ROI Isn't the Only Factor to
MBA and Dan Otto
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.
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.
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
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.
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
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.
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.
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.