Power Law
Marketers for the most part have missed the “power law of marketing” – that a relatively small percentage of customers account for a big chunk of revenues and make an even bigger contribution to profits. For many non-subscription brands, an analysis based on customer lifetime value (or even past transactions) will show that 20% of the customers contribute 60% of revenues and more than 100% of profits. What this also means is that 80% of the customers contribute 40% of revenues and are a net cost to the brand if one factors in acquisition and servicing costs.
The power law of marketing (which can also be interpreted as the 80-20 rule or the Pareto principle) is core to the idea of simplifying marketing. I have discussed this in a previous blog series The One Number to Predict Revenue. Here is how it looks:
The X-axis sorts customers while the Y-axis is the CLV. The area under the curve is the net predicted revenue – the aggregation of the CLV of each customer. The Best customers are towards the left of the X-axis (their revenue represented by the green shading) while the Rest customers make up the long tail (their revenue represented by the yellow shading). As I explain in my series, power laws are all around us. Most marketers have not opened their eyes and seen their customers in this context.
The complexity in marketing has arisen because of a lack of understanding of the fact that all customers are not equal and some are more valuable than others. By not differentiating between the Best (top 20%) and Rest (remaining 80%) customers, marketers have complicated their own lives – having to focus on a much larger base than they actually need to. Instead of providing amazing experiences for the most profitable customers, marketers have gone down the path of trying to provide a “lowest common denominator” experience to their entire base. This is ineffective and results in the churn of the Best and continuous re-acquisition of the Rest. No one is happy with the outcome.
What marketers need to do is to actually create two internal business units to focus on the Best and Rest customers. Their needs are different, the approaches to be followed are different. The same team cannot address the top 1% and the bottom 1%. And yet, I have not seen brands do this – outside of a few industries like airlines where a single transaction itself enables the segmentation and experience differentiation.
The reason for this is that most marketers do not think about customer lifetime value (CLV). Ironically, marketers are awash in customer data and the CLV calculation and identification of Best Customers is much easier now that it ever was. Marketers tend to think of the more immediate past (which customers have been active in the past 30/60/90 days) rather than analysing the long past (2-3 years) to predict the near future. The right CLV model needs to be used to factor in recency and frequency to calculate CLV for each customer and then segment them into Best and Rest. Without bringing in CLV and just looking at transactions from a narrow lens, all customers will look the same. As a result the focus ends up becoming on the trees (campaigns) rather than the forest (experience).
The power law of marketing is the big foundation idea for simplifying marketing. Understanding that the 20% Best Customers are many times more valuable than the 80% Rest Customers is the big insight that can remake marketing.
