What Else Should Founders Consider When Assessing Customer Lifetime Value?

Questions Founders Should Consider About Customer Lifetime Value There are many secondary factors to consider when estimating customer lifetime value. Even if your calculated LTV appears too low to support the business, founders should check whether the following factors are properly accounted for before considering whether adjustments could improve LTV. 1. The business model matters ★ The choice of business model has a major impact on customer lifetime value and revenue. A recurring-revenue model, such as usage-based fees, can increase revenue, but it may require investors to provide additional capital upfront, resulting in a high cost of capital. A one-time, upfront-payment model can reduce the company’s initial capital requirements, but it may be less profitable than a model based on recurring charges. 2. Customer lifetime value is about profit, not revenue ★ Gross profit and the cost of capital are both essential to an accurate estimate of customer lifetime value. Founders often simply add up different revenue streams and mistakenly treat the total as LTV. In reality, customer lifetime value focuses on profit, not revenue. 3. Do not overlook operating expenses ★ Customer lifetime value must be substantially higher than customer acquisition cost for the company to be profitable. Operating expenses, such as research and development and administrative expenses, are not included in product gross profit. These expenses can be allocated across units sold; the more units you sell, the lower the overhead cost per unit. 4. Different revenue streams have different gross margins ★ Combining a low-margin core product with a high-margin add-on can increase customer lifetime value. LARK Technologies initially sold the LARK silent alarm clock. As a hardware solution, that business model was difficult to sustain. The company later developed a new revenue stream, offering users professional sleep-analysis reports in return for a service fee. This increased the company’s total revenue, created a more profitable recurring revenue stream, and made it easier to maintain close customer relationships and sell additional products. 5. Customer retention matters too ★ The longer customers stay, the higher their lifetime value. This is an important factor in improving profitability. A modest increase in retention can lead to a substantial increase in cumulative profit. 6. Upselling opportunities are an added benefit ★ As the LARK Technologies example shows, selling additional products to customers can materially improve a company’s profit. The products offered should fit the customer model and its needs; the company should not pursue sales growth for its own sake. Overemphasis on upselling can lead a company astray, causing it to forget its fundamental purpose of creating value for customers and, as a result, lose their trust. #DisciplinedEntrepreneurship ---- Robin’s note: “Founders shouldn’t rely too much on gut feel. Many steps need to be clearly quantified and calculated.”