So the example I'm going to give you I'm just going to construct it.

It's for a company we've discussed in some of our other lessons and

sessions together, Dollar Shave Club.

We can all relate, I think, to the process of shaving.

So let's imagine that the customer acquisition cost is a dollar.

So it costs Dollar Shave Club to get my attention to encourage me to use them,

the money they're spending on search, all of the things they're doing they're

figured out on average it's costing them about a dollar to reach me.

And how much money might they expect to get from me in the future?

Well let's imagine that the margin they get,

that's m from selling me a $6 razor is about $5 because of some shipping costs.

So m is $5.

Let's imagine that by looking at past data they figured out that about

90% of customers continue from one month to the next, so r is .09.

And let's imagine for simplicity they decided that the discount value, or

the time value of money is 10%, so d is 10%.

So now, let's calculate the customer lifetime value for me, a customer that's

going to be around for three months or three periods, so big T is equal to three.

So, the margin in the first period, t equals 0 at the beginning, is $5.00.

We multiply $5.00 by 0.9 raised to the 0,

that's just 1, divided by 1 plus 0.1 to the 0, that's just 1 as well.

So, time period, t equals 0 we get $5.

And then, in t equals 1, we now take the $5,

we multiply it by 0.9, raised to the power of 1,

divide it by 1 plus 0.1 again raised to the power of 1 and so on.

So, what's interesting about this formula is we've made two implicit

assumptions that are simplifying.

First thing is, we've assumed that the margin is constant every period,

which of course may not be true,

because we may be able to up-sale the customers into other products or services.

And then secondly, we've assumed also that the retention rate, as constant over time

as well but of course the retention rate could be going up

as I'm becoming more captive or it could be going down as I think about switching

away to other competitors like Gillette or Harry's or one of those other companies.

But again, what I'd encourage you to do is to sit down and

play around with these two formulas with your team to see if you can't get a sense

of how much value you might extract over time from your customers.

The bottom formula just makes it a little bit more simple by saying that

the customer is essentially living in perpetuity.

If that's the case then we can simplify the equation just to be the margin

multiplied by the retention rate divided by one plus again the interest or

discount rate minus the retention rate.

So try and play around with those numbers a little bit for your own business.

The next piece I'd like to introduce now is the idea of return on investment.

And so now if you take the customer lifetime value that you've calculated by

either of those two methods.

And you subtract the acquisition cost and

then divide that whole number by the initial acquisition cost itself.

You've got sum estimate of the return on investment that you're getting

from each customer.

So, now what I'd like you to think about is if you have different kinds of

customers with different labels of CLV and also different labels of acquisition cost.

You might be able to then plot the customer lifetime value

against the return on investment, and

you might find that customers that have very, very high lifetime values

are not necessarily the ones that give you the highest return on investment.

Now again, the whole goal of going through this exercise

as we think about acquisition is not to be

absolutely precise on these numbers because we just using a model after all.

But to think about the important components that then also tie back into

the diagram that I showed you in the beginning that the value of the customer

can be increased over time, hopefully to recoup the acquisition cost.

So as you're doing it, two other things I want to mention number one in the formula

for customer value, the most important component typically is retention.

The more you can increase the retention rate of the customer the larger that

number is going to be.

And then secondly, goes without saying but often firms violate this principle,

particularly entrepreneurs in the early days.

Never pay more for a customer than you can expect to get back in return.

That's the relationship between CLV that you see right there and

the acquisition costs that we're paying to get customers into the fold to begin with.

So now as entrepreneurs, if we take the concepts around customer acquisition and

we marry those with the customer lifetime value ideas and

return ideas that we just talked about.

We then sometimes want to sit back and

take a very holistic view of what I term customer equity.

And customer equity really has four pieces to it.

We've really just focused up on the upper left, which is the direct value that we

get from a customer, the acquisition cost, and then the lifetime value.

But we might also think about,

as entrepreneurs, is there an information value from dealing with customers?

The customer data that we have may allow us to be better at servicing customers in

the future or it may be monetizable even in its own right.

As we continue on around the circle, we also think about communication value.

So maybe there's something going on with customer equity,

certain kinds of customers.

I'm going to give an example in a moment.

That generate value for us by telling other people to join our business and

also become customers.

And then finally, of course,

in customer equity there's the notion of relationship value.

