CEO of Big Wheel Consultancy Julian Thorne is interviewed by Scott Howland of Zephr on the importance of Customer Lifetime Value. In this podcast, Julian and Scott discuss:
What Lifetime Value (LTV) is and why it matters,
How LTV is measured, and what it tells you about acquisition, churn and retention,
How applying LTV metrics can change your business model and drive revenues,
What strategies to adopt to improve LTV.
And most importantly...
Skatelites music and a lovely Kent lager!
Welcome to the Zephr podcast sessions with your host, Scott Howland. To find out more about Zephr and how we're helping leading brands and businesses with customer journey orchestration, visit www.zephr.com. Today we've got Julian Thorne of the Big Wheel Consultancy joining us on the Zephr podcast sessions.
Julian, great to have you on the show. And it would be great if you could just introduce yourself.
As you said, Scott, my name is Julian Thorne. I'm the founder and owner of Big Wheel Consultancy. I started the company six years ago to help any business organisation grow their recurring revenues, for their membership or their subscription business models. We work with most of the UK’s leading magazine newspaper publications, partly because my own background is in media, but we also work with traditional membership organisations, as well as startup businesses looking to grow their recurring revenues.
I set the consultancy up to offer strategic marketing consultancy, as well as data analytics and forecasting services, but it's all focused on the recurring revenue business models.
Recurring Revenue Models
Obviously, in today's economy, there are recurring relationships, which result in recurring revenue models. And it's getting more and more common in the business use cases.
Yeah, because revenue is one of the fastest-growing business models out there, partly driven by the likes of Netflix and Spotify, from the consumer side, but also investors are really starting to understand the value of recurring revenues, especially when you learn a business model.
So it's great to be able to talk to you today and learn about lifetime value. And I hear you're an expert.
Nice of you to say. I think if you work in recurring revenues, you have to understand lifetime value. So, I'll be fortunate if I claimed to be a recurring revenue expert without understanding lifetime value, so hopefully, I can talk about it with some knowledge.
Customer Lifetime Value
That's great. I'm going to ask you the question, let's see how simple we can get an answer. What is lifetime value?
In very simple terms, it's the total customer revenue over the course of a customer's relationship with the company, minus the cost of acquiring that customer, and then serving that customer.
Can you take us through that step by step? And what does that mean?
Yeah, sure. So the total customer revenue that a customer creates over the lifetime of their relationship with the business is, in essence, all the money that they spend on that business.
If it's a successful recurring revenue model, every year or every period, customers will increase the amount of money they spend with you on average and their average revenue per user (ARPU) will increase. The difficult bit, I suppose, is determining how long a customer is going to be with you if you're trying to anticipate or forecast future lifetime value.
They're looking past lifetime value since you can only really calculate that after customers leave because then you know that they've gone. So, in terms of how useful lifetime value is, it is often essential to use cohorts of different customers. So, the revenue is one element, then the marketing cost of acquiring the customer is another.
And then serving the customer is the cost of producing the goods or the services that the customer is buying from you. And so if it was a magazine subscription or print subscription, that would be postage, printing the magazine, wrapping the magazine, and sending it out. These could be some elements of the cost of serving that customer, but sometimes the acquisition cost is left out of the lifetime value model, and that's a mistake because you should always include the cost for lifetime value.
Sometimes people only calculate the revenue and not the cost of serving the customer, so it's important to include the revenue, but minus the cost of acquiring and servicing that customer.
The Lifetime Value Model
Is there an ideal kind of model, LTV versus cost of acquisition? Is that something that you've seen out there?
Yeah, it's quite well known often in investment circles that the lifetime value, or in other words, the revenue, minus the cost of serving the customer, should be at least three times the cost of acquisition. And there is some confusion on that.
When I talk about lifetime value, I'm saying you have to include the acquisition cost. But sometimes people refer to the lifetime value as only the revenue and the cost of serving that customer. If that is the case, then the value that the customer creates needs to be three times the cost of acquiring that customer.
That does create some confusion around what lifetime value means when people try to come up with that ratio, still a useful ratio, but it's a slightly different way of calculating lifetime value because it's only the revenue minus the cost of serving that customer.
I'm just going to try and put this into simple terms. So you're looking to get £30 from that customer and you spent £10 to acquire them.
Yep, that'd be three to one. So if we have a customer that we're spending £100 with, but it costs you £10 to send the product, you are making £90 in the margin, hundred minus 10. And if you have spent £30 acquiring that customer, then 90 divided by 30 is three. So you're making three times the cost of acquiring a customer. That's the three to one ratio that a lot of investment companies who are looking to invest in startups are looking for, something that's going to generate a three to one ratio of revenue minus cost over acquisition.
