Many subscription business leaders swear by the Lifetime Value (LTV) model. This tool calculates the total profit a customer generates over their relationship with a company.
On the surface, it seems harmless. Businesses often compare the cost of acquiring a customer (Subscriber Acquisition Cost or SAC) against the projected future profits from that same customer. Companies usually justify aggressive marketing spending if future profits outweigh the initial cost.
While the LTV formula can be a helpful tool for comparing different marketing strategies, it's easy to misuse. Some companies become obsessed with the model, letting it dictate their entire business strategy. Let's explore why blindly following the LTV model can be harmful.
The perils of the lifetime value model
It's essential to grasp that the LTV model is a tool, not a strategy. It's designed to measure the effectiveness of marketing spending, but it doesn't ensure long-term success. Some companies mistakenly view acquiring customers at a lower cost than their lifetime value as a foolproof business strategy. However, this is risky as competitors can easily replicate this approach. Calculating the LTV formula isn't overly complex and can be done by any business student.
Furthermore, the LTV model can lead to excessive spending on marketing. Marketing executives often seek substantial budgets to increase revenue. The LTV formula offers a rationale for freely spending today in anticipation of future profits. It's not coincidental that many companies fixated on LTV incur significant losses before becoming profitable.
Overspending on marketing comes at the customer's expense. To offset high marketing expenses, companies frequently raise prices, diminishing customer value and creating opportunities for competitors to offer lower prices. Investing in customer experience and cultivating strong relationships represents a more sustainable long-term strategy.
The LTV model is also prone to misuse and misunderstanding. Marketers often manipulate the calculations to justify higher spending. For instance, they might include organic customers in their spending calculations, even though these customers would have joined regardless of marketing efforts.
Next, the LTV model is based on predictions, not certainties. Businesses are complex systems that constantly change. The future is uncertain, and relying solely on a model can be misleading. LTV enthusiasts often treat the model as a crystal ball, ignoring the possibility of unexpected challenges.
Many factors influence LTV, and they are interconnected. Increasing prices to boost revenue might lead to higher customer churn. Aggressive marketing can inflate customer acquisition costs and lower customer quality. Improving customer service to reduce churn can increase operating costs, impacting profitability.
Customers acquired through marketing often have lower lifetime value than organic customers, leading to lower satisfaction, higher churn rates, and less revenue. LTV-focused companies usually prioritize acquisition over customer satisfaction, oversimplifying complex relationships.
Then rapid growth can become a grind. As companies expand, acquiring new customers becomes increasingly difficult and expensive. The pool of potential customers is finite, and competition for their attention intensifies. Assuming that customer acquisition costs will continue to decrease as spending increases is unrealistic.
Finally, the promised land of profitability often remains a distant dream. Companies that rely heavily on the LTV model frequently struggle to achieve sustained profitability. Unexpected challenges, rising costs, and declining customer satisfaction can derail even the most carefully crafted plans.
The illusion of control
The LTV model creates an illusion of control. Numbers and formulas can be comforting, but they don’t guarantee success. Companies often become so focused on manipulating the model to achieve desired results that they lose sight of the bigger picture. Instead of building genuine customer relationships, they become obsessed with gaming the system.
This tunnel vision can lead to short-term gains at the expense of long-term sustainability. When the model starts to falter, as it inevitably will, these companies find themselves unprepared. They’ve built their house on shaky foundations.
Remember, customers are people, not just data points. True business success comes from understanding and meeting customer needs, not outsmarting a mathematical formula. While the LTV model can be helpful, it shouldn’t be a crutch.
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