Lifetime Value Versus Payback Period
The problem is that LTV is rarely used as a day-to-day decision-making tool. It contains assumptions about risk and future sales that managers outside of marketing typically choose not to trust, regardless of the rigor with which it was developed. Worse yet, LTV usually does not answer a question that managers outside of marketing ask.
A multiyear LTV doesn't answer the basic, gut-level question non-marketers ask about any campaign, "How long until we make our money back?" To most managers, the campaign that gets in the black first is the best, and the one that gets in the black last is the worst.
Businesses view risk mainly by how it affects cash flow and amount of risk is tied directly to the amount of time it takes to earn their investment back. A potentially valuable client that would take several years to pay back initial marketing costs may not be worth the risk. A lower potential value client who takes a few months to become profitable may be what they are looking for today.
As a result, a five-year LTV calculation may be little more than an academic exercise. Few businesses, except for those selling long-term capital projects, are willing to wait more than six months or a year to recover prospecting investments.
Consider this example. A cable TV provider wants to offer one of two upgrade services to subscribers. It can offer either upgrading current service to all digital or upgrading service to all digital and adding a high-speed Internet connection. Let's review two possibilities using simplified spreadsheets to compare payback period and LTV.
With the current marketing results, setup costs (equipment and installation) and additional monthly net revenue (gross revenue minus additional cost), the payback period shows the digital-only offer to be the winner. Despite lower net monthly revenue, the digital-only offer reaches payback in six months while the digital-plus-Internet offer requires 12. For a short-term-focused, risk-averse manager, digital-only is preferable.
With the same revenue and cost assumptions as before, and assuming that 80 percent of subscribers will renew from year 1 to year 2, and also year 2 to year 3, the picture changes. Over three years, upgrading a customer to digital-only is worth $116, but digital-plus-Internet is worth $173. Digital-plus-Internet appears better in the longer term.
However, a manager who hopes to be promoted in six months probably will choose digital-only. A company short on cash or in need of a quick boost to profit will choose digital-only as well. Whether it appears better in the long run may be of little consequence.
Without looking at both payback period and LTV, marketers inadvertently present an incomplete picture to decision makers. Both methods have merits in differing circumstances. Marketers serious about using data to build sales should consider using both.