Stop Using ROI Alone and Start Doing Math to Learn LTV
Which is better, ROI or LTV?
Many marketing teams are dependent on return on investment (ROI) as their primary metric for success. This calculation is used to measure how effective a team or campaign is performing against the investment. However, the simplistic calculation can give us a misleading indication of true success. To really understand your campaign’s performance we should dive deeper into all the factors involved.
The base calculation of ROI is defined as (Profit – Cost) divided by Cost.
This is a good overview of the simple way of figuring out ROI. However, marketing departments have many variables, and we can tweak our formula to be even more specific.
Cost is usually associated with the cash spent, but it can also include an assortment of parameters. SaaS products specifically used, outsourced creatives, image rights you purchased, or or other campaign considerations. And if you are doing it right, you should be consulting with legal from time to time to ensure compliance. This cost, if not in house, should be noted on the expense column.
Time is one of the biggest factors when determining true ROI. Is this based on 30 days, 3 months, or 3 years? To help understand a fair time table think through several factors: sales cycle and add that to end of campaign, perhaps MQL vs. SQL or a ratio there of, and could report in a pattern that fits product cycle.
Profit can be determined simply or more detailed. Profit should be determined based on cash calculations for the company. Whether it is up front, payment plans, LTV focused, etc. should be reflected in the ROI calculation within the timeframe and cost structures above.
The amount of variables can be quite large, and in some cases pedantic. However, if you take the time to set up an excel sheet thoroughly with all potential variable cost, it should auto pop your calculations quickly. A working template that each team member can utilize or customize will make your reports a true reflection on the numbers.
Now to take this to the next level, take the template to determine opportunity cost. Do the math before your campaign. Insert the expectations into your new calculations and compare one campaign to the other.
Realism is another element to add to the reporting. By calculating the true cost, true profit, and opportunity cost, you can add in stress tests to see how things would look in best case/worst case scenarios. The stress tests encourage good questions about what it would take to achieve the best or what can happen to create the worst case scenarios. Both bring out dependabilities to influence marketing success.
A good practice is discuss this with the team so everyone agrees. Then take the time to educate your superiors so they have buy in and input as well. Going forward, everyone will have the same vocabulary and formulas as they report on marketing.
As good as ROI is in revealing return, it has some drawbacks. In order to really make decisions on whether you should do, or continue, a campaign, you should evaluate your Life Time Value (LTV) which is the amount of money given to company by a customer.
LTV is calculated as : Average Revenue – (Cost of Acquisition + Average Cost of Maintaining) = LTV
Like ROI above, we can determine this in multiple ways. The first obvious assertion is time. Time is usually a known number, lifetime. You can average this out to determine what it IS, not what you HOPE, it to be.
The cost of acquisition is average cost it requires to get a new paying customer. This may vary by channel, but can also be averaged out from all the known customer flows.
Cost of maintaining is harder to define as you can get really granular. We do suggest doing this though, as the hard work and good questions will benefit the team in multiple ways. Many aspects could be: customer support, server cost, hosting costs, 3rd party tools, on going updates from development, API costs to run, as well as any factor your company deems a burden such as time, legal compliance, etc.
Having this calculation in an excel sheet will again save time and make the process part of your decision making. Let’s review when and how to use these metrics.
How are ROI and LTV different?
- ROI is a metric at an exact moment. LTV is the true reward for increased business
- ROI works well for short term projects and experiments. LTV is the mark to judge strategy
- Using both gives a better understanding of the story and its context.
A good example of how this works is coupons. This form of marketing dilutes profit from the initial sale. So our ROI will be very small for the campaign. For example, let’s say you make $15 from it. Based on this metric alone, you may lean toward not running it, considering you usually make $45 in profit. But what if the LTV of a customer is $115. You may look at the long term effect and decide it is a good decision to shave some profit now, to gain much more in the future. LTV alone is not a definitive yes, as cash flow may influence decisions as well as the period of time to collect full amount. But with both metrics in hand, you are better equipped to make a good decision and have a great discussion with your team.