2 Must-Have B-to-B Metrics
Smart CEOs know two essential B-to-B metrics to successfully grow their businesses:
- contribution per order (CPO) for new customers; and
- life-time value (LTV) of existing customers.
They may sound difficult to figure out, but the process is actually easy.
The CPO metric for new customers is a close approximation of your cost to acquire a new customer. Those two metrics aren't exactly the same. However, it's usually easier to calculate your CPO, which you determine by segment of your mailing. The formula by segment is as follows: (sales - cost of goods sold - promo cost) / total number of orders = CPO.
Let's say you rented and mailed your catalog to a prospect list of 10,000 names. From this segment you received 50 orders for a total of $6,250 in sales. Your cost of goods runs at 45 percent for a product cost of -$2,813. You mailed those catalogs for 50 cents a piece, totaling -$5,000 in promotional expense.
Your calculation is ($6,250 - $2,813 - $5,000) / 50 = -$31.24.
You're acquiring customers at an initial loss, but don't worry. You now need to compare your customer acquisition cost to your LTV.
Notice that we don't spell this metric as "lifetime." The reason is that life-time value measures a customer's value over specific increments of time, such as months or years. Otherwise you could be comparing and averaging results from customers with 10-year purchase histories vs. customers with only one-year histories.
A good place to start is to calculate this metric cumulatively for one year, two years and three years. You can get more granular than yearly, but often year increments work. In the chart below, LTV is calculated as additional incremental sales to the initial purchase. The calculation by timeframe is: (sales - cost of goods sold - promotional cost) / number of customers.
A common mistake is to calculate LTV based only on the individual acquisition cost, which in this case is 50 cents — the cost of the catalog. This method doesn't take into account the full promotional expense of the entire prospect list that you rented and mailed. You actually spent $5,000 to acquire 50 customers, not $25, which is only the cost of the catalogs for the 50 customers who responded.
Obviously B-to-B companies want to make money on customer acquisition. In reality, they settle on breaking even within the first 12 months to 18 months. In this case, the year-one additional sales calculate to a contribution of +$28.38 per new customer. After the first 12 months, you're close to breakeven but are still underwater by -$2.86 ($31.24 - $28.38). During year two, things turn around dramatically. You show a contribution per customer of +$91.13, which calculates to a two-year profit of +$59.89. In Year three, with a +$291.38 contribution per customer, you're ahead by +$260.14.
Of course, you can get more detailed in these calculations and include a value-of-money calculation and an estimate for overhead, usually in terms of a percentage of sales. But these are the essentials to get you started.
Based on these metrics, some companies will limit any new customer acquisition list or channel to their calculated LTV target. If an effort falls beyond their parameters, they cut it. Other companies will dollar cost average all of their prospecting efforts. This means that some lists turn a profit immediately and others turn a profit beyond the calculated LTV target, but on average their combined prospecting efforts are within their target range. The first technique is a bit conservative, while the second may be too aggressive. Usually a balance between the two approaches works best. Regardless of which approach you choose, you can now comfortably determine what you can invest for new customer acquisition.
A columnist for Retail Online Integration, George founded HAGUEdirect, a marketing agency. Previously he was a member of the Shawnee Mission, Kan.-based consulting and creative agency J. Schmid & Assoc. He has more than 10 years of experience in circulation, advertising, consulting and financial strategy in the catalog/retail industry. George's expertise includes circulation strategy, mailing execution, response analysis and financial planning. Before joining J. Schmid, George worked as catalog marketing director at Dynamic Resource Group, where he was responsible for marketing and merchandising for the Annie's Attic Needlecraft catalog, the Clotilde Sewing Notions catalog, the House of White Birches Quilter's catalog and three book clubs. George also worked on corporate acquisitions.