Customer Lifecycle Value vs Cost of Acquisition in Ecommerce

You cannot acquire a customer for life. In ecommerce, loyalty is a thing of the past. Many startups and new businesses struggle to find the right balance between customer acquisition & retention. This is especially true for the ecommerce industry. In the quest to growth hack to the next level, ecommerce businesses go all out to acquire new customers sometimes at unsustainable costs.

Over a longer term, online retailers might want to discontinue the channels that have a consistently higher cost of acquisition (CoA). But customer acquisition cost alone is not the right metric to evaluate the performance of an acquisition channel. Ecommerce businesses should instead be including average customer lifecycle value for customers from a particular channel as an important metric for strategic decision-making. This article can help ecommerce businesses garner a better perspective to guide their business decisions.

Customer Lifecycle Value (CLV)

In simple terms, customer lifecycle value is the projected value a customer generates over the entire lifetime of their interaction with the brand. Focusing on CLV can help a company determine optimize the marketing spends, allowing it to focus on more profitable customers.

CLV as a metric assumes greater significance when put together with CAC. The CLV:CAC ratio is a powerful metric to define the Return on Investment (ROI). Focus on both the levers can help you devise a winning strategy.

Let’s take a look at the comparative illustration of 3 customers from different acquisition channels (A, B & C) assuming 1 year as the time period under consideration:

How to calculate the Customer Lifetime Value

First step would be to segregate the customer acquisition and purchase data on the basis of marketing channels. Once this is done, there are 2 principal models of calculating the customer lifecycle value:

• Historic Model

Under this model, the gross profit from all historic purchases of individual customers is summed up & divided by the total number of customers. This gives the average CLV for each acquisition channel.

• Predictive model

This is an advanced method built upon the historic model. Predictive model uses the past customer behavioral pattern to predict the lifetime value of customers. This factors taken into account by this model are as follows:

1. Number of visits per month (N)
2. Average customer basket size per visit (B)
3. Average profit margin per customer (m)
4. Historical customer retention rate (r)
5. Discount rate for future cash flows (d)
6. Average customer lifespan (l)

Assuming next 10 years as the time period (T) for consideration, let us look at the formula that can help you arrive the lifetime value.

Average customer value per month (v) = N*B

Total customer value per year = S = v*12

Total lifetime spend of the customer = L = S*10

Average gross margin per customer lifespan = G = L*m

CLV 

= N*B*12*m*[r/(1+d-r)]*T  

= S*m*T*[r/(1+d-r)]

= G*[r/(1+d-r)]

The final CLV value obtained can be plugged in the ROI ratio (CLV:CoA). Greater the ratio, the better the impact on the company’s growth strategy.  The ROI ratio can be used as a good measure to evaluate the performance of the marketing channels and accordingly optimize the budget allocation.

Factors boosting customer lifecycle value

For the CLV model to work, the data set under consideration has to be long enough to provide. CLV is not just for evaluating the marketing channels and campaigns, it can be a great lever to look at the overall business strategy for ecommerce businesses. There is nothing wrong in looking out for new customers. But, it’s important to look at the value brought by ten new customers acquired vis-a-vis ten retained customers. From the cost perspective, it mostly turns out cheaper to retain existing customers. With the wide array of choices thrown open to the consumers with just a click of a mouse, brand loyalty and customer retention becomes more important.

A quick look at Nielsen’s Global Loyalty Sentiment Report provides good insights into the consumer sentiments that result in switching retailer & brand-hopping.

The 5 factors listed above- price, quality, service, selection and features; can together drive the lifetime value of your customers. Doubling the CLV of existing customers is equivalent to doubling the customer base. Here’s some handy tips that can help online retailers increase the CLV:

• Loyalty programs has been used by offline retailers for a long time to create long term loyalty and drive repeat purchases.
• Do not charge for product returns. It does put in a load on the operations side but brings in the baggage of good experience and more future purchases.
• Size Fittings is one of the major reasons for product returns. Interactive tools for size fittings can go a long way in aiding customers to find the right size for categories like footwear, apparels, etc.
• Ecommerce is all about providing easy access to products and services from the comfort of the home. Similarly, customers expect an excellent 24*7 support to aid them for their queries and complaints.
• Wider range of custom delivery options is required. Ecommerce players like Amazon provide different delivery options that allow you to get the product delivered even in 1 day. Other possibilities can be incorporated like the option for nominating friends, etc. to be delivered the product in the absence of the customer.
• Being in touch is important. Sending post purchase emails and festival wishes can be a way to continue to have relevant mind space. We usually recommend using Mailchimp or Sendgrid for sending out emailers and tracking its results.
• Do not fail to surprise them. Sending a small reward or gift along with their purchased product can win their heart and create a long term goodwill for your ecommerce brand.

Don’t stop marketing on unprofitable customers but start actively engaging with profitable customers

In the rapid-growth ecommerce boom, it’s easy to get lost in the race for acquiring new customers. Brands go upto the extent of acquiring new customers at 10x the historical averages. They fail to remember that retaining your existing customer can cost lesser and would pay in the longer run to get hold of these low-hanging fruits.