Member Exclusive   //   October 16, 2019

How brands try to make customer lifetime value and retention rates look as good as possible

Brands, especially venture-backed ones, live and die by a few metrics. Customer lifetime value and retention rates are especially critical in proving to investors that their company is worthy of being valued at five times or ten times revenue.

But in the rush to report as rosy of numbers as possible, some brands resort to creative accounting. Others may cherry-pick which group of customers they use to report such metrics, using their best group of customers.

Modern Retail asked a handful of marketing experts what some of the most common tactics they’ve seen have been employed by brands to make their metrics look better than they actually are.

Customer Lifetime Value
Because customer lifetime value (LTV) is a projection of future spending activity, not a current activity, there’s no one right way to calculate it. “The rule of thumb is companies want to report as big of a value as possible,” said Dan McCarthy, the co-founder of data analytics company Zodiac, which was acquired by Nike in 2018, and a professor of marketing at Emory University.

Essentially, customer lifetime value attempts to calculate how much a customer will spend with a brand over his or her lifetime. Companies may calculate it by taking into account the: average order value, how frequently a typical customer purchases with a company over a year, as well as how much it costs to provide the customer with that particular good or service. If a company is a subscription company, they also need to take into account how long customers typically stick with a subscription for.

As a result, ask a company how they calculate LTV, and the answer can get quite lengthy. Peloton, for example said in its S-1 that it calculates average lifetime value generated by its customers acquired in a given period of time by taking its monthly fee of $39 for its connected fitness subscription, multiplying it by the number of new subscribers in a period, multiplied by the months of subscription lifetime “implied” by its average monthly churn rate.

Then, Peloton takes that number and multiplies it by subscription contribution margin, which is calculated by taking the profit generated by those subscriptions, divided by subscription revenue.

Peloton says that, per new subscriber, that works out to an average lifetime value of $3,433, $4,015, and $3,593 in fiscal years 2017, 2018, and 2019 respectively.

McCarthy said that one of the most common ways he’s seen brands try to inflate LTV is by only taking into account the total sales brought in by a customer — not how much it took to acquire that customer, if a discount was offered to that customer, or how much it took to get the physical product to that customer. One vp of growth at a subscription brand said that they’ve seen one company only take into account the cost of a physical good — not shipping costs — when calculating LTV.

“We know that customer lifetime value in truth is supposed to be how much value I’m going to get — which is a profitability measure — so to report a sales-measure is going to vastly overstate the value of customers,” McCarthy said. As a result, many investors want to see what the ratio is of a brand’s lifetime value to customer acquisition costs.

Other companies might assume that a higher percentage of customers will buy from subsequent product lines than they actually do, or overestimate how long a customer spends using a product.

With retention, the biggest issue is what cohort a brand uses to calculate retention. Marketers say that a brand’s first customers are typically its most loyal — so the retention rates might not look the same for customers acquired in year one versus customers acquired in year five.

“Churn is rarely linear,” said Alec Barrett-Wilsdon, who leads growth tooling at subscription skincare brand Curology, adding that a subscription company within a year might see “10% [churn in] the first month, 6% the next three months, and 5% the next eight months.”

He also said that seasonality and subscription cadence should be taken into account when calculating retention  — many cancellations, for example, will usually come right before or after a billing notification.

Peloton, for example, noted that it calculated its retention in a fairly straightforward way in its S-1 — it took the number of cancellations in a given quarter, net of reactivations, divided by the average number of new subscribers customers in each month, divided by three months.

However, the wrinkle in this calculation is that while Peloton now only offers month-to-month subscription plans, before June 2018, it offered 12-month, 24-month, and 36-month subscriptions.

So, some customers acquired before June 2018 may have remained active, not because they chose not to cancel their monthly subscription, but because they had already paid for a 12, 24, or 36-month subscription.

Peloton does not break down exactly how many customers before June 2018 subscribed to which plan. Given that Peloton eventually switched to a month-to-month only subscription, it’s likely that most customers were buying that type of subscription anyways. But without it, it makes it more difficult to tell which customers were truly at risk of canceling their memberships.

As such, McCarthy said that the best way to understand is retention is to look at it across multiple cohorts, to see how much retention may change in later cohorts.

“Companies, they may not be comfortable disclosing some of this information in their filings, but it’s going to help them in the long run,” McCarthy said.