(2012-09-04) Gurley The Dangerous Seduction Of The Lifetime Value LTV Formula

Bill Gurley: The Dangerous Seduction of the Lifetime Value (LTV) Formula. ...people who have a hidden agenda or who confuse a model with reality can misuse it.

Here are ten reasons to avoid worshiping at the LTV altar:

It’s a Tool, Not a Strategy. Heavy LTV companies forget that the LTV model does not create sustainable competitive advantage.

arbitrage games rarely last.

The LTV Model Is Used To Rationalize Marketing Spending.

It is no coincidence that companies that put a heavy emphasis on LTV are also the ones that have massive losses as they scale, frequently even through an IPO.

Consider that most companies limit any “affiliate fee” they would be willing to spend to 5-10% of sales. Yet when they are marketing, they use different math. They use LTV math, and all the sudden it’s acceptable to spend 30-50% of revenue on customer acquisition.

The Model is Confused and Misused.

If you have organic customers, they shouldn’t be included in the spend calculus

Also, many people discount “revenues” rather than marginal cash contribution. It is critical to bundle all future variable costs of supporting the customer in order to fairly estimate the future contribution.

Business Isn’t Physics – The Formula Is Not Absolute

LTV zealots often hold an overly confident view of the predictive nature of the formula

The LTV Variables “Tug” at One Another.

Tren Griffin, a close friend that has worked for both Craig McCaw and Bill Gates refers to the five variables of the LTV formula as the five horsemen. When one horse pulls one way, it makes it more difficult for the other horse to go his direction.

If you try to grow faster by spending more on marketing, your SAC (CAC) will rise (assuming a finite amount of opportunities to buy customers, which is true). Churn may rise also, as a more aggressive program will likely capture customers of a lower quality.... Ironically, many company presentations show all metrics improving as you head into the future. This is unlikely to play out in reality.

Growing Becomes a Grind.

How realistic is it to assume that your SAC (CAC) will drop as you 4X your spend? Supply and demand analysis suggests the exact opposite outcome

Purchased Customers Underperform Organic on Almost Every Metric.

The Money Could Go to the Customer

Providing a better value-proposition to the customer is much more likely to endure goodwill than spending on marketing.

LTV Obsession Creates Blinders

Some of the most efficient forms of marketing are viral marketing, social media, and effective PR). Most companies that obsess about LTV are less skilled at these more leveraged techniques

Tomorrow Never Arrives. The Utopian destination imagined by the LTV formula is a mirage.

The bottom line is that “one day we can stop spending and be remarkably profitable” rarely comes to fruition.

This should not be misconstrued as a eulogy for the LTV formula. It has a very important place in business as a way to contrast and compare alternative marketing programs and channels. It is a tactical marketing tool that requires candor and thoroughness in its implementation

Companies need a sustainable competitive advantage that is independent of their variable marketing campaigns.