When it comes to SEM acquisition marketing, there’s no such thing as a free lunch.
As acquisition marketers can attest, there’s almost always a tradeoff between the number of new customers acquired, and the customer lifetime value (CLV) of those customers.
In short: The more new shoppers you bring in the door, the less each of those customers is likely to be worth to the business in the long run.
What accounts for this widely-observed phenomenon? There are a couple of factors that explain why number of customers acquired and CLV tend to move in opposite directions:
Self-Selection. As a thought experiment, consider two customers: one who clicks on your paid search ad in a top position, and one who seeks you out on page three of search results. Which customer is more likely to have a strong affinity for your brand and products? Probably the customer who was willing to wade through all those pages of search results!
In contrast, the customer who clicks on your paid search ad shows less self-selection toward your site — they may simply be curious but ultimately have a lower level of brand attachment, resulting in a lower CLV.
The same principle is true across all paid acquisition channels. Gaining a wider reach often comes at the expense of acquiring just high-value customers. The consequence? “Acquisition double jeopardy.” Customer acquisition shows increasing marginal cost (it costs more to acquire each new customer than the customer before) as well as diminishing marginal returns (each new customer is likely to be lower-value than the previous one).
Organic Customer Mix Evolution. Relatedly, many businesses start with a small but fiercely loyal coterie of brand loyalists. Over time, they start attracting a more diverse mix of customers, including those with less attachment to the site and its products.
Seasonality. The holiday season is generally when retailers bring the most new shoppers in the door — but those customers are often disproportionately flighty and price-sensitive. On average, their lifetime value is 15% lower than that of shoppers acquired during other times of the year.
Many times, these shoppers are “gifters” with little natural brand attachment, or they were enticed into placing an order with steep promotions. (Think Cyber Monday or last-chance holiday rush.) As a result, fewer of these folks tend to stick around after their first purchase than customers acquired at other times of the year.
Of course, the job of the retention team is to maximize the value of every customer relationship.
But as an acquisition marketer thinking of your customers as an investment, you need to be able to optimize the tradeoff between the number of new customers and their value to the business — to determine, in other words, what level of acquisition spend on Google AdWords will provide the best return on investment (ROI).
This means you need to find the sweet spot between quantity and quality — and the single most important metric to help you optimize that tradeoff is customer equity.
Customer equity is a metric that provides visibility into that tradeoff. In this case, it represents the amount of new customer value generated in any given period (whether it’s a week, a month, or a quarter) through new customer acquisition — in other words, the cumulative long-term value of all the new customers acquired today.
Here’s how customer equity is calculated:
Customer Equity = # of new customers acquired * new customer CLV
Note that customer equity represents a tradeoff between the quality and quantity of new customers acquired. Teams can boost the new customer equity generated in a given period by acquiring a greater number of customers (without a commensurate decline in their predicted long-term value), or by acquiring more valuable customers (without too great of a decline in the number of customers acquired).
For example, all else being equal, a company would prefer to acquire 10,000 customers in a given month worth $120 each in CLV ($1.2 million in customer equity), than to acquire 15,000 each worth $75 ($1.125 million in customer equity).
For businesses that are serious about viewing their customers as long-term investments, customer equity is the definitive key performance indicator (KPI). And in the best customer-centric marketing organizations, it’s a dashboard metric tracked by everyone from SEM channel managers all the way up to the CMO. Teams can easily use cohort analysis to determine historical CLV, or a predictive analytics platform to identify the CLV of actual recently-acquired customers.
For most teams, it makes sense to track new customer equity on a monthly basis. That’s typically the cadence at which acquisition strategy decisions are made (e.g., shifting budget between different acquisition channels); and for the majority of retailers, it provides a robust sample size for tracking changes over time.
Customer Equity, as important as it is, is not the only metric customer-centric marketing teams track. It is joined by KPIs like Repeat Rate, Winback Rate, and The Leaky Bucket Ratio (read more about these KPIs and download a cheat sheet of them here).
Ultimately, customer-centric marketing is about understanding what makes customers unique. For acquisition marketers (for both SEM and other channels), this comes down to the CLV impact of varying acquisition strategies — and customer equity is the single most vital tool for acquisition marketers in optimizing their strategies around long-run customer value.