Understanding Life-Time-Value Analysis

by Stephen Lett

Very few catalogs can make money on first time buyers. The ultimate profitability of a new buyer depends on their Life-Time-Value (L-T-V). We tend to evaluate lists based on the first or initial sale. We compare the results against an incremental breakeven point and make a determination as to whether that particular list is going to be mailed again or not. We take a short-term view to a long-term opportunity. It is the value of that “new” name from a particular list over time that is important to a cataloger.

Life-Time-Value is the value of all of the purchases a given customer has made to-date plus the value of the purchases this same customer is likely to make (discounted for present value) over time. L-T-V helps you determine how much you can afford to invest for a new buyer looking beyond their initial purchase.  For example, you can afford to investment spend for a new buyer as long as it is less than the average lifetime profit per customer (including your buyer acquisition cost). This assumes, of course, that your cash flow is sufficient to handle this level of spending.  You are making a financial investment to acquire a new catalog buyer in hopes the payback will come in the future. How long you can afford to wait for the investment to payback depends on your financial situation and the payback opportunity itself. Generally, we feel the payback should come within one year.

Most likely, you will find that the Life-Time-Value of a new buyer depends on how they were acquired. For example, people who buy as a result of an event, i.e., sale or promotional offer, probably do not have the L-T-V of a new buyer who converts from a catalog request ad or from a rented list. There are also differences in the L-T-V from the different types of prospect lists, i.e., direct response lists, subscriber lists and compiled lists. The same could be true for first time Internet buyers. For these reasons, it is important to calculate the L-T-V of a buyer from different media, lists, offers, etc.

There is one factor needed in analyzing L-T-V which often creates an obstacle.  You need to know what your “contact” history has been with the group of customers you are analyzing. For example, initial results are easy to calculate. But, once you have the initial buyers, their repeat activity and therefore contact pattern will be as diverse as your house file segmentation. You won’t know how many catalogs you sent as follow up to their initial purchase. Therefore, if you want to know the L-T-V of a group of prospects you mailed three years ago the only way to really know how many catalogs you sent this group on average is to track your contact history. This is expensive and hard to recreate but an essential requirement when calculating L-T-V.

So, how can the average mailer track L-T-V? Usually, you can get the information you need to understand your payback and how much you are willing to invest by analyzing a prospect’s 12 month value. This assumes that all new buyers will get every mailing for a 12 month period, and takes the guess work out of subsequent mailing costs. It’s also a lot cheaper than maintaining contact history.

Below is a sample 12 Month Value analysis where we show the initial results and the 12 month repeat results rolled into an income statement. The left-hand columns show that we would need $1.31 per catalog mailed to breakeven on our initial mailing. For most of us, if we were to use this as the threshold for what to mail, we would cut out a large portion of our prospecting which would not necessarily be a good thing to do. This would have significant impact on our long term growth.

As you will see from the middle columns, our initial mailing resulted in a loss per customer of – ($14.45). However, after 12 months activity, we had a gain overall of $5.52 per customer. This shows that if we made this initial investment, we would make our money back in less than one year.  This is good news assuming we want to grow!

In the right-hand columns, we see what our initial results need to be to breakeven after 12 months. In this example, if we were to invest $19.97 per customer initially, we would breakeven after 12 months.

ABC Company - 12 Month Value Analysis
LETT Direct, Inc.
5/7/08
Initial Break Even   Sample 12 Month Value   12 Month Break Even
Circulation  20,000   Circulation  20,000   Circulation  20,000
Orders  309   Orders  230   Orders  210
Response rate 1.54%   Response rate 1.15%   Response rate 1.05%
A/O $85.00   A/O $85.00   A/O $85.00
$/Book $1.31   $/Book $0.98   $/Book $0.89
Demand $26,262.56   Demand $19,550.00   Demand $17,809.77
Net Sales (after ret./cancels) $23,636.31   Net Sales (after ret./cancels) $17,595.00   Net Sales (after ret./cancels) $16,028.80
Contributing Margin $12,999.97   Contributing Margin $9,677.25   Contributing Margin $8,815.84
Cost in the mail $13,000.00   Cost in the mail $13,000.00   Cost in the mail $13,000.00
Net ($0.03)   Net ($3,322.75)   Net ($4,184.16)
Profit/Customer ($0.00)   Profit/Customer ($14.45)   Initial Cost/Customer ($19.97)
               
      Repeat Results     Repeat Results  
      Repeat Circ  2,760   Repeat Circ  2,514
      Repeat Orders  152   Repeat Orders  138
      Response rate 5.50%   Response rate 5.50%
      Average order $85.00   Average order $85.00
      $/Book $4.68   $/Book $4.68
      Demand $12,903.00   Demand $11,754.45
      Net Sales (after ret./cancels) $11,612.70   Net Sales (after ret./cancels) $10,579.01
      Contributing Margin $6,386.99   Contributing Margin $5,818.45
      Cost in the mail $1,794.00   Cost in the mail $1,634.31
      Net $4,592.99   Net $4,184.14
               
      Net Initial + Repeat $1,270.24   Net Initial + Repeat ($0.02)
      12 MonthProfit/Customer $5.52   12 MonthProfit/Customer
Considered Breakeven
($0.00)
               
* Factors used:
Net after ret./cancels 90%, Contributing margin 55%, Cost in the mail $.65/book, 12 repeat mailings 1/month
 

Ideally, once again, you will want to break even within one year.  These sample charts are what you can use to determine roughly what your initial sales should be to meet your goals.  Ultimately, it is important to track the actual results for initial and 12 month subsequent activity to make sure that each list met these goals.

You will want to focus on reducing the payback period and on maximizing the Life-Time-Value of a new buyer especially during their first year. Here are a few ideas to consider:

  1. Make a special promotion to 1st time buyers. We like to refer to someone who purchases once as a buyer. Someone who purchases more than once is a customer. Include a bounce-back offer to first time buyers to encourage them to buy again in order to increase their L-T-V.
  2. Pack a “welcome new buyer” notice in their outgoing package. Make them feel special and let them know how much you appreciate having them as a new buyer. This will encourage them to buy again and again.
  3. Mail new first time buyers more often, at least initially. It is difficult to over mail your house file, especially first time buyers. Increase the frequency of mail drops to this group or to a portion of this group in order to encourage them to purchase.
  4. Use promotional offers to encourage buyers and customers who have not ordered for awhile to make a repeat purchase. If someone has not purchased for a 12 to 18 months or more, give them a special offer to encourage them to make another purchase.

Know where and how to prospect and know how much you can invest in a new buyer based on their L-T-V. Don’t just assume or hope the L-T-V will be there. Use promotional offers, add mailings, use bounce back offers, etc., to improve the L-T-V of your house file. Good marketers know they can have an affect on the L-T-V of their customers. Most importantly, take a long-term view with regard to the cost to acquire a new buyer.  Basing your mail vs. don’t mail decisions on initial results may not be enough.