The Dangerous Seduction of the Lifetime Value (LTV) Formula

[LounginMKL]

Since more companies are moving to a subscription-based model, I thought this blog post from Bill Gurley has a lot of relevancy. An oldie but a goodie.

 

http://abovethecrowd.com/2012/09/04/the-dangerous-seduction-of-the-lifetime-value-ltv-formula/

 

"Tomorrow Never Arrives.  The Utopian destination imagined by the LTV formula is a mirage. It almost never works out as planned in the long run. Either growth begins to slow, or you run out of capital to continue to fund losses, or Wall Street cries uncle and asks to see profitability. When this happens the frailty of the model begins to appear. SAC is a little higher than expected. You met your growth target, but the projected loss was bigger than expected. Wall Street is hounding you for churn numbers, but you are reluctant to give them out. The lack of transparency then leads to cynicism, and everyone assumes the worse. It turns out that the excessive marketing spend was also propping up repeat purchase, and pulling back to achieve profitability is increasing churn. Moreover, a negative PR cycle has ensued as a result of your stock decline, and the press’ new doubts about your model. This also impacts results and customer perception of your brand. The bottom line is that “one day we can stop spending and be remarkably profitable” rarely comes to fruition."

 

My notes

- LTV is a predictive tool, not a strategy; Don't bring a measuring tape to a fight.

- Finance should own LTV Calculation, not Marketing.

- Marketer or executives abuse it to rationalize bigger marketing spending.

- SAC should exclude organic growth.

- ARPU, Churn, marketing spending, SAC, variable costs are interdependent and often negative correlated.

- Growth is a grind- many LTV calc assumes ARPU and SAC to grow in similar ratio- assuming you will get better at marketing, thus lower marketing ROI, is a dangerous assumption.

- Organic users typically have a higher NPV, a higher conversion rate, a lower churn, and more satisfied.

- Focus on providing better value prop, instead of shouting match about the service.

[LC]

Lifetime value is the DCF of the marketing world.

 

That said, subscription based models work best if you have a large subscriber base (relative to your development costs) and limited competition. Remove one of those two and it becomes a race to the bottom where customer acquisition costs takes years to recoup.

 

In most cases I am wary of start-up subscription models. I would guess that established products/services moving to a subscription model have a higher probability of long-term success.

 

Good discussion topic in today's business environment.