Monday, March 05, 2007

Building the One Big Button (Using LTV to Find Business Opportunities)

As anyone who reads this blog regularly might have expected, I did go ahead and add the page of questions (see last Friday’s post) as a sort of index to the sample Lifetime Value system. I like the results even more than I had expected. It’s much easier to read the questions than to look at the report names and remember which data that report presents. And, come to think of it, there’s no reason to limit this approach to one question per report. Since many reports answer several different questions, you could have several question-buttons point to the same report.

Adding the question-buttons didn’t take very long, so most of my attention went to the more challenging question of whether I could build the One Big Button that identifies business opportunities. This took a bit more thought.

Of course, the proper response is that every company will have its own way of analyzing the data, based on the nature of its business and on corporate and personal preferences. It would be legitimate, and possibly wiser, to let it go at that. But I did wonder whether there could be a generic analysis based on the generic nature of the Lifetime Value components themselves.

I think there is. Start with the three major divisions in the LTV model: original orders, renewal orders, and cross sell orders. For each of these, ask: which components of total LTV does it affect, and what business decisions can we identify that would change those component?

- For original orders, the key components are acquisition cost and customer quality. (Quality is measured by back-end results; that is, renewals and cross sales). The key decision is source mix. So it’s plausible to identify situations where there is an opportunity to improve results by investing more in higher-performing sources and less in the weaker ones.

- For renewal orders, the key components are years per customer and value per year. In the real world, how long customers remain active (i.e., years per customer) is determined primarily by their experience with the actual product or service. (Companies can and do create retention programs, but these can only work at the margins and are rarely a major expense because the amount of dollars that can be spent effectively is quite limited.)

It’s hard to identify a single variable that impacts experience quality in the same way that source mix affects acquisitions. But it’s probably valid in general to assume that improving the experience will increase product and/or service costs, and thus decrease margin (revenue – costs). (Yes, I know that higher spending does not necessarily produce a better experience and that experience improvements sometimes even reduce costs. I’ll readily agree that this particular area is the one where company-specific analytics offer the most improvement over generic LTV components.) Note that increasing years per customer affects cross sell as well as renewal revenue—a model relationship which probably reflects most businesses’ economic reality.

- For cross sell orders, once we assume that years per customer is mostly the result of customer experience, the remaining component is value per year. This again can be considered primarily a factor of marketing efforts. So we can look for situations where greater investment in cross sell marketing is likely to improve overall results.

In brief, we’ve identified a key variable for each LTV element: source mix for original orders; margin for renewal orders; and marketing spend for cross sell orders. Respectively, these impact acquisition cost and back-end value; back-end value and longevity; and cross sell value. As you see, each element affects itself and its successors.

So far so good, but we still haven’t explained how to identify opportunities for improvement in each element, let alone how to estimate the impact of any change or how to prioritize the changes. I’ll start to reveal those mysteries tomorrow.

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