More and more profitability is being discussed within the affiliate marketing industry.  Incremental sales, new customer acquisition, cart sniping etc, these all are concepts that advertisers are now very aware of and requiring their affiliate managers to know, manage and develop strategies for.  They are also looking at Customer Lifetime Value.

The old way to evaluate the success of a given channel, especially the affiliate channel, was to subtract the cost of the channel from the revenue of the channel.  It’s pretty basic.  But the way that customer can engage in multiple channels and the potential for costs to be higher to acquire a customer if these things are not managed, as well as a general poor reputation of this channel for driving sales that “would have existed anyway”, has prompted JEB, as well as our clients and other advertisers, to dig deeper into the value of their affiliate partners.  One way to do that is to look at the  Lifetime Value of the customers that the channel and each partner is bringing to the table.

What’s Customer Lifetime Value?  I bet you are pretty sure what it is, but it’s best at this point to give you a primer that not only works in our industry, but across the board.

An Introduction to Customer Lifetime Value

Customer Lifetime Value is a simple concept (really). But, it suddenly gets complex as you dive into specific figures and equations that change it from a mere concept to a reality capable of boosting your company’s ability to anticipate future customer interactions – both profitable and unprofitable.  It allows you to value the customers from one marketing channel vs. another and gives you much needed insight into where to focus your marketing and sales budgets.  The higher Customer Lifetime Value channel should get more budget, engagement and resources.

When introduced to the idea of Customer Lifetime Value, abbreviated CLTV or CLV, different organizations have different measurements.  I thought about providing you with exact formulas here, but it varies so differently that I felt it best to say that CLV is equal to the dollar value of that customer over their life of engagement with you.

Do you use top line revenue as the metric?  Number of orders?  Margin contribution of that customer over their lifetime with you?  These are all questions you’ll need to answer.  I prefer top line revenue, it’s easy to back out your costs from that number and easy to compare it across channels.

A short-term example of CLV would be a diaper company. If you consider the baby to be the customer, a diaper manufacturer can reasonably expect the customer lifetime value to be calculated at a length of two or two and a half years.

A long term example is an automobile manufacturer. They might calculate a customer’s lifetime value in terms of the length of time the consumer is expected to be driving – perhaps as long as 60 years from the first vehicle purchase to their final vehicle purchase.

Those are both the anticipated lifetime period that those customers can be customers of your company.  Your may find that your lifetime of customers is x” number of years, or simply as long as they are purchasing.  Knowing the length of time you consider to be a “lifetime” is important when factoring the value of your customers.

Robert Blattberg, co-author of a study on Customer Lifetime Value and Professor of Marketing at the Kellogg School of Management, said, “Companies are focused on rewarding the best customers, because they think they’ll continue to be the best customers.”

Companies use discretionary marketing investments out of the belief that yesterday’s good customer will also be tomorrow’s good customer. Airlines may give seating priority, cruise lines may give complimentary room upgrades, credit card companies may waive fees…all under the expectation that if a consumer was a good customer in the past, he or she will continue to be a good customer forever. They look at the channels that provide the best LTV and direct their budgets accordingly, or at least use this information to determine their marketing mix spend.  But, this is not always the case.

A Disclaimer

In fact, even with the best prediction model based upon the Blattberg-Malthouse study, which encompassed more than 272,000 consumers over the course of up to 12 years, and gathered data related to length of contract, amount of service usage, date, price, type and value of purchases still showed a 25% false positive or false negative rate for whether or not a high-value customer would continue to be one or if a low-value customer would continue to be one. However, despite the necessary flaws inherent in attempting to predict the future of a customer’s relationship with your business, the numbers from the Blattberg-Malthouse study are valuable in anticipating risk.

LTV Is Immensely Valuable

When companies are able to attain a 60-75% accuracy rate on anticipating Customer Lifetime Value, they are better-able to target their marketing efforts and perks. A company will also be able to more accurately judge the risk to its profits when it offers incentives to increase customer satisfaction. The company can evaluate:

• the cost of giving the perk
• the cost of alienating customers by not giving perks to those who deserve them
• the extra profit gained from loyal customers who received perks
• the extra profit gained from customers who didn’t deserve perks but received them anyway

Customer Lifetime Value is a function of four key metrics:

1. the total margin generated from the consumer base in a given period
2. the percentage of customers who do not buy in the following period
3. the acquisition cost of a new customer
4. the retention cost of a current customer

It is useful for forecasting remaining customer lifetime, future revenues, costs, and the net present value of future profits. Successful analysis of CLV provides good information and gives you an idea of how much money a company would require if it took external investment, how long it would take to turn a business profit, and how much cash a company would need and how quickly it would use that money (burn rate).

