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Customer Lifetime Value - Nice Idea or Critical Concept?
By: David Shepard, President David Shepard Associates, Inc
This article first appeared in Direct magazine
Let’s talk about Lifetime Value, why not, everyone else does. Lifetime Value even made it into InfoWorld, May 21st Edition, page 68, where one of their columnist’s replayed the “old saw” about the Manager who looked at his customer leaving the store and “envisioned him or her (I don’t know why he couldn’t tell the difference) walking out with $50,000 worth of groceries, which is what [he] expected the customer to buy during the life of the relationship”. The author used the above example to help describe “what the term CRM really means.”
Nice idea, great concept, now what? Was that customer really worth $50,000, and if so, what should the store manager be doing about it…perhaps he should build a database so that the surly teenager at the checkout counter doesn’t completely ignore him after he passes his loyalty card through a reader that has kept track of his lifetime-purchases-to-date and has predicted that unless he comes down with mad cow disease, from the meat he just purchased, he will come back on Saturday for a six pack of beer and some toilet paper…which helps explains why the beer and the toilet paper are kept in close proximity. (Readers not familiar with the groundbreaking beer & toilet paper study, conducted, I think, in the early 90’s by market researches using three-dimensional cubes, should look it up.)
So, to paraphrase Don Corleone in that great scene from Godfather I, how did we come to this? I think I know.
For as long as I can remember, which is pretty long, closed-loop direct marketers have recognized the concept of lifetime value but have argued, endlessly, about how far to carry the notion.
Here’s one reason why, it has to do with product managers and the product manager system. Suppose you’re a product manager responsible for the P&L of either: a book club, a music club, a catalog, an insurance product or a continuity program– all good examples of traditional, closed-loop direct marketing businesses. And, in your company there are other product managers responsible for other product lines.
Now let’s assume that you’re considering mailing to a list of 500,000 prospects that will yield 10,000 new customers at a cost-per-new-customer of $30.00, and that your best estimate of the present value of the resulting cash flow (for your product alone) is $28.00. Should you do the mailing? Obviously not.
Now, what if you’re told that the 10,000 new customers could be cross-promoted by 5 other product lines managed by other product managers (many of whom you personally dislike) each of whom will pull a profitable 2% response resulting in 1,000 new sales for the corporation– and from the corporations’ point of view making the entire promotion profitable. Should you do the mailing?
Well, at least the answer is no longer obvious and depends upon your point of view. If the product manager is still to be judged solely on the basis of her or her investment decisions, and if the product manager does not share in the incremental economic value generated by cross promotions, then the selfish practical answer is still no. Even though the correct answer from the corporations’ perspective is yes.
One possible solution, and one not too difficult to implement, would be to include in the product manager’s calculation of the present value of the proposed investment an appropriate allowance to reflect the present value of the names acquired, to the corporation, stemming from the use of the names by other product lines, as well as an allowance for expected list rental income.
This adjustment would allow the product manager to make the right corporate economic decision. At a minimum this solution should be considered before closing down a product line because it’s projected P&L –not including the value of its potential future income from other products within the corporation -- didn’t meet minimum requirements.
Another solution, theoretically superior but considerably more sophisticated and requiring some nifty database management and reporting skills would be to change the product line reporting system so that the transactions from cross-product promotions would appear on what I’ll call the “Customer P&L” of the (newly defined) Product/Customer Manager (PCM) that recruited the customer in the first place.
This method of reporting would drive home the significance of the lifetime value concept. It would also cause the PCM to be concerned with both the costs and the rewards of presenting his/her customers with complementary product and service offerings– in addition to the product to which the customer was initially attracted. Under this plan the problem of cannibalization would be eliminated, because a smart PCM (SPCM?) might choose to move one of his/her customers into another product line because their future contribution will appear on his/her “Customer P&L” – not on the P&L of the competing product manager.
So, where are we – Nice Idea or Critical Concept? I would say it’s both. Even in a business where measuring Lifetime Value is hopeless – not because of the business per se, but because the systems required to measure it are non-existent – it might make for a more customer friendly customer service – it might even cause you to replace your universally hated voice mail system with a live customer service rep. And, for those of us who are in a position to measure it, if knowing a potential customer’s true lifetime value would cause us to change our promotion decisions (for the better, of course) then it’s critical.