I am pleased to report that we have a new paper in the Journal of Interactive Marketing. My coauthors — Paul Farris, Raj Venkatesan, and Andrew Petersen — and I looked at the challenge of assessing the ROI of customers. One problem we saw was that marketers were getting misleading ROIs (returns on investment) for their projected investments in customers. Why?
What Is The Investment In A Customer?
A fundamental problem, which was largely being overlooked by marketers, is that the definition of an investment in a customer was unclear. The advice we saw all suggested that the investment in a customer is the firm’s cost to acquire the customer. (Such acquisition spending might be in the form of mailings, advertising, referral incentives, etc…) The same advice said that the return on the investment could be assessed by comparing the acquisition cost, to a return estimated as the customer lifetime value (CLV) of the customer.
There is a basic error with this advice. The investment being assessed, the acquisition cost, is a one-off payment, while the return is the CLV. This CLV is the return to an entire relationship with the customer. CLVs projected almost always assume that the marketer will make future spending to retain the customer. Where this is the case there is an investment in retention being implicitly assumed which is planned because it increases the CLV. Yet, this later spending, which must be incurred to get the planned return, is not included as a part of the investment. So the prior advice was to compare a fraction of the investment to the entire return. Voila, projected ROIs are too high. If you underestimate an investment and estimate the return accurately then the Return divided by the Investment will be higher than it should be.
The ROI Of Customers
It is possible to look at the ROI of only acquisition spend but to do so you should compare that spend (A) to the baseline CLV (CLVBL). This baseline CLV is the CLV that is predicted without any further investment in the customer, i.e., no retention spend is assumed. We call this Acquisition ROI (AROI).
If you want to use CLV (assuming future retention spend) then you must compare this to the full investment to deliver the CLV. This is the acquisition spend plus (suitably discounted) retention spend. We call this customer ROI (CROI) and suggest it can be used as the core metric when targeting new customers.
You can also use our approach to assess the return on investments in current customers — retention ROI (RROI). Interestingly, you simply cannot assess the return on investments in current customers with the approach previously being recommended by marketers. Thus, when using the prior approach the marketer needed to use unconnected methods to assess 1) acquisition ROI and 2) retention ROI. As we show, this can lead to situations where money is spent to acquire a customer by the acquisition marketers in a firm yet the retention marketers immediately want to get rid of the customer without any new funds or information being gained. The prior approach is a recipe for inefficiency and inconsistent approaches which destroy marketing’s credibility and waste money. It even spoils the experience of customers who are actively pursued and then treated badly after being acquired.
Option ROI
We also outline option ROI (OROI). This is a way of looking at customer acquisition spending as gaining an option to invest more into the customer relationship after additional information is learned about the customer at the time of acquisition. For example, whether the customer responds to the acquisition attempt with a large or small order might supply the information needed to decide how much to spend on retention later. Treating the customer as an option can help make customer acquisition investments financially viable even where such investments do not appear to be so prior to acquisition using the traditional metrics.
The Suite Of Metrics
In the paper, we shared a full suite of metrics (below). This is a practical guide to the ROI of customers. By the way, if you think that the practical applicability of this paper would make it popular with reviewers you haven’t met many academics. (But thank you to the Journal of Interactive Marketing for publishing it). We hope that people will find it useful.
For more on CLV see here, on ROI see here, and for the book I wrote with Shane (Xin) Wang see here.
Read: Neil Bendle, Paul Farris, Raj Venkatesan, and J. Andrew Petersen (2024) A Suite of Metrics to Understand Return on Investments in Customers, Journal of Interactive Marketing, First published online April 22, 2024