Time for DTCs to Get Serious About CLV
Direct to consumer (DTC) brands and small businesses are facing challenging times. Costs continue to rise due to ongoing supply chain issues and increased advertising prices coupled with the loss of reliable measurement for their customer acquisition channels due to privacy protections. Now more than ever, it is critical that brands focus their efforts and investments on maximizing the value of their customers.
A key step is to understand the right customers for your brand, which products they are really interested in, and what messages engage them. Not all customers are equally valuable – finding more of the right ones and fewer of the wrong ones can have substantial positive effects on the business.
Customer Lifetime Value (CLV)
Customer lifetime value is the estimated revenue that a business will generate from a customer, over their entire relationship – i.e. their “lifetime” with the company. CLV is arguably the most important metric for all businesses to measure. Yes, it determines how valuable each customer is to your business, but it is also a measure of how valuable your business, product or service is to your customers.
High CLVs can be an indication of a loyal customer base, with high retention and a higher potential to be advocates (although advocacy is not typically calculated in CLV). While underperforming CLV can mean… well those customers want a different product or service.
Sample CLV Calculation
Let’s say an imaginary company, Ice Cream Trux (aka- The Dollar Shave club for ice cream) sells a 3 month ice cream subscription to customers for $200 with an auto renew. Let’s say that on average customers stay 1 year and then cancel. In that case, Ice Cream Trux’s average CLV across its customer base is $800 ($200 x 4 x 1= $800).
Per this example, if the company’s CLV were to increase or decrease over time – that would be a signal to the owner that they are doing something very right or something very wrong, and can then take action either way.
Benefits of using CLV metric
- Easy way to gauge business performance when comparing your CLV to your customer acquisition or marketing cost
- Good metric to test and measure tactics (e.g. marketing, retention, merchandising, etc) against
- Good attribute to segment your customers to focus your retention strategies and acquisition strategies
Managing CLV to CAC
Since we all can’t be like Tesla and grow to unicorn status without advertising, DTCs have to spend money to acquire customers. The metric to measure these costs is what is referred to as CAC (Customer acquisition cost). CAC includes all expenses incurred by the company to acquire new customers, i.e. sales and marketing staff, paid advertising, agency fees, etc. In measuring this metric it is very important to segment your marketing costs into new customer acquisition costs versus retention costs.
Back to our example, Ice Cream Trux. Imagine the company spent $400,000 in marketing and agency expenses in a year to acquire 2,000 new customers. Their CAC would be $200 ($400,000 / 2,000 = $200). So while Ice Cream Trux is spending $200 to get a customer and getting $200 on their first order, they have a CLV/CAC ratio of 4:1 and so this is a great business but they are going to need to manage their cash flow and may need working capital to grow the business!
A next level analysis can subtract the cost of retaining customers, delivering to customers, from the Lifetime value. This would move the analysis to a Customer Lifetime Contribution Value which in the ice cream example would subtract off the cost of the ice cream and the cost of any promotional advertising that was used to get the customer to buy four times. Incorporating this result with marketing costs gives the company a metric that is useful in predicting gross profits over time.
Getting down to the segment
While these averages across the customer base are easy to compute and are necessary for running the business, companies have to dig deeper to focus and grow the business. If Ice Cream Trux engages with Zeenk to build an individual CLV and CAC model they might find that customers who live in one region and tend to place larger family sized orders, have an LTV of $1400 with a $300 CAC. While they are more expensive to acquire, these customers have a better 4.7:1 CLV to CAC ratio and so are better customers than the average. Further, they might find that this group represents 20% of the company’s total revenue.
The implication for the business is that offer and promotional mix should be created to focus on growing this segment and then measuring how this segment is growing as a proportion of the company’s total business. As this segment grows, the overall average CLV to CAC ratio for the business will improve and the company will have more free cash to invest in growing the business.
Predicting Individual CLV
It’s important to remember that your customers do not equal your acquisition channels. So optimizing your CLV means more than just optimizing your advertising strategy and focusing on return on ad spend. Customers have needs that different products in your mix are satisfying and the needs are going to resonate with different marketing messages and product offers. Segmenting your customers through the lens of CLV to CAC and then looking at the products, locations, timing, lifestyle, interests, and messages for those consumers can have a significant impact on your business.
If modeled correctly and expediently, each of these attributes can help product teams predict future purchase behavior, retention and CLV and then segment the customer base to improve the business. At Zeenk, we are pioneering this individual level customer centric approach to understanding customer engagement with your brand and product mix.