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• What is the value of your customer list—today and projected for the next three years?
• What does it cost to recruit or acquire a new customer? and
• What is your “payback” period—that is the time it takes for a new customer to become profitable?
These are critical measurements of the financial health of a company.
Let’s look at ways to value your customer list, and home in on the specific customer metric of lifetime value (LTV)—how to calculate it and use it in the day-to-day management of your business.
Putting a Value on Your Housefile
Most direct marketers will tell you their customer list is their most important asset. In this time of frequent mergers and acquisitions, understanding what assets a company has and putting a value on them is very important. Typically, a multichannel marketer has dollars tied up in inventory, equipment, furnishings, real estate and certainly the people who run the business. However, the real equity the investment community values is the housefile. Appraising your list of customers helps financial people estimate the overall value of your company.
If your housefile is such an important asset, how does your accountant put a value on it? Here are three methods of appraising the customer list.
The cost-replacement method.
Every catalog or Internet seller should know what it costs and what it can afford to spend to get a new customer—from rental lists, various Internet marketing efforts, space advertising, trade shows or a friend-get-a-friend referral campaign. By looking at the annual average cost to get a customer across all media, it’s simple to multiply that cost times the number of buyers and arrive at one method of putting a value on the customer list.
Example: Your company has 130,000 buyers and it costs you an average of $20 to acquire a customer. Therefore: 130,000 x $20 = $2.6 million customer list value.
To fine-tune this calculation, discount buyers who are more than a year old. (See the chart below.)
You also can calculate the cost to acquire customers by media. For example, you can summarize the cost of all the names coming from list rentals. Repeat the same process for buyers who came from space ads or search engines. This will produce a true, weighted average of what it costs to obtain a new customer. Incidentally, most marketers are looking for a “payback” from customers within 12 months.
List-rental value of the buyer file.
A second method of determining the value of the customer list is to calculate its list-rental potential over a two- or three-year period. Today’s list-rental business is extremely “hotline” oriented. Names older than 12 months have little list-rental potential.
The calculation is quite simple. Multiply the 12-month buyers times an average list-rental fee (let’s say $100 per thousand), then multiply that sum by the number of times your list manager can rent the names (sometimes referred to as annual list turns or annual turnover).
Example: Start with a total buyer list of 100,000. If half of those names are 12-month buyers, then 50,000 12-month buyers x $100/M x 20 list turns = $100,000 gross list rental income.
Generally, strong rental lists will turn their 12-month buyers file between 20 and 30 times a year. Approximately 60 percent of the gross list-rental income will become net profit contribution to the catalog’s bottom line. Here’s the breakdown:
100 percent list rental income =
• 20 percent - to the list broker
• 10 percent - to the list manager who promotes your list
• 10 percent - for list fulfillment
• 60 percent - contribution to profit.
Future buying potential method.
An alternative method is to look at the LTV of customers, or the future propensity of existing buyers to buy additional products from your company. This calculation assumes you’re tracking customers by original source code and maintaining buyer purchase history over time. Three years is a normal time to measure LTV. A simple calculation to determine future buying potential is shown in the LTV chart at right.
It’s easy to determine what the value of a customer is after year one, year two and year three by tracking customers via original source; following the promotions sent to each customer source grouping; and gauging resultant sales. The chart below illustrates the LTV calculation, which is the value today of future profits from a select group of customers.
Our hypothetical catalog has 1,000 customers from a specific source code it wants to track. Year No. 1 starts with 1,000 buyers who spend $500 each, or $500,000 in total sales. When the cost of goods (50 percent, or $250,000), fulfillment (12 percent, or $60,000) and advertising (25 percent, or $125,000) are subtracted from total sales, $65,000 is the remaining profit contribution. This represents a first-year LTV of $65 per customer.
Year No. 2 shows that 50 percent of the customers make purchases of $500 to generate sales of $250,000. From those total sales, cost of goods, fulfillment and advertising again is subtracted. What remains is $32,500. Also, a 20 percent cost of money or time value of money is shown in the chart to indicate that the catalog needed to borrow extra dollars to finance its selling effort. The true net present value profit is $27,083 or $27.08 for each of the original 1,000 customers. When the second year’s profit is added to the profit from year one, the cumulative LTV is $92.08.
Year No. 3 shows improvement in the percentage of people buying—300 customers or 60 percent. This year’s customers again spend $500. When cost of goods, fulfillment and advertising again is subtracted, $19,500 remains, which is further reduced for the time value of money. The net present value profit for year No. 3 is $13,542 or $13.54 for each original customer—a cumulative LTV of $105.63.
Completing the Valuation
The chart on page 35 shows an example of applying the LTV chart to each segment of your housefile. In this example, there are four customer segments and an inquiry/catalog requestor segment. This hypothetical example shows name counts for each segment and the declining name value of the segments over one year and three years. Note that even the inquiry/catalog requestor names have some value and need to be included. Overall, this file shows a 12-month value of more than $17 million and a 36-month value of more than $34 million. This method of evaluation most commonly is used to put a value on the customer list of a company for acquisition or merger activity.
How to Use LTV
Now that you know the value of your customer list, how can you use this information? What are the day-to-day applications of the data to improve your business?
The obvious first use of LTV is in any merger and acquisition (M&A) discussions. These computations also can be used to negotiate a continuing line of credit. LTV also helps determine what the company can spend to get a new customer. Most direct marketers like to be able to recoup any investment for new customers in the first year. Look at the “payback” time by media—e.g., rental list, space ad, search engine—and determine which medium is best for you.
By tracking customers by original source code and measuring repeat purchase activity over two and three years, a catalog or Internet company can determine where its best customers are coming from and change the front-end prospecting mix.
The Internet has added a serious level of complexity and change to historical catalog metrics. Tracking results and building new Internet-specific benchmarks will be important as this side of the business grows. If a direct marketer wishes to grow its future value, these calculations force it to examine the key metrics that drive business success. Every LTV calculation includes key metrics such as:
• Cost of goods, or gross margin;
• Cost to fulfill an order;
• Cost of a catalog in the mail or an e-mail campaign “push”;
• Repeat purchase activity of customers;
• Average order value and annual spend by customer;
• Response rates by customer segment and media; and
• Number of contacts per customer per year.
The re-examination of your business model’s metrics will help you plan for future growth.
Jack Schmid is founder of J. Schmid & Associates, a Mission, Kan.-based consultancy. He can be reached at (913) 236-8988 or through his firm’s Web site, www.jschmid.com
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