It does make complete sense. What is the best LTV to cost of acquisition that you've seen?
Yeah, this is a very, very good question. It comes back to the point about cohorts actually. So if you look at customers across an entire business, LTV is divided by customer acquisition costs. That's useful for you to understand the entire business's success. On the other hand, if you look at it by customer cohorts, some of the customers within a business might be 10 sometimes 20 to one, and others might be only 1.5 to one. So it depends on the cohorts of customers, and it’s really useful to work out what types of customers are generating you greater value than other types. LTV is very powerful, enabling you to understand that a bit more, but it can vary massively to answer your question.
Understanding Lifetime Value
What's the most common mistake you've seen around LTV?
I found the most common mistake is how the company defines LTV is not fully understood by the decision-makers within that company or the marketing managers within that company in a consistent way, all the way through. So as we talked about earlier on, Scott, LTV is calculated in the traditional sense by the total revenue generated by that customer over the lifetime of your business which is interesting to look at in practical terms.
If you're trying to work out how to spend your marketing budget, then it's sort of almost a bit useless actually. Because when it comes to spending your marketing budget, you're trying to work out over what period of time you're going to make your money back. If a customer is with you for, say, 30 years, not many people have got a 30-year investment timeframe. Some people do that if you're investing in infrastructure, but if you're selling a magazine subscription or newspaper digital subscription, no one is going to wait 30 years, even though customers might stay with you for 30 years.
So understanding what LTV means as commonly understood in the business is really important. That's often a mistake people make, the marketing manager or marketing director, or CMO is talking about LTV in one sense and the finance directors are talking about it in a different sense. When that happens, you end up with a problem. So I always encourage people to think about LTV over a period of time, wherever the investment time frame is for that business.
If the aim is to make your money back in three years, talk about customer lifetime value, over a three year period from start to finish, from year one to year three, then talk about it over the lifetime of that customer, because it's important to understand when you're going to get your marketing money back.
Once that's established, and you've got a commonly understood way of talking about LTV in a business, then it becomes quite powerful. Because you then say okay what's the return over a LTV for mastering a TV campaign combined with a PPC campaign and what's the LTV of our customer cohort, age 45 to 55, as opposed to those aged 25 to 35? And as you start to understand that comparative LTV, between different customer cohorts, different marketing approaches, then you can make quite informed marketing investment decisions about where you put your money in order to generate a return, using customer LTV as a way of calculating that.
Nice, I like that. And that was very concise. Because I know how long these kinds of conversations can go on for sometimes, especially trying to sync together finance, marketing, and all these different teams and verticals within an organisation. It's good to have that common understanding of LTV and understand that across the business.
Yeah, no, that's true. I think if you don’t have a common language, you end up with misunderstandings.
That's any business, right?
Calculating Customer Lifetime Value for the Subscription Business Model
We're hearing a lot at the moment about subscriptions and we're seeing a lot about propensity models to buy, to churn. How does this relate to LTV? Can it be taken into consideration? Does this go back to the cohort side of things?
Yeah, it does. If we take the customer acquisition cost, the way of driving it back down is to increase the propensity of your target market to subscribe to your product. So understanding the potential conversion rates of your target market is key to understanding how to reduce your customer acquisition costs, which in turn feeds through into your lifetime value.
Understanding that propensity is important - in the case of digital newspapers, for example, it's often the case that people who subscribe to email newsletters are more likely to subscribe to the digital subscription, than people who don't. Once you understand that, then it informs how much effort, resources, and money you put into developing your email newsletter strategy; doing so will decrease your acquisition cost and therefore increase your lifetime value, again, it's about allocating scarce resources into the right place.
When it comes to a propensity to churn, out of all the numbers in the lifetime value model, the renewal rate is the most important one, it's the one that if you move it by a couple of percentage points positively then it has a pretty big impact on the bottom line. So understanding what causes churn and, conversely, what leads to higher retention are two sides of the same coin. This is really key to being able to drive retention rates up, understanding the correlations between customer behaviour and higher retention, and using the same example, customers that pay in for digital subscription products, and regularly read their email newsletters tend to have a high retention rate.
So in that particular example, investment in email newsletters will give you a positive impact on two elements within the lifetime value calculation, first on reduced acquisition costs, and the second on higher retention rates. So understanding those correlations between behaviours and outcomes is very important when you're trying to develop your lifetime value model.
