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Understanding the True Value of Your Customers

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Top executives are under an increasing amount of pressure from demanding shareholders to take company profits to new heights. In a desperate search for additional revenue opportunities, most executives dismiss their website as practical solution for increasing company sales and a vital tool for increasing their customer’s lifetime value (LTV). Even worse, those that do understand this opportunity often leave the planning and strategizing to designers, developers, and search engine optimizers, who rarely come with the expertise necessary to manage these types of projects. Because of the depth of knowledge these campaigns require, they’re best left to individuals with a lot of experience, plenty of business acumen, and a reasonable amount of common sense. These individuals have to understand how to increase the percentage of customers who make repurchases and refer other individuals, how to de-commoditize the company’s products and services, and how to effectively implement concurrent cross selling and up selling strategies. This can leave even the smartest executives scratching their heads, wondering why the website’s not performing as expected.

This article outlines a process to incorporate “Conversion Value Maximization” techniques into your website and marketing strategy that will ultimately (1) generate more value from every customer interaction; (2) increase both the number and frequency of customer repurchases; and (3) incentivize customers to mention your products and services to others (aka: word-of-mouth advertising)

“A Rose By Any Other Name…”

In William Shakespeare’s play Romeo and Juliet, Romeo states, “a rose by any other name would smell as sweet.” Shakespeare includes this line to suggest that more than one word or phrase can be used to describe the same thing without changing its nature. This is also true of the words and phrases used to describe the process of increasing customer LTV. At Netmark, you’ll hear us refer to this process as “Conversion Value Maximization,” or sometimes “CVM” for short. Regardless of the name we use, we’re referring to the processes and techniques we use to generate additional value from visitors that make certain, predefined commitments while visiting a website.

Don’t Know Your Customer’s LTV?

Next to your website’s conversion rate, your customer’s LTV may be the second most important number to know in 2012.  We will explain why it’s so important that C-Level executives know this number in just a minute.  But first, if you don’t know your customer’s LTV, Netmark has created five formulas you can use to calculate this important number:

(1) The quick and dirty formula (requires minimal information, and is the most conservative estimate of your customer’s LTV):

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(2) If you know your customer’s repurchase rate (the % of customers who repurchase from your company) and referral rate (the % of customers who refer others to your company that make purchases), you can incorporate these values into your customer’s LTV: 

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(3) If you know your customer’s lifespan (as measured in months) and purchase frequency (as measured by the average number of annual customer purchases), you can calculate an even more precise customer LTV: 

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WARNING! We’re going 100% geek now. We’ll now include time value of money theory into our LTV formula. Netmark has never before shared these formulas with the general public. You should STOP reading if your brain is already fried! 

(4) If you know your desired rate of return, you can calculate the net present value of a customer’s LTV:

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(5) And finally, if you know your customer’s referral frequency (as measured by the average number of annual customer referrals), you can calculate an even more accurate customer LTV:

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The variation of formula #5 provided above assumes the customer’s referral frequency = the customer’s repurchase frequency.

Formula Key:

  • CM: Contribution Margin Per Customer Purchase
  • RPR: Customer Repurchase Rate
  • RR: Customer Referral Rate
  • AP: Annual Customer Purchases
  • CL: Customer Lifespan (measured in months)
  • DRR: Desired Annual Rate of Return
  • LTV: Lifetime Value

It should be clear that the more you know, the more accurate your LTV estimate will be. Please note that these formulas make certain broad assumptions about your customers and their buying behavior.  It’s important that you adapt these formulas to your own company in order to get an accurate customer LTV. It’s also important to consider your cash flow timing when forecasting a customer’s acquisition cost against LTV.

Why is Customer LTV So Important?

So why is customer LTV so important? For starters, it establishes a company’s break-even amount for acquiring a single new customer. Coupled with a website’s conversion rate, it also establishes a company’s break-even amount for acquiring a single new website visitor. Let’s do an example to illustrate this point.

Let’s say we form a company that sells widgets with the following information provided:

Contribution Margin per Purchase: $60.00

Customer Repurchase Rate: 20%

Customer Referral Rate: 10%

Website Conversion Rate: 2.5%

Using this information, and formula #2 from above, we estimate a customer LTV of $83.33. Now let’s go one step further and calculate a website visitor’s LTV. To solve for this number, multiply the customer’s LTV ($83.33) by the website’s conversion rate (2.5%). We now have an estimated visitor LTV of $2.08. We’ve just established our spending limits for new customers and website visitors, $83.33 and $2.08 respectively.  This means we can’t spend more than $2.08 to attract a website visitor and $83.33 to attract a customer.  This is pretty important stuff to know, right?

Now here’s the catch: In order to your spending limits, you will either need to improve your website’s conversion rate or increase your customer’s LTV, or both. In this article we’ll stay focused on customer LTV. For conversion rate strategies, refer back to the article we wrote for the summer 2012 edition of Visibility Magazine.

