Why Lifetime ROI is the only metric that (really) matters in search marketing
It can be tempting, when measuring the success of your search marketing campaigns, to judge them based simply on your Return on Advertising Spend (ROAS). Or, you might want to concentrate solely on winning new customers and measure your campaign success by cost per new customer or just the number of new customers.
But, we think the true value of your campaigns is slightly more complicated. Gaining lots of new customers might sound great, but they can be very expensive to attract. And let’s not forget about returning customers. Sure they may not spend as much per purchase as new customers, but you wouldn’t want them buying a competitor’s product.
To truly understand, and be able to optimize, the value of your search marketing campaigns, you need to calculate the Lifetime Return on Investment (ROI) of each market or campaign. Lifetime ROI is primarily driven by two factors:
- Expected market specific lifetime values (Customer LTV)
- Campaign efficiency based on marketing investment (ex. ROAS)
A unified approach is essential to know how much you should be investing in retention vs new customer acquisition. Let’s look at each of those factors, in turn, starting with CustomerLifetime Value (LTV).
Figuring out your Customer Lifetime Value
A customer’s Lifetime Value (LTV) is the projected net margin (ie after returns) they will generate over a defined period (usually 12 or 24 months), churn being considered. The two biggest factors that contribute to this value are their Purchase Frequency — how many timesthey will buy from you — and their Average Order Value (AOV) — how much they will buy from you.
This chart shows the average purchase frequency over 24 months for a newly acquired “average” customer at one of our major retail clients.
In this example, you can see that within the first 12 months, customer purchases steadily increase and then begin to level off. This plateau is due to customer churn.
Customer churn is the reason you can’t put all your marketing efforts into attracting new customers. Marketing to existing or past customers is just as important to keep them engaged with and interested in your products. Of course, if you have strong Customer Relation Management (CRM) and Retention Strength, you will have far less churn and will be able to invest more of your marketing budget in acquiring new customers.
Finding the ideal balance between customer retention and acquisition is why calculating LTV is so important. Knowing at what point a customer becomes profitable, is an essential part of knowing how much budget you can allocate to a particular channel or a market.
Adding you current marketing efficiency to LTV
As we’ve just shown you, customer LTV is calculated over a long period — usually 24 months. But, to get an accurate Lifetime ROI, you also need to know how efficient your current marketing strategies are.
To do this, you measure two things:
- Return on Advertising Spend (ROAS) — how much profit you are generating from every dollar you spend on advertising
- New Customer Rate (NC-rate) — how quickly you are gaining new customers
Both ROAS and NC-rate can be calculated for different advertising criteria. For example, here is the breakdown of ROAS and NC-rate by location.
As you can see, the return from marketing efforts in the UK is looking good, but they’re not generating many new customers. Of course, we said earlier that new customers aren’t everything. So to find out if the UK is striking the right balance, we need to continue figuring out the Lifetime ROI.
Calculating Lifetime ROI
The actual calculation for Lifetime ROI would also include margins and channel incrementality — a bit too much to cover in a single blog post — but the general principle is that you combine your monthly returns (ROAS) with your projected returns for new customers (LTV) and subtract your marketing spend.
The result looks something like this:
*Bubble size represents the current budget
If you compare this chart to the earlier one about ROAS, you can see that, while the UK market is currently seeing high advertising returns, based on the type of customers they are attracting (LTV), they will be running at or below break even over a 12 month period.
The calculation also shows that efforts in the EU are having the greatest effect. As a result, we would recommend investing more in the EU market while keeping budgets stable in the UK, or even pulling back slightly, until you can improve their New Customer Rate. You might be able to improve New Customer Rate by shifting budgets to different ad inventory (or product) or by excluding existing customers from your ad serving — but that’s a topic for another time.
In this Lifetime ROI scenario, you are, in a sense, “trading” New Customer Rates against ROAS efficiency. The more new customers you win, the further you can allow ROAS to fall and still break even against your marketing spend.
For example, both these products are break even in Google Shopping, even though their acquisition profiles are very different. Meaning that the New Customer Rate and ROAS will even each other out in the long-run — i.e. after the defined number of months we used to calculate LTV.
Both products are “break-even” after marketing spend:
For our retail clients, we not only measure NC-rates and ROAS per market but, given enough data points, we can figure out which products are most attractive to new customers. These products are what we call door openers, and many retailers choose to invest more in advertising them.
Unified Lifetime Value Calculation
Remember that this type of calculation isn’t just applicable to different markets. You can run the same Lifetime ROI calculation for every different product offering within each market and channel. When you combine all those calculations you reach a Unified Lifetime Calculation (ULC) that automatically balances new customer acquisition and retention.
Growing businesses can use the Unified Lifetime Calculation to compare budget scenarios and answer questions like:
- What is the greatest number of new customers I can attract if I want to break-even after 12 or 24 months?
- What is the maximum share of voice I can reasonably achieve?
Armed with that kind of information, you can make smart, targeted decisions about which products in which markets and on which channels should get the most attention for the greatest positive result.
Stay tuned for part two where we explore how Lifetime Value changes the way you invest in Google Shopping and Google text ads.
If you would like to know more about how you can balance new business and retention automatically with camato, please get in touch.