by Trey Pruitt
Early in my career, I was working in a finance role at an e-commerce company. I had the following discussion with the head of customer acquisition.
Me: "What's up with all the new customers from partner X (a bargain website)?"
Marketing: "Yeah, we're getting a lot of traction there. That paid marketing program is important for us to hit our new-to-file customer acquisition targets."
Me: "Discounts for those customers seem pretty high." [concerned look on my face]
Marketing: "Well, we know that a customer is worth $100. And these customers are costing us $30 to acquire. That's 3x CLV [Customer Lifetime Value] to CAC [Customer Acquisition Cost] ratio. So we should be ok."
Me: "I'm worried that these are low-value customers. The discounts are significant and I'm guessing their repeat purchase rates will be low."
Marketing: [Shrugs]. "Maybe a little less valuable but it works out on average."
After the discussion, I thought: that can't be right. Those new customers from discount sites have to be worth significantly less than average because they receive incentives for first purchase (less margin) and they repeat less frequently in the future. I did a back-of-the-envelope calculation based on recent data which confirmed my intuition: these customers would likely generate less than half of the CLV of an "average" customer. That meant that contribution profit was barely covering the cost to acquire the customer, much less contributing to company overhead. Not a solid foundation for growth.
Two decades later, I still see companies using CLV as if all customers have roughly the same value. I am guessing that their "mental model" of the distribution of lifetime values across customers from worst to best looks like this:
The average customer lifetime value is $100. This is also the "typical" customer value (i.e., the median, or 50th percentile). Our best customers are worth about 20% more than average. Our worst customers are worth about 20% less than average. Our best customers are worth about 50% more than our worst customers.
My experience analyzing customer data over the last 20 years has taught me that the difference between the top 20% and bottom 20% of customers is HUGE. Much, much more than you might think.
The average customer lifetime value is $100. However, because our best customers generate a majority of profit, the "typical" customer value (i.e., the median, or 50th percentile) is about $55. Our best customers are worth 3x more than average and 6x more than the "typical" customer. Our worst customers are worth about 70% less than average. Our worst customers are worth about 10x less than our best customers.
If you are using CLV to guide decisions about how much to spend to acquire a customer, it's critical to understand the difference between high- and low-value customers. Not doing so means that you will overpay for low-value customers and miss opportunities to acquire more of your best customers.
For assistance with understanding your customer lifetime value, contact me.