CVM Requires a Change in Mindset

Conversion value maximization (CVM) strategies are not so much about getting the first sale, as they are about maximizing the value of a website visitor after making a certain, predefined commitment. For this article, we’ll refer to this commitment as a “sale” and those making this commitment as “customers.” It’s important to note that some CVM strategies can have an immediately impact on a customer’s value, while others can have an impact well into the future.

Most companies we see today seem to have a culture that celebrates the first sale as a onetime victory. Once the sale is “closed” it’s onto the next person. This type of thinking can severally limit a company’s potential revenue and shows a lack of understanding of how revenue is generated for most companies. The first sale is really just the beginning. It’s a means to an end, but not the end itself—not even close. The first sale is an information-gathering opportunity to help you better position your products or services for future engagements with your customer. You’ve probably seen several e-commerce websites do this in order to make purchase recommendations during checkout. By leveraging the information collected during a visit to their website, these company’s are able to make smart recommendations to customers in hopes of increasing their website’s revenue-per-transaction.

Are you using the information you collect from visitors to create value in a similar way? Are you gathering the right information during a visitor’s first engagement to ensure you are better positioned in the future? If not, we recommend you first create a process to collect this information before moving on to the following CVM strategies.

The Ten “R’s” of CVM

Once you have the right information gathered, you’ll need a strategy to increase your customer’s LTV. Below are 10 techniques we use to generate more value from customers. We recommend you seriously consider each point if your company hasn’t already implemented a similar strategy.

#1: Develop a Remarketing Strategy

Meet with you top salesperson, your fulfillment department, and your front line customer service teams. Determine which techniques most effectively bring customers back to your website.

#2: Increase the Amount of Revenue-Per-Transaction

“Cross selling” (proactively selling complimentary products or accessories in conjunction with an initial purchase) and “up selling” (persuading customers to spend more for a higher valued product or service) are two effective ways to do this.

#3: Incentivize Customer Repurchases

There are several ways to incentivize customers to purchase again.  As shown in the formulas above, we measure two specific repurchase metrics:

  1. The percentage of overall customers that repurchase products or services.
  2. The total number, or frequency, of purchases made by those same customers.

Repurchases naturally increase by reinforcing the customer’s reasoning behind their initial purchase and by reigniting the emotion created during the initial purchase.

#4: Increase Customer Referrals

Everyone knows that customer referrals are the highest qualified leads you can get. Why not incentivize customers to refer individuals back to your company as well as increase the frequency they do so, both online and offline?

#5: Improve Customer Retention Rates

Globalization has turned most products and services into commodities. No company is free of competition or price comparisons. So how do you combat this issue if you’re not the low cost leader? Without a patent, you can’t normally “de-commoditize” a product or service very effectively. By comparison, it’s easy to “de-commoditize” a customer RELATIONSHIP. This is usually done by increasing the value you offer customers by providing customized “relationship builders” that set your company apart.

#6: Remove Purchasing Barriers

Avoid tying the hands of your customers at all costs. Here are a couple of words to think about: OPTIONS, CHOICES, FLEXIBILITY, and VARIETY. Do you offer multiple solutions to help solve a customer’s problem, or does your company think everyone else should adapt to the one solution you offer? What about purchasing terms? These are just a few things to think about.

#7: Increase Requests for Information

A lot of companies don’t know how to collect information from their customers. We’ve found that this can be most effectively accomplished through customer engagement. Do you regularly communicate with your customers? Are you able to collect meaningful information as a result of those communications? Are you using that information to improve your customer’s LTV?

#8: Reaffirm Original Decision to Buy

Make your customers glad they purchased from your company. Has your company been honored with an industry award recently? Has an employee been interviewed or spotlighted in the news? Sharing this type of information reaffirms your customer’s original “buy decision” and builds trust for the future.

#9: Reevaluate Price Points

A different price point for a particular product or service can have either a positive or negative effect on company profits. Have you tried different price points on your products and services? If so, did you measure the overall impact on your company’s profits?

#10: Reassess Your Conversion Value Maximization Strategy

As they say, “There is nothing as constant as change”. Your industry, products, or services might cause you to reassess your CVM strategy regularly. Reviewing what you’re doing, how it’s working, making changes, and tracking the effect of those changes will ensure that your company continues to thrive and grow.

With Awareness Comes Change

Most executives don’t have the luxury of coasting along without worrying about increasing profits and shareholder value. On the contrary, many executives are under more pressure now than ever before to keep these numbers rising. We’d like to encourage everyone not to underestimate the impact of conversion rate optimization and conversion value maximization. These two marketing methods can have a big impact on profits and shareholder value. By treating the first sale as an opportunity to collect information from your customer, you can begin formulating a strategy that leads to additional revenue and profits through future engagements. This is a paradigm shift for most companies. It requires the IT staff to quit thinking like an IT staff, and start thinking like the company owners. If you can successfully change this mindset, it will help your company to create and follow what we think are very common sense strategies that regularly lead a lot of companies to be very successful.

Terry Hansen and Josh Dalton consult with companies all over the world to improve customer lifetime value.

See us in Visibility Magazine!

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