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DETERMINING THE LIFETIME VALUE OF YOUR CUSTOMERS
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In last month's lesson, we explored how to calculate a budget for our first mailing. In order to get started, we determined our budget based on the break even point for that mailing.
As our mailings continue, however, we will want to take a more structured approach to calculating our direct marketing budget. In fact, rather than aiming to break even on our mailings, our goal will be to lose money.
Why? Because we should always lose money when we prospect. If we're not losing money when we prospect, we’re probably not prospecting effectively. And if we're not prospecting effectively, we're not growing our business.
That concept was drilled into me by my boss at Value Line. He would tell me: “You’re making too much money, Rosalie. You’re not spending enough. You’re not bringing in enough new customers to grow our business.”
What's It Worth To You?
But how do we know how much we should be paying for each new customer? In order to answer that question, we first need to know how much a new customer will be worth to our business over time. For this, we will use a calculation called the lifetime value of a customer. This value estimation will give us a much more accurate picture of what we can afford to spend in order to acquire that new customer.
The lifetime value of a customer is defined as the future value of a customer calculated at today's prices using net present value. It is the present value of a future contribution to overhead and profit that each customer is expected to bring in over its lifetime.
Database marketing is based on the concept of lifetime value. Lifetime value is a practical technique for determining the effectiveness of various marketing strategies. It can and should be applied to any marketing program for testing before a significant amount of money is spent. Before we act on our hunches or prejudices, we can always prove to ourselves, at least theoretically, whether a proposed program has a possibility of success (in fact, most of our clients, if they have a big enough customer file, will test their new offers extensively before they go out and rent names).
When we use lifetime value estimation as the foundation for our direct marketing efforts, our focus shifts from achieving a one-time transaction with a customer to building a relationship that will lead to multiple transactions over time.
Now let's look at an example. We will use a very straight-forward calculation based on current dollars to estimate the lifetime value of a subscriber to a publication. We shouldn't take into account inflation, cost-of-funds or any other future value -- we'll just use today’s dollars. We will use a publication as our example because it presents a straight-forward approach to lifetime value. If we were to use a cataloger as an example, it would make our calculations much more complicated. So keep in mind that our goal here is to teach you the "process" of calculating lifetime value.
OK. Let's go on to the example! |
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