Customer Journey - Metrics to Watch
You picked out the renewal rate as the most important lifetime value metric. I'm going to flip that slightly. What, in your opinion, is the most important part of the customer journey?
Good questions. It's related to the retention rate. People often look at first time retention rate, second time retention rate, third time retention rate, but the most important one of all of those is the first time retention rate for that seemingly obvious reason that if someone doesn't retain the first time, then it's literally impossible for them to retain the second time. So the first-time retention rate is the most important one.
And the thing that has often the biggest impact generally is the experience that the customer has during the welcome and onboarding process. If their first impression is a very positive one, it tends to lead to higher retention rates, even if that retention decision is made a year later.
The first impression is vital. If the first impression is weak, the company is already on the backfoot in that relationship with the customer, if the first impression is strong, then the relationship with the customer tends to be strong as well and that tends to be reflected in higher retention rates. The great thing about analysing your welcome and onboarding programme is that it forces companies to understand the intersection between their acquisition marketing and their potential marketing.
I've often come across marketing teams where the acquisition marketers are heavily incentivized to acquire new customers, and they do a great job, they get all the bonuses, and then the retention marketers are incentivized to retain those customers, and they have an absolute nightmare, don't get any bonuses and leave.
For example, in terms of acquisition, the customer will subscribe to a product in exchange for a £50 Marks & Spencers voucher, but there's no real effort to sell the true value proposition of the product. And in a good welcome and onboarding programme, what you're trying to do is a couple of things, really, you're trying to deliver on the value that you offered the customer in the first place when they decided to part with their money to join you.
The welcome onboarding process is designed to allow the customer to extract value from that decision immediately. And as they do, they think well of you, and retention goes up. But the flip side of that is you also get to understand a bit better how they're interacting with you, how they're engaging with you, which then allows you to get to know the customer better.
And as you get to know the customer better, you can start to personalise the experience and the customer will feel more valued, and again, that's then reflected in the retention rate.
To answer your question, the most important part I often focus on and I encourage my clients to focus on is the onboarding and welcome programme. Because if it feels coherent, it means that the acquisition marketing is coherent with the retention, marketing, and product proposition. If all of those three things are nicely joined together and coherent, which is the secret to a good onboarding and welcome programme, then you've got a good product, a good acquisition marketing programme, and a good engagement and retention programme. Got all three of those together, you've got a good business, so it's a good place to look.
I like that kind of finishing statement there. The three of those get you a good business. I think it’s great to finish on that note on the subject of lifetime value. I will now recap some of the things you covered.
One of the key things is don't think about lifetime value as a whole customer throughout their whole journey with a company because it might be 30 years before you realise that value. Instead think of it over a period of time, when you are going to get that kind of marketing spend back, the cost of acquisition back and how that's going to work.
Some of the key metrics, we've looked at here: renewal rates, which are one of the key metrics in the lifetime value calculation. But most importantly, retention is a key metric to look at.
Last but not least focus on a great first impression, make the onboarding and welcome programme great, which will then help with retention.
And my last one is the ideal lifetime value versus cost of acquisition. This is embedded in my head now, three to one. Thank you very much for that great kind of lightning talk there on lifetime value, good informative understanding of what that is and how that relates to different businesses.
I've got a couple of random questions that I'm going to ask you. And I'm going to start asking these in every interview I do on the podcasts. The first one is, we're building out our coffee club playlist. Can you name an upbeat song that we can add to that?
I'll give you a song that makes me smile. Every time I hear x is it's by a band called the Skatalites, and it's called Eastern Standard Time.
I will make sure that is added and it's on the Zephr coffee club playlist, which will be sent out on a link. The second one if we were going to a bar and it was a Thursday night in London and you were ordering a drink what would it be?
You can get this drink on the net. It's a beer, a lager made by a local brewer near me in Kent it’s called Curious Brew. It's a really nice summer lager. Actually, I say you have a pint of that and listen to Skatalites.
And the last question from me: How can listeners get in touch with you to find out more about what you're doing and learn more about lifetime value models?
Well go and have a look at our website www.thebigwheelconsultancy.com or email me at firstname.lastname@example.org.
Perfect, Julian. Wow. It was great speaking to you. I know we're all in lockdown at the moment but a pleasure to speak to you, a pleasure to connect, and thank you very much for being on the Zephr podcast sessions.
Thanks, Scott. It’s been a pleasure. Thank you.
This is a transcript from the podcast, which has been edited for clarity.