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ROI Isn't the Only Factor to Consider

by Barbara Lewis MBA and Dan Otto

Acquisition or Retention?  That is the question.  Should you put more money or less money in retention next year?  A recent survey claims that this year more companies have spent additional money in the retention arena – a swing from previous years when acquisition spending was king. 

The problem faced by many marketing managers is that, traditionally, marketing budgets are based on a percentage of last year's revenues or budget, which ignores the relationship between marketing spending to profitability effectiveness and has a short-term focus leading to limited success.   While marketing and database executives may concentrate on optimizing databases and lists, few, if any, optimize the total marketing budget.   

Yet optimizing the marketing budget can be a valuable strategic tool that will improve long-term success.  With less than a dozen statistics, the optimal marketing budget can be determined through computer modeling.  Once the total budget is calculated, the division between acquisition and retention is optimized. 

While executives guess and try to figure out the best marketing budget and how to split it between acquisition and retention, computer models are pointing the way.  There are several basic principles that provide the foundation for optimizing the marketing budget: diminishing return market response curve, customer lifetime value and customer equity. 

The diminishing return market response curve is based on a commonly accepted principle that no matter how much money is spent, not every prospect will be converted to a customer.  As spending reaches this “ceiling rate,” the next dollar spent will have less impact than the last dollar spent.  Using historical data, executives can calculate their market response curve.  

Customer lifetime value is the net present value of a today’s customer’s current and future contributions to profit.  Customer equity is the net present value of contribution of all current and future customers. 

While certain executives are still calculating return on investment (ROI) for marketing spend, others are not focusing on campaign ROI, but rather on customer equity.  For example, you offer a promotion on a product and you generate two times the amount spent, which appears to have a very positive ROI.  However, let’s say that not one of those customers buys again.  You have not retained one customer for a second purchase.  Your customer lifetime value is low, there is little contribution to your customer equity and your retention rate is in the pits with this group of customers.   

On the other hand, you offer another promotion in which you only break-even.  However, every one of those customers orders again and again.  And these customers continue to order for years to come.  The result:  your retention rate is high, your customer lifetime value increases and your customer equity is high as well.  However, your ROI is very low. 

Which is the better scenario?  Most executives probably would opt for the high ROI; however, that metric is not optimal.  The better metric is to optimize customer equity, which will increase long-term revenues and profits.  The short-term view might be to focus on immediate ROI; however, the long-term value of the firm is diminished.

Optimizing on customer equity will dictate how much budget should be spent on acquisition compared to the amount that should be spent on retention.  This figure can be statistically calculated, rather than using a guestimate.  The shift of budgets between acquisition and retention should not be the result of the economy or the campaign ROI or popular trends.  The shift should occur when maximum customer equity can be achieved by reallocating the budget.

Prior to computer modeling, it would be nearly impossible to calculate the optimal marketing budget and the optimal amount for acquisition and for retention.  However, using the three basic principles of diminishing return market response curve, customer lifetime value and customer equity as the foundation for calculation, the marketing budget with its acquisition and retention allocations can be optimized.

After the acquisition and retention budgets are optimized, the cross-sell, segment and channel marketing budgets can be optimized, as well.  Requiring additional inputs and using more sophisticated concepts, these optimizations can help firms maximize their marketing performances.  

No longer are marketing budgets left in the realm of guesswork or percentages of dollar figures or target amounts.  Marketing budgets can and should be optimized to increase revenues and profits, as well as customer equity.  For executives focused on long-term value, customer equity optimized marketing budget allocations are a must.

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