Pick your war and check lifetime value is the constraint

1. Lifetime gross profit, and why that name

The formal definition: the total gross profit one customer produces over the whole time they are a customer. Lifetime value and lifetime gross profit may both be used here for the same thing. The definition, and what goes into the number, sit on SOP 55 — Compute lifetime gross profit and the ratio that gates spending, section 1.

What this page adds is why the name spells out gross profit. The view here is that lifetime value has confused many people, especially in service businesses, because a lot of the writing on it comes from software. Software companies tend to run very high gross margins, and so they tend to work the figure out as basically revenue multiplied by the months a customer stays. That is only really true for them. A service provider, or someone who sells a physical product, has other costs to take out before the figure is true.

2. What the number is for: earnings per click

Lifetime value is not the real aim, in the view here; it is kind of an end result. The aim is to make each click pay you more than it pays any rival, since every business is bidding against every other in the same auction for attention. The prices you set, the churn that follows from them and your conversion rates all feed into a single figure: earnings per click.

If a click, not a view, is the prospect's first act, the goal is to be able to put the largest sum you possibly can into that auction, and so buy whatever attention you want. Why being worth more lets a business outbid the rest is set out on SOP 55, section 9; this page adds the per-click reading.

The per-click reading applies to a business that sells online. The rest of this page is mostly about lifetime value.

2.1 A lower price can earn more per click

The illustration comes from software. You test $29 a month against $99 a month. Let's say each price gets 100 clicks. Say the signup rate moves from 3 percent to 4.5 percent, that is, 3 signups against 4.5. In the example, churn runs twice as high at $99. Walk all of it through, and earnings per click come out higher at the lower price.

In the same example, the "blended price" at $99 appears as $3 against $28, and the trial conversion as $33 against $66. Neither pair reads as a price or as a rate. Which price had which signup rate, and what those pairs measure: Not established on this page.

This is why the subject gets complicated, and it gets more so once you add trials and front ends. There are also different cohorts, left aside here.

Many of the variables act on each other. The more of them there are, the more of them need study; you can give up because it looks too complicated, or learn to play it. That example was a recurring business. Where customers do not pay on a cycle, the arithmetic is far simpler.

3. Pick one of the two wars

Strategic principles set the frame. One: whoever makes a customer worth more to their own business than the competition can wins; this is the one to write down. Another: whoever can pay the most to win a customer wins.

In the view here, there are two wars a business can choose to fight. One is fought on what a customer costs to get; how low is not established on this page. The other is making so much from each customer that what it cost to win them stops mattering. Anyone in between, unaware that a war is on or that the game favors one extreme or the other, gets nowhere.

3.1 The ratio as the unit of growth

Take lifetime value over acquisition cost as the basic economic unit of growth, and you have two figures to work on. Push one very high or the other very low, and either way you can make the ratio large. The benchmark on the ratio is on SOP 55, section 6.

A comparison: one business spends $1 to win a customer worth $20; another spends $1,000 to win a customer worth $5,000. Some would call the first silly, since it only makes $20. The preference here is to trade $1 for $20 a zillion times rather than $1,000 for $5,000. The like-for-like version of the first is spending $1,000 to make $20,000, or $1 million to make $20 million. Given two businesses with ratios like those, the pick here would probably be the one where customers are easier to get.

3.2 Which war a service business is in

Many of you are not sure which game you are playing. If you run a service business, a category reckoned here at 80 percent of US businesses (one would probably imagine the share holds kind of the same across the world), you are probably in the game of raising value as high as it will go.

The reason is the people. A service business has humans delivering what it sells, and what humans cost has a floor: you cannot pay someone less than they need to eat. That leaves better process or better technology as the only real ways to drive cost down, and that is, basically, the other war. The big companies with vast numbers of customers are almost all built on software. The other big companies almost all have huge lifetime value, because they are not software: their edge has to come from customers who love them and keep buying for life.

4. More customers, or customers worth more

The only way to grow a business is either to win more customers or to raise what each one is worth. Nothing else enters into it. SOP 184, the constraint page, rests on the same arithmetic in its section 7.

To see where your own business is heading, multiply sales velocity by lifetime value. The result is the revenue you would reach, in theory, if you kept going at that level indefinitely. By this measure some of you will be growing and some of you shrinking; one owner reports using it every day. See also SOP 223 — Read the revenue ceiling off sales velocity.

Sometimes you have to make customers worth more before you can get more of them. Some of you would take on more customers but cannot pay to get them; that is lifetime value that is not high enough, and it is why the number is a ratio. Many variables affect a business in general, and many affect lifetime value, but lifetime value affects everything else.

5. The usual reason leads feel unaffordable

The case comes with its conditions attached. Assuming your lead costs sit inside industry averages, your selling works, and your cash flow covers acquisition cost when you close (a lot of assumptions, admittedly), you get fewer leads than you want, and the reason is that you cannot afford more. Put another way, you make too little per customer.

Picture a hypothetical, with no amount given: if you could spend that much, a lead problem is probably off the table, because you could afford to buy as much traffic as you liked. That is the place to reach. First, though, make sure the problem you are solving is the right one.

