Tuesday, March 27, 2007

Lifetime Value is More than Another Way to Spell ROI

One of our central propositions at Client X Client is that every business decision should be measured by its impact on customer lifetime value. This is because lifetime value provides a common denominator to compare decisions that are otherwise utterly dissimilar. How else do I choose whether to invest in a new factory or improve customer service?

I was presenting this argument yesterday when I realized that you could say the same for Return on Investment. That brought me up short. Is it possible that we’re really not adding anything beyond traditional ROI analysis? Have we deluded ourselves into thinking this is something new and useful?

But remember what most ROI analyses actually look like: they isolate whatever cost and revenue elements are needed to prove a particular business case. The new factory is justified by lower product costs; better customer service is justified by higher retention rates. But each of those are just portions of the actual business impact of the investments. If the new factory produces poor quality products, it may have a negative impact on lifetime value. If better customer service only retains less profitable customers, it may also be a poor investment.

This is the reason you need to measure lifetime value: because lifetime value inherently forces you to consider all the factors that might be impacted by a decision. As my previous posts have discussed, these can be summarized along two dimensions, with three elements each: order type (new, renewal and cross sell) and financial value (revenue, promotion cost, fulfillment cost). Those combine to form a convenient 3x3 matrix that can serve as a simple checklist for assessing any business analysis: have you considered the estimated impact of the proposed decision on each cell? There’s no guarantee your answers will be correct, but at least you’ll have asked the right questions. That alone makes lifetime value more useful than conventional ROI evaluations.

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