More on Customer Lifetime Value Modeling - Using LTV as a Marketing Strategy Tool

My two previous posts about LTV were more descriptive than prescriptive, let us take a look into how LTV can be used as a tool to drive Marketing Strategy at a high level.

Some notes:

• LTV is shared by Marketing, Finance and Treasury - Marketing is most likely owner of the metric and the one that will use it the most but Treasury can use it as a measure of risk and Finance is instrumental in calculating and updating the measure. Ron points out that Activity Based Costing should be used in the calculation of LTV, I agree but don't find it essential, a reasonably accurate knowledge of the margin associated with each sale is all that is required for implementing LTV.
• learn to live with losses - it is very likely that every company will always have some unprofitable customers; this means that you have to adjust your projections accordingly and:
• set your risk of losses to a realistic and objectively calculated LTV
• try and reduce the variability associated with the unprofitable customers

Looking at the plot of the previous post, we recognize that there are two areas under the bell curve: the one to the left of the y-axis that represents the probability of a customer being un-profitable and the one to the right that represents the likelihood of being profitable. Marketing Strategies strive to bring as much of the curve as possible into the positive domain (i.e. reduce the likelihood of having unprofitable customers), this can be accomplished by targeting the three customer LTV groups:

• target the unprofitable segment - the idea is to reduce un-profitability risk, and this can be accomplished in a variety of ways:
• change the product mix - eliminate configurations with lower margin as well as heavily discounted items, discontinue items with low inventory turns that are sold unbundled, etc.
• change the processes that support communication between the customers and the enterprise with a view to reducing the pool of unprofitable customers
• change the return policy - for instance, charge a re-stocking fee or reduce the return period
• change the policy for access to customer support - make it difficult for customers to "game the system", not to access your services and products
• target the profitable segment - this will shift the curve to the right by reducing the proportion of customers that fall in the unprofitable segment (i.e. shrink the ratio of unprofitable to profitable customers)
• acquire profitable customers - get more customers that actually drive your business to success, use clone modeling, any targeting process or gimmick but get more of these folks to buy from you
• change the product mix - same as above but try and cater to the tastes of these customers more that keeping an eye on the individual profitability of the products you sell
• increase the frequency and magnitude of purchases; for instance, increase up-sell and cross-sell - this can be as much a sale exercise as one of pricing, product configuration or even product re-design or service
• deploy a loyalty program that actively caters to this customer segment
• change you supply/value chain to allow for better product delivery and experience
• target marginally profitable customers - have them either fall in the un-profitable group or the profitable one

This list is not meant to be exhaustive but to give you an idea of how different tactics can be used to address the need to decrease the risk of customer unprofitability.

Comments

[Ron Shevlin]

"Ron points out that ABC should be used in the calculation of LTV, I agree but don't find it essential, a reasonably accurate knowledge of the margin associated with each sale is all that is required for implementing LTV."

I probably should have spent an extra 2 minutes and thought through my statement. Because the need for ABC depends on (at least) two factors: 1) the complexity of the sale, and 2) the degree of post-sale support and service required.

Since I tend to focus on financial services -- with extensive sales activity, and post-sale support -- I'm more inclined to believe ABC is a requirement. If your product is toothpaste, it may be a completely different story.