When a marketing manager evaluates and explains CLV to executives, it becomes easier to justify marketing efforts that will maximize customers’ lifetime value based upon predictable datasets. Armed with this data, marketing staff can increase the effective value of both advertising for new customers and incentive rewards plans for current customers in order to ensure more money goes to where it will achieve the best possible positive, targeted results instead of being wasted on people who will likely never become high-value customers.

A savvy business owner or manager knows that not all customers are alike, so it doesn’t make any sense to treat them that way. Marketing teams can use CLV to divide customers into groups not just by demographics and psychographics, but also by their value to the company. This allows the company to serve high-value and likely high-value customers with promotions and incentives designed to boost profitability, decreasing the attrition rate of these consumers while recognizing and anticipating the possibility of losing low-value customers.

Harvard Business School Publishing has made an excellent CLV calculator available here: http://hbsp.harvard.edu/multimedia/flashtools/cltv/. This tool allows you to view example lifetime values, as well as enter data from your company’s own analysis of its customers, profits, and costs. The tool allows calculation out to six years and accounts for multiple factors, including the unpredictability of future customer interactions by including an annual discount rate.

This discount rate operates under the reality that future profits are not guaranteed until the money is in-hand and therefore any prediction of those profits is of lower value the further out the equation is carried. Dollars received 10 years from now cannot be fully counted upon, and thus must be discounted further than dollars received five years from now, which must be discounted further than dollars received one year from now. Taking this factor into account makes the Harvard calculator a very powerful tool in analyzing customer lifetime value.

Customer Lifetime Value is a very simple concept that can have powerful results in attracting and retaining high value, long term customers and getting the most bang for your marketing buck. While the data gathering and formulas become complex, CLV is a worthwhile pursuit in order to attain the best possible business results. It is a tool that established businesses can use to refocus their rewards/incentive programs and that startups can use to attract investors by giving accurate projections on needed investments and future profits. Pursuing CLV is a advisable pursuit for any business that wants to maximize the potential of money invested in both customer acquisition and customer retention.

While CLV can be a key component of any marketing plan, it may factor more heavily in some businesses than others. For example, a company that mass-produces packaged goods like candy may have a broad consumer base for which the buy-in is low and retention rate or brand loyalty does not matter as much as for other businesses. Yet for a company, like an airline, which hopes to provide a high-cost service over a number of years will need to have a robust understanding and implementation of a marketing plan based upon CLV where rewards and incentives such as frequent flier miles and high-quality customer service are vital to converting and retaining customers.

No matter where your company stands on the scale of need for CLV analysis, it is important to have a complete understanding of the concept and to know where and how heavily it fits into your future marketing plans.

What does this mean to affiliate marketers?

Have you heard things such as:

  • Affiliates are only taking credit for sales that already happen.
  • I can’t justify my spend in this channel?
  • I don’t know if the affiliate program is profitable.
  • It’s all coupon sites and they just steal my sales.
  • Affiliates are just taking credit for what my SEM agency is driving.

I’ve heard those as well.  So, what this means is that you will be armed with better data to show the actual value of the affiliate channel, or if you are an affiliate, you can show the value of these customers to your merchant partners.  For too long the affiliate industry has not tackle the issue of attribution and profitability.  We have to now, from all sides – networks, affiliates, advertisers and agencies.  And being armed with this data means different things for different groups.

Affiliate Managers:

  • You’ll be able to see a much better picture of the true value of your entire channel.
  • You’ll be able to see which affiliate partners are driving greater value over time and spend your resources and budget with those partners
  • You’ll have better insight into the customers that are coming through your channel and can create promotions to encourage the good to do more and the bad to get crackin’.
  • You may find that things are better than expected, right in line or way below expectations.  Either way, it will be much better to know where you stand than proceeding with little quantitative back up.

Affiliates:

It will be difficult for you to get a lot of this data, but your top notch partners should be willing to work with you to get this.  It will most likely play a role in negotiating commissions, placement and your partnership in general.  Knowing the true value of the customers you send to clients will also help you fight the above questions that so often come your way.  When you are armed with good data, you can help your merchant partners make great decisions.

Now what?

Many of the metrics we have encouraged you to look at over the years are often great ways to incentivize your affiliates to generate the type of customer acquisition you are looking for.  You can even develop commission schedules around them.  LTV is really not one of those.  It’s difficult to know the LTV of a customer who just walked through the day, and no one has the time to model that out for each newly engaged customer.

I do recommend you use this data to evaluate your channel and each individual partnership over time.  If LTV is high, spend your time and resources thee.  If that starts to drop off, you need to look at the way that partner is marketing you and your products and work with them to increase that number.

All of these things are ways for you to get a better handle on your programs performance and are things we work with our clients on each day.  If you’d like help, have questions or comments, please comment below or give us a call.  This is what we call a “big concept” that has huge potential to help you generate a profitable program today.

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