Are Your Customers Looking for a One Night Stand? Why Lifetime Customer Value Matters
Published: November 15, 2007
Author: David Rodnitzky
Every day on my way to work, I walk by two stores. One is Starbucks. Though it’s a mega-chain, when you go inside, you somehow feel that this is your local Starbucks. There’s a big sign that says “Your Barista is . . .”, comfy chairs, soft music, and very friendly staff.
Directly across the street from this Starbucks is an Art Gallery. The gallery appears to sell cheap mass-produced sculptures, starving-artist paintings, and knock-off art prints. I’ve been walking past this store for eleven months now and they’ve had the exact same banner out front. It reads: “ART GALLERY CLOSING. 50%-80% OFF.”
I should point out that both of these stores are located in the touristy Fisherman’s Wharf/North Beach section of San Francisco, and both are within 100 yards of one of San Francisco’s famous cable car lines.
Of course, while tourists might frequent both art galleries and Starbucks, locals like myself would never dream of strolling into a tourist trap and coming home with a $2500 bronze sculpture of a unicorn.
More to the point of this post, any local like me would especially avoid this art gallery, simply because we know that it is a scam operation. Obviously, the “50-80% off” sale is a con designed to make one-time visitors (e.g., tourists) think that they have happened across an incredible deal. Locals seeing the sign for months know better.
In the Internet marketing world, we often talk about the concept of “Lifetime Customer Value”, or LTV. The concept behind LTV is simple: when you acquire a new customer, you should calculate the value of that customer as the aggregate money you’ll make from that customer over the lifetime of your relationship with him/her.
If you can get the customer to return five times and spend $100 each time, that’s $500 more you could spend profitably acquiring this customer. Moreover, it turns out that repeat customers tend to spend more than new customers, require less customer service, and are more likely to recommend your business to others. LTV can be a real cash cow for businesses that can crack it.
But the Starbucks/Art Gallery dichotomy reminded me that not all Internet businesses care about LTV, simply because some online businesses can’t really expect more than a one-time interaction with the customer, not unlike an art gallery in a tourist area.
Consider, for example, an online lead generator. Let’s say you are marketing ringtones and you get paid $20 for signing up new customers to a subscription ringtone service. You create a Web site called My-Ring-Tones.com (for the record, I actually own this domain, but have never done anything with it!) and you advertise it on Google AdWords, banner ads, etc.
As soon as someone comes to your Web site, you have one objective: get them to fill out a form so that you get your $20. You could care less whether the experience after they hit “submit” is good or bad; after all, they can only fill out the offer once (or, more specifically, you can only get paid once), and what are the odds that anyone would refer their friends to a ringtones form?
In such an example, the online lead generator is no different than the art gallery – you only need to satisfy the customer for a very short period time – once you make your one-time fee, whether the customer experience falls apart later on doesn’t matter to you at all.
On the flip side, businesses like eTailers are like Starbucks. Imagine what would happen if you bought a book on Amazon and it arrived at your house two weeks later than promised, it was damaged, and then Amazon refused to exchange it? You’d tell five friends how horrible your experience was, you might post some bad reviews on Epinions, and you certainly would never shop at Amazon again.
Few retail businesses could survive long-term without repeat customers and positive word-of-mouth, simply because retailers with better LTV will eventually be able to spend more to acquire new customers than retailers with bad LTV. Over time, the high LTV retailer will maintain its existing base and grow its new customers, while the bad LTV retailer will die a slow death.
Judging from the fact that my local art gallery’s ‘going out of business’ sale has now lasted at least one year, I’m confident that you can in fact create a decent business – offline or online – through one-time sales. But the art gallery is a solitary store, whereas Starbucks has tens of thousands of locations.
Translation: running a business without LTV can be profitable, but it can’t be scalable. Lead generators can only grow by moving into new verticals. Growing new businesses is costly, time-consuming, and labor-intensive. An eTailer like Amazon grows simply by adding to it’s existing business (new products) and through loyal repeat business. This is less costly and more profitable that the ‘new business of the week’ model.
And ultimately, the barriers to entry for a LTV business are much greater than one without. I know I would get crushed if I tried to open up a coffee shop across from Starbucks, but I’d have greater confidence going head-to-head with Cheap-Sculptures-R-Us. Similarly, setting up a lead generation business is reasonably easy (which explains why there are tens of thousands of affiliates doing just that) but growing a successful eTailer is much more challenging.
To read more on this topic, I highly recommend Fredrick Reichheld’s book, The Loyalty Effect.