6. Check that lifetime value is the constraint

A quick test, asked in this order:

• Could the business take on more customers? Answer yes or no.
• If it could, can you pay to win more of them? Again yes or no.
• If you cannot pay, is lead cost the reason? You would know by setting your cost against the industry average: yours would sit above it.
• Are too few converting? You would be under the benchmark for the way you sell. Examples: selling in person, you close 10 percent of the people who come through the door where 30 would be the norm, by a good guess; on webinars 5 percent buy, and as long as the webinar draws good attendees you should probably be converting 10 to 15 percent.
• Do you make too little from each customer? Industry averages exist for the ratio of lifetime value to acquisition cost, and for lead costs too. If your acquisition cost matches the average and you still cannot afford it, each customer likely earns you too little.
• Or do you lack the cash flow to cover it?

Flag: the benchmark rates. SOP 245, section 4, gives other figures for the same check, both one-on-one and on webinars. What each costs: by this page, a webinar selling 5 percent is converting too few, so you work on selling where SOP 245 would call the rate usual; by SOP 245, an in-person team closing 30 percent sits below its line and goes to fix the sales process, where this page would put it at the norm. This page does not settle which reading is right.

The same test, asked in the same order, is on SOP 196 — Answer the money question, starting with acquisition cost, section 8, along with what to do when you can both handle and afford more customers. That page gives no benchmark conversion rate; the figures here are examples, with a good guess on the in-person figure and a condition on the webinar figure. The case of an average cost you still cannot afford is SOP 196, section 5. The fixes for making too little per customer are listed on SOP 197 — Solve a leads, sales or profit-per-customer problem, section 4, and cash that arrives too slowly has SOP 198 — Accelerate cash flow when profit does not come fast enough.

7. Any gain raises throughput, unless supply is the limit

A side point. If you are not supply-constrained, raising any part of the funnel raises what comes out of it. For example: raise prices by 10 percent, lift conversion by 10 percent and cut churn by 10 percent, and you get 33 percent growth.

So which one should you work on? As long as supply is not the limit, every improvement adds growth. That, admittedly, is probably the reason more businesses are out hunting for customers. The exception is the done-for-you service business, which usually is supply-constrained, and which a lot of you run.

SOP 196, section 10, makes the same point with its own worked figures. When supply is the limit, the page to open is SOP 200 — Treat a supply constraint as demand for talent.

8. Take the path with the best risk-adjusted return

Lifetime gross profit can be grown in many ways that work equally well. The hope here is that you choose the path with the highest risk-adjusted return given the skills and resources you already have; it is also the one that would be chosen for you. Some of the strategies may leave you doubting you could pull them off, or that they would work in your industry; to that the answer is maybe, maybe not; it is not known. If one makes you think you could certainly pull it off, the preference here is that you start there.

Weighing one route against another by what you can already do is the subject of section 4 of SOP 186 — Pick the path up the mountain that fits your skills; SOP 197's section 2.4 gives the same advice for leads.

9. The short version

Put as straight as it can be, probably like this: if value per customer truly is what limits you, you probably just need to:

• sell to better customers;
• charge more;
• provide fewer things, and better ones;
• remind people, relentlessly, to buy again;
• offer something extremely expensive, or at least set a high anchor, so that whatever you price next looks low beside it.

That is probably what it takes to raise lifetime value. With only thirty seconds to say it, it is probably what you have to do.

10. Where this sits

• The definition of the number and what counts inside it: SOP 55, section 1. Its benchmark, and why it decides who may advertise: sections 6 and 9 of the same page.
• For the cost side of the ratio, open SOP 56 — Define and compute what a customer costs to acquire.
• Finding the one constraint in the first place: SOP 184.
• Sorting the money problem, and the fixes for each branch: SOP 196 and SOP 197.
• Pages beside this one, by their titles: SOP 223 — Read the revenue ceiling off sales velocity; SOP 226 — Set a gross margin goal and close the gap three ways; SOP 224 — Set fractal price tiers and read price off the close rate; SOP 228 — Weigh a downsell against raising the core price; SOP 227 — Hold the margin line with targets, not industry averages; SOP 229 — Sell to richer customers and rewrite what you measure.

11. What this page does not decide for you

• The price test. Which price drew which signup rate, and what the $3 against $28 and $33 against $66 pairs measure. Not established on this page.
• The first war. How cheaply customers must be won in the first war. Not established on this page.
• The hypothetical spend in section 5. This page gives no figure for the amount.

12. The checklist

Step	What to do
1	Count lifetime value as gross profit, not revenue
2	Judge value by what a click earns you, since that sets what you can bid for attention
3	Decide which war you are in: cheap customers, or customers worth so much that cost stops mattering
4	If you run a service business, you are probably in the value war
5	Ask whether you can handle more customers, then whether you can afford to get more
6	If you cannot afford more, ask in turn: lead cost, conversion, too little per customer, cash flow
7	If you are not supply-constrained, treat any funnel gain as growth
8	Start, as preferred here, with the path of best risk-adjusted return for your skills and resources

13. What this page does not cover

Raising conversion rates is SOP 197, section 3. Repeat purchases are SOP 235. Anchoring a price is SOP 68 — Run the anchor upsell.