As you start to build trust and

you build the brand that you have as an entrepreneur.

Then you can start to have a relationship, not just transactions with customers and

they may be willing to buy other products and services.

So if you're somebody like a Dollar Shave Club or a Harrys.com selling razors, as

the trust is built the customer may then be willing to buy other products related

to shaving or other kinds of products that the customers is using in the home.

And so, now let's move on to the absolutely critical concept of what I call

acquisition targeting.

And here's five principles that I want you to have top in mind as you go through and

you run the numbers, and you look at what's really happening

as an entrepreneur to the customers that you're acquiring.

So first of all, you want to be as selective as possible

when you acquire customers, and you should only acquire customers in the beginning,

unless there's some crazy exception where the customer lifetime value is positive.

So be selective, make sure that you're getting the right customers through

the gate in the beginning,

the ones that have the highest propensity to not only enjoy the product.

But also give you feedback about what they like and they don't like and

also to refer others.

Second thing you've got to be prepared for

on the slide to see your acquisition efforts get more and more difficult.

So the customers that you acquire in month three and four or year five and year six

typically be harder to acquire and harder to obtain than the initial ones.

The initial customer should be the enthusiast, so you should be prepared for

your efforts to get more strenuous and the costs to go up accordingly.

Third you should be aware that the more leverage you get from retention,

the more you should be paying upfront to acquire customers.

So, if you believe there are really critical things that you can do

to increase that retention rate lever, which is the most important

component of the formula that I just showed you If that's really true,

you might be willing to spend more in the beginning.

If you don't think there's much that you can do to bump up retention,

then you should be wary of overspending on acquisition to begin with.

And bullet point four on the slide is be aware that investors,

particularly savvy investors, like to see you recover the cost of acquisition

in the smallest number of transactions possible so if you're telling

your investors it's going to take a long time to pay back initial acquisitional.

Many, many transactions.

That can often be a red flag to the investor.

And, lastly as entrepreneurs, let's be reminded that

one of the most critical principles of marketing always holds true.

Customers are heterogeneous.

Some customers have large retention profit potential.

Some guys will be shaving with Harry's Dollar Shave Club for 20 years.

Others have much lower retention profit potential.

So understand what that spread is and also understand that

acquisition recovery time might differ for different kinds of customers.

Some customers, the payback is coming quickly others more slowly.

So those are two dimensions that you can essentially use to plot your customers.

How long will it take to get the money back?

And then relate that on the Y axis to the retention profit potential.

And now, we're going to close out our discussion of customer acquisition.

Which is a fascinating topic and critical for

all of us as entrepreneurs with, first of all, an example, and

then secondly a piece of research that I think gives us some additional insight.

So on the slide there you're going to see the icon for Jet.com.

I'd encourage you to go to the website and check it out.

Jet is a relatively new company that's a challenger in the United States to Amazon,

has a very interesting business model around price transparency and so on so.

As part of the homework I encourage you to take a look,

maybe read a few articles about the company.

So, there were two critical principles that apply to customer acquisition by

jet.com and also other companies.

The first is the principle of selection and

the second is the principle of treatments, so let me explain those.

The principle of selection is that customers that are selected by other

customers, or that come in because of referral, on average tend to have

higher customer life time values and lower customer acquisition costs.

So if I refer my friend Kat to Jet.com, she's likely to be a better customer

than somebody who was just acquired at random because the reason I referred her

is I know that this product or service is going to be a good match for her.

So this tells us that encouraging customers to acquire other customers

on our behalf is an absolutely vital level in the customer acquisition process.

Secondly in the customer acquisition process,

is the idea of a treatment of fate.

So one of my colleagues, Crystal Vandenbolt, here at the Wharton school,

did a very, very nice piece of research looking at a European bank, and

their customer acquisition process.

And you found the customers who became customers because of referral, also had

a higher customer lifetime value and were also more likely to refer other customers.

If that's the way I learn about a business, I'm just more

likely that it was the treatment, I'm more likely to then to do it myself.

So one really important engine for the entrepreneur and acquisition dynamics is,

get existing customers to refer other customers, they'll have higher CLV's.

And those customers who were referred,

will then be more likely to do referral themselves.

This now brings me on to a piece of research that I conducted myself with some

colleagues on an e-commerce business, that's going to tie some of

these ideas together, and make one additional final point.