Marketing measurement performance is notoriously difficult. Were that not the case, the famous adage from John Wanamaker about not knowing which half of his advertising spend was wasted would not be cited in so many marketing texts. Given that measurement is hard to do – and getting harder with many of the changes taking place related to tracking and privacy – it is interesting that marketers are increasingly being asked to prove the value of their investments and activities.
CFOs or their delegates are often the gatekeepers on marketing dollars and are likely to want marketing data in a form that can easily be compared to data from other parts of the organization. As a result, marketers have become increasingly reliant on Return on Investment (ROI) as the metric of choice for communicating marketing performance. This metric, common to Finance, allows marketing investments to be stack ranked against investments in technology or infrastructure and makes annual planning and budget decisioning much easier at the top of the house.
The Challenges of ROI
While ROI can have value as a means of understanding whether or not marketing is working in the most general of terms, it has been my experience that organizations tend to consider it as a precise metric when, in fact, it usually isn’t. There are dozens of assumptions and caveats that go into the makeup of both the numerator (return) and the denominator (investment). I’ve seen the entire formula for Marketing ROI change from one organization to another. Some define ROI as Revenue/Investment while others define it as (Revenue-Investment)/Investment. Some companies define revenue as gross revenue; some define it as incremental gross revenue. Some organizations even have different definitions of ROI depending on channel. I have seen companies that hold Search programs to one ROI standard while holding other digital channels to another simply because Search tends to have better data. Simply stated – even in very disciplined organizations, ROI has some swags built in.
ROI also tends to over-emphasize both short-term returns and the immediate ‘pain’ of acquisition costs. I have worked in multiple organizations where, because of the way annual budgeting is done, the entire approach to customer acquisition was to sell as many units as possible (at an estimated return that was applied evenly across every unit) at the lowest possible cost per unit. This approach maximized ROI, helped us maintain our budgets year over year and, for the most part, kept everyone at the top of the house happy with the job we were doing in Marketing. In those environments, though the organizations knew (at least intuitively) that the value of every customer was not identical and, thus, should be thought of differently, the lifting required to make a move to a more meaningful metric was too hard and created too many complexities – so we simply stuck with what we had always done.
The Benefits of Customer Lifetime Value (CLTV)
Now, assuming the definitions and caveats are well documented and clearly communicated, I’m not saying that ROI as a metric should be completely abandoned. It’s useful for some of the comparisons and planning processes mentioned above. I also believe, however, that organizations would be better served to focus on CLTV as the true measure of marketing’s performance.
Before I state why I think CLTV is the superior measure, let me acknowledge that some of the limitations that I just cited as problems with ROI – assumption based, differing definitions across organizations, difficult to get precision – those can exist with CLTV as well. That said, if we can acknowledge that both are imperfect and imprecise, my belief is that the superior one is the one that allows me to at least move closer to what I intuitively know to be true – that all customers are not going to bring my organization the same value.
Assessing the long-term value different customers bring your organization requires more analytics horsepower than simply looking at ROI. CLTV requires looking at revenue over a specified period of time, often grouping customers into cohort groups (as doing true CLTV at the individual level would be virtually impossible) and implementing predictive modeling that forecasts how much a customer or group of customers will spend in the future based on historical buying behavior. It can also get much more specific and complex than that – looking at cross channel and even intra channel acquisition costs.
With that information at the ready, organizations can begin to re-orient their marketing spend to focus more on high-value customers and less on low-value or one-time customers. Rather than thinking about acquiring a lot of customers at the cheapest possible price, CLTV helps companies optimize acquisition spending based on the value each customer brings to the organization over time. Understanding that value – and how it differs across customer – is critical. It means that for some customers, the organization should be willing to spend far more in acquisition costs because of the value that customer will bring over time. That notion is simply lost in an ROI-only world.
Another major hurdle to implementing CLTV is the mental leap it requires organizations to make. It’s my experience that most companies have a hard time accepting significantly higher in-year acquisition costs – even if they mean more dollars coming in the door in future years. Budgeting and decisioning tends to be a same-year exercise and does not allow for that kind of flexibility – even if it ultimately drives the better outcome.
In the extreme case, consider Starbucks. A 2016 study found that the average CLTV of a Starbucks customer was a whopping $14,099. In that instance, Starbucks should be willing to pay thousands of dollars to acquire some customers. Very few organizations have an appetite for that kind of spend. Governance inside the organization would almost certainly dictate that marketing is better off spending $5 for a customer with an CLTV of $25 (5:1) rather than $1000 for a customer with an CLTV of $14,099 (14:1) – even though the math says otherwise.
CLTV is not the sole measure organizations need to use to measure performance or drive growth for the business. It is perhaps the most critical measure, however. Armed with an understanding of value over the life of the relationship will allow organizations to re-orient their marketing mix and focus spend where it’s most impactful. It may also require facing some inconvenient truths – that many of the tactics that are tried and true in your organization are no longer worth your time and investment. Unlike 100 years ago when John Wanamaker lacked the tools needed to understand which parts of marketing were working, today’s marketer may discover that, while they had tools for measuring marketing performance, they were measuring the wrong things.