Lifetime Value

Saturday, July 24, 2010

Lifetime Value

Check out this recent email from Chuck McKay:

How to Make Money by Losing Money

Would you buy a dollar for 50 cents?

OK, that one was easy. If you could hand me 50 cents, and get a dollar back every time, you'd push as many fifty cent pieces in my direction as I'd be willing to accept.

What about for 99 cents? Would you be as excited about that exchange? Maybe. As long as there's a profit to be made you might be willing to make it slowly.

How about $1.35? Could you imagine spending $1.35 to get back one dollar?

Your first reaction is likely "no," but the correct answer isn't so obvious.

How could anyone stay in business losing 35 cents on the dollar?

Pretend with me that your music store consistently sells twelve guitars a week, at an average price of $850, and an average profit of $332 (39 percent).

You're planning an Anniversary Week guitar sale, and have budgeted $10,000 for advertising. Knowing that you'll get to keep 39 cents of every dollar you take in, it would seem that to recover your $10,000 advertising investment you'll need to generate $25,641, or roughly 30 additional sales (for a total of 42) just to break even.

But wait a minute. Selling 42 guitars this week doesn't have you showing a profit. You're merely recovering your costs. And what happens if you don't sell 42 guitars? Wouldn't you have been better off not advertising this sale at all?

Maybe we need to re-think this Anniversary Week sale idea.

Then again...

We probably will sell a lot of accessories. We'll probably draw some new people into the store, and remind former customers that they used to enjoy shopping with us. OK. Even if we can't sell enough guitars to pay for the Anniversary sale advertising, we might sell enough other items to recover the ad budget.

And then there are the rumors of the way the new competitor does business. You've heard he will happily lose money on the first sale if he gains a new customer in the process. What the... How can anyone stay in business with a silly business model like that?

Well, your competitor has recognized that the customer who buys the guitar will also need a case, maybe a strap.

Over the next weeks he'll see the value of a battery-powered tuning standard, or a capo. He'll need picks, and strings. Over his lifetime as a player, he'll need lots of strings.

Then, too, over his lifetime as a player, he may purchase several other instruments, and all of the accessories. Maybe he'll even need lessons.

If a business is willing to invest money in advertising to gain new customers, why not invest in the customer himself?

When we consider the probability of all those additional purchases, and all of the profit derived from them, would you be willing to lose a few bucks on the "front end" of this relationship to "buy" the customer, and gain a profitable "back end?"

Twenty years ago Jay Abraham brought up the concept of back end sales by telling the story of a coin dealer. The dealer offered a $23 starter coin set at cost, and gained 60,000 new customers.

Within six months, 6,000 of those 60,000 new customers each bought another $1,000 worth of coins.
Two months later 2,000 of the 6,000 customers each purchased roughly $4,000 in additional coins.
Finally, 500 of the 2,000 bought another $10,000 each.

By being willing to break even on the initial sale, the coin dealer was able to generate a list of qualified customers who were responsible for $19 million dollars in additional sales:

And this part is critical: every one of the 60,000 names on the initial list turned out to be worth $317 in additional sales, even though nine out of ten of those new customers never spent another dime.

This is a great illustration of Lifetime Customer Value (LCV).

Make your profit on the back end.

How many customers would you be willing to sell at no profit, if it meant each would directly or indirectly generate $317 in new sales in the next year? Would you maybe even be willing to lose money on the front end, if there was enough profit on successive back end deals?

Would you give away the $400 (retail price) cellular telephone, in order to gain the 24-month usage contract at $100 per month?
Would you give away the new $60 (retail) chrome plated coffee brewer to gain a customer who spends an average of $234 on your gourmet coffees?
Would you be willing to sell gasoline at an average profit of $14.32 per month (four, 20-gallon tanks), when that driver will spend an average of $31.92 each month in interest and carrying charges on your company credit card?

Yes, I suspect you would. Next time, in "How to Calculate Lifetime Customer Value," we'll determine in dollars and cents the value of each new customer. We'll also get a handle on how long that new customer will continue to do business with us.
____________

SChuck

Chuck McKay is a marketing consultant who helps customers discover, and choose your business. Questions about making money with back-end sales may be directed to ChuckMcKay@ChuckMcKayOnLine.com.

Fishing For Customers And Reeling Them In
is a marketing guide for small retail and service business owners.

This book will help you to attract and keep your most profitable customers.

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