more information on MCM Live, which explores the multichannel organization from the inside out and from the front end to the back, go to www.MCMLive.com.