Why you’re not spending enough to acquire customers

By Jordan Elkind , written on May 9, 2013

From The News Desk

Bottom line, you’re not spending enough on customer acquisition.

This might seem a bold claim. After all, with competition increasing as the e-commerce market tops $200 billion, marketing managers are finding it more and more expensive to acquire customers. As a result, many are trying to minimize cost pre acquisition (CPA). This is a bad idea.

The reason that online retailers systematically under-spend on new customer acquisition is because they’re treating them like a short-term splurge when they’re often more valuable to a brand than its other balance sheet assets. They should be viewed as an investment, and the single most important concept in managing that investment is customer lifetime value (CLV).

CLV refers to all of the future profit a company expects to earn from a customer throughout his or her lifetime. It’s a deceptively simple concept, but one that has the ability to transform your company’s mindset and significantly boost your return on investment.

CPA, CLV, ROI – sorry for the acronym stew. I promise that’s all of them. And they don’t gunk up the writing like “customer lifetime value,” etc.

Shifting from cost to value

The term CLV might conjure up business school jargon or dusty marketing textbook formulas but the idea itself is straightforward and powerful. To effectively manage your business, you need to understand what your customers are worth -- not just today, but over the long term.

Think of your customer base as an investment portfolio. Like stocks or bonds, each of your customers had an upfront cost to acquire and each has an expected future cash flow. Your job, similar to that of an investment manager, is to maximize your overall return on investment. And making acquisition decisions to minimize CPA is like loading up on penny stocks. Sure, it allows you to scoop up the maximum number of shares today. But from a return-maximizing perspective, you’d be better off investing in stocks with long-term growth potential even if they cost hundreds of dollars a share.

The same holds for customers. In the short term, minimizing acquisition costs can help a company hit new customer acquisition goals and grease its bottom line. But regardless of your industry, you probably want to keep your customers around after their first purchase. This means that companies should consider all of the future value they will get from their customers before deciding how much to spend on acquisition — and which customers they want to target.

Any company that doesn’t view customers as a long-term investment is effectively leaving money on the table. Let’s say a retailer is seeking a 25% ROI on its display ad campaigns but only looking at a customer’s first purchase. If the average first-transaction profit is $50 per customer the company would be willing to spend up to $40 per customer. If it were to look at all the profit it expects to earn over this customer’s lifetime, it should be willing to spend several times that amount and still meet its required rate of return!

Putting CLV to work

So, now that we have a firmer grasp on CLV, how can your company use it to maximize your return on new customer acquisition? Here are three key takeaways:

  • Look beyond short-term metrics. As we’ve seen, minimizing CPA can lead to under-investment in customer acquisition. This doesn’t mean you have to forecast your customers’ cash flows until the end of time. Instead, pick a timeframe that represents your company’s realistic expectation of when you need recoup an investment in customer acquisition. For a cash-starved startup, this might be a period of 6 months. For a stable, established retailer, it might be five years or more.
  • Savor the differences. It’s important to know the lifetime value of your “average” customer...but not enough. The most impactful acquisition decisions aren’t based on the average customer. They’re based on an evaluation of performance across channel, affiliates, advertising networks, adwords, and social media campaigns — each of which attracts a different kind of customer. Identifying the lifetime value of each kind can help you make the savviest decision possible about where you want to spend your next marketing dollar.
  • Make CLV part of the conversation. It can be difficult for traditionally product-focused retailers to shift to a more customer-centric mindset. Make sure to get buy-in not just from the marketing team, but also from cross-functional partners like IT and finance. This will help you ensure that you are capturing all the data you need in order to track long-term value, and that you have the support you need to turn insight into action.
Ultimately, CLV is an essential tool in the marketer’s toolkit. Whether you use your own historical data or rely on more complex statistical models, using CLV can help you figure out how much your customers are worth - and make the best investments for the long-term.

[Image courtesy Dell's Official Flickr Page]