What eventually came to be known as Gillette Formula is essentially offering a high value product to acquire a customer at a cost to the company. The company aims to recover the costs and make profits through repeated high value sales from that customer over many years through selling other products. In effect it is nothing more than creating a dependency of the customer on the company by creating a need to buy a secondary product which is essential to justify the purchase of the primary product, even though it was bought at a low or no cost. If you buy a mobile phone at a low cost through a service provider, that is precisely what is happening as you sign a contract for two years or so to be with the service provider. The cost is eventually covered but how much profit that service provider makes depends on whether the customer stayed with the provider after the expiry of the contract or not.
The marketing concept that looks at the long term value a single customer can offer over many years is what is called “Customer Life Time Value” (CLTV) which is now an in thing in e commerce space. How CLTV will pan out for internet based services is a topic that creates immense interest for many analysts.
Amazon’s Kindle is an example where each Kindle Fire that is sold at $1991 is not really the true cost of the Kindle. An analyst estimates that the selling of Kindle Fire at cost or even at a little loss may reduce the profit margins of Amazon from 3.5 % last year to 1.5 % this year. However, the company aims to recover the cost through repeated sales of the complementary products that customer will buy over years from Amazon. The idea behind this is to rope the clients in, rather than letting them go to the competitor and hence build loyalties elsewhere. Amazon is looking at the total economics of the model, which comes from the ‘device, accessories, the content, ad based revenue and special offers.” Google offers free search service to the users on the internet, but has one of the most sound and robust economic and revenue model. Even though not discussed as a classic example of CLTV as there is no physical asset that Google offers initially, it is essentially utilizing customer loyalty of their brands or free services to make profits through ads and other paid services. Zynga, is doing the same. The access to the game is free but revenue model is about selling the virtual goods for real money. And are there buyers? Who would debate that, when the company is doing well.
One of the main challenges that one has in calculating CLTV is tracing each individual customer over the lifetime (which can be 6 months to five years or more). In fact, it may be far easier for internet based services to track the customer to calculate CLTV much better than traditional businesses. But how do they really calculate CLTV is still debatable. Peter Fader, a marketing Professor at Wharton admits that there is no standardized method of calculating CLTV which may still be an issue to accept this as a standard marketing practice.
While calculating Customer Life Time Value, a number of factors are considered such as the initial cost of acquiring a customer, frequency and value of subsequent orders and number of years that the customer sticks with the company. If the cost of acquiring a customer is offset by the subsequent purchases by the customer quickly, it would be considered a success. Some argue that happy customer referrals should also be included in this calculation as that reduces the cost of acquiring an additional client through direct marketing. Kaushik dismisses traditional marketing tools for internet marketing such as click through rates, visits, bounce rates and conversion rates as normal stuff with a focus on short term success and stresses on recognizing the value of CLTV. So essentially, it is a long term business model, not a short term success formula. He further argues that most often the emphasis is on value a customer adds as an average to gross profit over years. Which is where he thinks the mistake is, as this average hides certain high value and best customers who at a certain acquisition cost, order high value products, more number of times and for several years. So, these best customers add up to the revenue and profits far more than the average one’s do. But is it for every business to segregate its best and average customers?
Peter Fader believes that CLTV works best in a contractual setting. Sprint that sells the iPhones for Apple are apparently going to make profits only in 2015 banking on CLTV, which may or may not prove to be worthwhile. However, if the belief in customer loyalty is very strong, the company can become very profitable after 2015. While the contractual obligation of the customer can be a security for a company, not every internet based service can have contractual obligations attached to its primary product.
Free from the tenets of ‘contractual business’ is a marketer like Groupon that gets a business some or many new customers, when it runs an e campaign for the business. However, businesses actually incur massive revenue loss in the hope that the customers become its regular client. Can it always work for Groupon clients? Coleman Barney emphasizes that it really depends on each business and what kind of product or services they offer to see if running a Groupon campaign is worthwhile for them. Basing his opinion on analytics of a company that ran a Groupon Campaign, he suggests that although the company got increased revenues and new customers but they not only compromised on top line revenue but also on gross profit margins, whether they will recover this through repeat customer visits remains to be seen.
Customers, Nic Windley suggests are an ‘expensive thing to find’. So, with Groupon campaign, at least the businesses are getting the customers. While the Groupon clients may contribute to the negative profit margins immediately after the campaign, it is for the businesses to look at CLTV and track the customers to see whether the campaign really worked for them in the long run.
How CLTV creates value for business who are internet based service providers remains to be seen in coming years. Whatever the method of calculating CLTV, segregating best or average customers, or adding value of referrals or not, customer loyalty where tracking is feasible is going to be a significant marketing trend. For any company, getting the attention of a customer is not easy in this very competitive space. Until a company is willing to offer a peep into what it can offer, people are hesitant to spend their resources on the product or service. If the most recognized and successful names on the web believe in customer loyalty, others would probably have to follow the suit.