This is the third article in our Retail Math series, continuing our journey toward profit maximization.
This article focuses customer value maximization in particular; finding and improving the KPIs that make up Customer Lifetime Value.
If you feel lost, or want to learn to maximize profit by focusing on the KPIs outside of customer value, please take a look at the first two articles, Retail Math: The Most Important Formula in Online Retail, and CAC vs CPA: How to Cut Marketing Costs When Acquiring Customers.
Table of Contents
Profit Maximization Through Customer Lifetime Value (LTV)
Our last article focused on Customer Acquisition Cost (CAC) and the KPIs (Key Performance Indicators) that determine it. This article will do the same for the most important metric most companies ignore: Customer Lifetime Value (LTV).
LTV is a measure of a customer’s value over the entirety of the time they spend with your brand. It’s half of the most important profit maximization formula in retail:
CAC < LTV (keep your Customer Acquisition Cost lower than your Customer Lifetime Value).
If CAC is a path toward measuring your total cost, LTV is the same for your total revenue.
Once you’ve broken CAC and LTV down into the KPIs they’re comprised of, you can use them to figure out which aspect of your business is leaving money on the table.
How to Find Your Customer Lifetime Value
There are three KPIs that determine your LTV: Average Order Value (AOV), Purchase Frequency (F), and Gross Margin (GM). It’s important to look at each of these individually to find out which one needs the most work in terms of profit maximization.
How to find your Average Order Value (AOV)
AOV = Total Sales Revenue / Total Number of Orders
Average Order Value ANALYSIS: Company A
Total Sales Revenue (annual): $1,000,000
Total Number of Orders (annual): 40,000
1,000,000 / 40,000 = 25
Company A has an Average Order Value of $25
How to find your Purchase Frequency (F)
F = Total Number of Orders / Total Number of Unique Customers
Purchase Frequency ANALYSIS: Company A
Total Number of Orders (annual): 40,000
Total Number of Unique Customers (annual): 15,000
40,000 / 15,000 = 2.67
Company A has a Purchase Frequency of 2.67
How to find your Gross Margin (GM)
GM = Total Sales Revenue – Cost of Goods Sold (COGS) / Total Sales Revenue (express the result as a percentage).
How to Find Your Cost of Goods Sold (COGS)
COGS = Beginning Inventory (inventory left from last year) + Additional Purchases During Period Cost – Ending Inventory (inventory left at the end of the year)
Cost of Goods Sold ANALYSIS: Company A
Beginning Inventory: $180,000
Additional Purchases During Period: $450,000
Ending Inventory: $160,000
180,000 + 450,000 – 160,000 = 470,000
Company A has a Cost of Goods Sold of $470,000
Gross Margin ANALYSIS: Company A
Total Sales Revenue: $800,000
800,000 – 470,000 / 800,000 = .41
Company A has a Gross Margin of 41%
How to Improve Your Customer Lifetime Value (LTV)
With our KPIs ready, it’s time to work on our customer value maximization. But, what is a good profit margin? What is a good purchase frequency? (Don’t forget, a good retail profit margin wouldn’t necessarily be a good food services profit margin).
Compare your KPIs with industry benchmarks to determine which KPI needs the most improvement. Find current averages for your specific industry, then get to work. Which one could improve customer value the most? Remember to focus on your weakest KPI first in order to maximize profit.
How to Improve Your Average Order Value (AOV)
Having trouble getting your customers to increase their spending? Try these campaigns, which focus on providing incentives to increase average order value.
- Add personalized product recommendations to the site; the recommended products should be based on the ideal price point for each individual customer, thereby maximizing revenue.
- Send personalized newsletter campaigns with dynamic product recommendations optimized for price.
- Trigger product recommendations, based on what they’ve added to their shopping cart, directly on the site.
- Send an email campaign with product recommendations based on what they’ve added to their shopping cart.
- Create product bundles that offer a discount for making a larger purchase. Bundle products that can be used together, and recommend the bundle directly on the site, or through email, based off the user’s browsing and shopping cart history.
- Create a customer loyalty program, incentivizing spending by adding loyalty points that customers can use for discounts and freebies.
How to Improve Your Purchase Frequency (F)
Maybe your customers spend a lot, and you’re making a great margin, but they just don’t order very often. Try a few of these campaigns to maximize profit by getting your customers to pick up the pace.
- Communicate dynamically. Using historical customer data collected with a true unified Single Customer View, you can automatically send emails that arrive at the ideal time for each individual customer. (Make sure those emails are personalized!).
- Find out if you’re communicating through the right channels – does this particular customer respond better to email or SMS? Make sure each customer receives your message through their preferred channel.
- Segment your customers by their customer lifecycle stage, then re-engage with customers who haven’t purchased in a while, and are in danger of churning.
- Use push notifications and banners to highlight time sensitive deals based off their browsing history.
- Use banners that trigger when a customer enters and exits the site. Use these banners to recommend personalized products or sales.
How to Improve Your Gross Margin (GM)
It doesn’t matter how valuable your orders are or how frequently they happen if your Gross Margin doesn’t allow for a profit from the sales. Here are some ideas for profit improvement through increasing the revenue you make on the sale.
- Use an Inventory Manager to make better estimates for what you’ll need to resupply your stock for the next year.
- This is an easy one for maximizing profit margins: sell higher margin products! You can adjust your recommendation models to exclude products that are hurting your margins.
- Use a Price Optimizer to automatically find the ideal selling price for each of your products, based on where they are in the product lifecycle. This will inform you of any products with more room for profit maximization.
- Reduce your Cost of Goods Sold by selling the products left from the previous year.
Next Steps: Filling in the Formula to Maximize Profit
If you’ve been following our Retail Math articles this month, you should now know what you need to solve the online retail formula for your company. Maybe you already found all the KPIs we discussed – if so, it’s time to plug them in and see how your company is doing in terms of profit maximization.
Remember, you don’t just want your CAC to be lower than your LTV; you want it to be significantly lower; ideally a 1:6+ ratio. If your ratio is below 1:3, it’s time to find out where the problem is, and how you can maximize profit.
If this is your stage, the next steps are simple:
- Compare your KPIs to the benchmarks in your industry to find your weakest KPI.
- Improve that KPI (try the campaigns described in our Retail Math articles).
- Find your next weakest KPI.
If you’re ready for a comprehensive profit strategy to strengthen these KPIs in your company, schedule a free demo with Exponea. We’ll help you figure out where and how to make the biggest impact, then help you put it into action.