How to Calculate the ROI of Online Communities

By Richard Millington

ROI People

Customer Lifetime Value (CLV)

The customer lifetime value is the total predicted profit generated by an individual customer.

Imagine you run a community for a recruitment consultancy. Your recruitment community helps identify leads. A converted lead (i.e. someone who uses your service to recruit an employee) might generate $20k in profit. Let’s imagine you generate 30 such leads a year. This is $600k in profit. That is a good outcome.

But now imagine the average company remains a customer for a further four projects over three years generating $20k in profit for each person you place. The lifetime value of these customers is now $2.4m* ($20k * 30 * 4).

* (in practice, we should use a discount rate for profit generated in future years).

Do not ignore the lifetime value of the customers the community has helped acquire or retain for the organization. This is value directly created by the community and should be attributed to the community. Understanding the lifetime value can be the single biggest factor to determine if the community will gain the additional investment it needs.

How To Calculate CLV

There are several different formulae for counting the customer lifetime value. At the simplest level, CLV is essentially the length of time the customer continues to purchase from the organization and the amount an average customer spends during that time frame.

CLV = (T x AOV) x R

T = average monthly transactions
AOV = average order value
R = average retention rate (in months)

However, this ignores profit, costs, and the discount rate. This will grossly over-estimate the value of a customer. An improved formula would also multiply this figure by the average gross margin. This tells you how much profit you make from a customer rather than how much a customer spends.

CLV = ((T x AOV) x R) x AGM

T = average monthly transactions
AOV = average order value
R = average retention rate (in months)
AGM = average gross margin)

Instead of multiplying by retention rate, you can also divide by annual churn rate.

This tells you how much profit each customer generated for the organization. This is probably the deepest level we wish to go to here. A more complicated (and accurate) formula would discount this profile to its Net Present Value. While this is more accurate, the difference usually stays below 10% for until just below five years.

Maximizing customer lifetime value is the holy grail for many database marketers. The purpose of increasing loyalty, customer satisfaction, and a whole host of related metrics are ultimately designed to increase the lifetime value of a customer.

However, while it is the ultimate goal, it is not often the stated metric. Instead, the metric is a direct antecedent of that goal. These are shown below.

  1. Increasing Customer Loyalty. This is a nebulous term which can refer to physical or psychological aspects of customers. It can refer to what customers do (e.g. buying habits), or what customers think (customer sentiment, how customers feel about the organization and think about its products). However, while customer loyalty is possibly the most cited reason for creating an online community, it has no established metric. Instead, customer loyalty is usually evidenced in increased retention rates, frequency of purchases, share of wallet, or average order value.
  2. Retention Rate/Churn. Customer retention rate refers to the amount of time a customer remains a customer of the organization. For organizations that sell subscriptions or membership products (e.g. associations/SaaS companies), renewal rates are essential to the business. Retention rates are affected by customer satisfaction/sentiment and competition with other organizations. Many organizations believe it’s far cheaper to keep a customer than to create one.
  3. Share of wallet. Share of wallet is the percentage of a customer’s spending within the product category spent with the organization. A simple example would be restaurant spending. If a customer spends $500 a month on food and $30 on one food product, the restaurant would have a 6% (30/500) share of the customer wallet. Many organizations believe it is easier to increase the share of wallet than it is to attract new customers.
    This is because existing customers are more likely to know and trust the organization. However, defining the product category can be very subjective.Share of wallet is usually improved through increasing purchase frequency (how often the customer buys the product), increasing the average order value (how much customers spend when they do visit or buy from the organization), via upselling (selling premium level products), downselling (selling cheaper products alongside big products), or cross-selling (selling completely different products to the customer). Note the clear overlap between these categories (e.g. average order value and upselling).
  4. Average order value. The average order value is a widely used metric referring to how much of the organization’s products/services a customer buys when they make a purchase. The average order value can be increased through tactics such as bundling products together, upselling/downselling/cross-selling, discounts etc. We see this at precise interventions at the moment of purchase (for example, airlines adding travel insurance at the moment of purchase). In a community context, it is widely believed that the additional information/social proof provided in a community environment encourages customers to buy more of the organization’s products when they make a purchase.
  5. Frequency of purchase. The frequency of purchase refers to the number of purchases a customer makes over a specific period of time (usually a year). The more frequently a customer purchases the product, the greater the value. While many organizations sell products in which the frequency of purchase is relatively fixed (cars, holidays, replacement goods, etc.), others (notably in services) sell products that could be purchased far more frequently.
  6. Customer Satisfaction Score (CSAT). The customer satisfaction score refers to whether the organization’s products or services meet and surpass the customer’s expectations. This is traditionally measured with a question such as “How would you rate your experience with {product/organization}” with a response on a Likert scale from deeply unsatisfied to very satisfied (or 1 to 7). Customer satisfaction has a significant influence in frequency of purchase and retention rates. An online community may increase satisfaction scores by providing a sense of community with others and helping customers gain additional use or maximize the benefits of the products and services. However, the links between CSAT and returns are murky. Some estimate just a 1% increase in variation of company returns, while others note CSAT has little correlation with stock market returns. Others have found mixed associations.
  7. Advertising views or advertising rates (CPM/CTRs). The customer lifetime value category also includes online communities whose primary goal is to sell advertising. In this case, the number of ads served and cost per mille, or cost per one thousand views (CPM) are important. Increasing the number of ads served (more visitors) or cost per one thousand views (higher quality of visitors/greater click-through rates (CTRs)) might be an objective.

We have presented the framework for these benefits below.

Benefits List

Customer Lifetime Value (CLV)
Increased spending from existing customers
Retention rates

Length of time a customer purchases from the organization

Customer loyalty

Customer sentiment

Customer satisfaction (CSAT)

Customer sentiment score (CES)

Share of wallet

% of spending within the product category spent with the organization

Average order value

Frequency of purchase.

Upselling, downselling, cross-selling

Ads served / CPM Serving more ads.

Higher advertising rates

Chapters

Share

 LinkedIn LinkedIn

 Google Plus Google+