Customer Lifetime Value

Customer Lifetime Value Definition

Customer Lifetime Value also CLV or CLTV is defined as the prediction of all values that a business derives from their relationship with customers. Customer Lifetime Value is the most important metric to understand the needs and requirements of customers. It helps in making various important business decisions related to product development, marketing, sales, and customer support. For example,

  • Product development: How can a business provide tailored products and services for its best customers?
  • Marketing: What amount of money should be spent to acquire customers?
  • Sales: What type of customers should a business sales rep spend time upon to acquire them?
  • Customer support: What amount of money should be spent on service to retain customers?

Considering customer lifetime value can change the way a business thinks about customer acquisition. Instead of focusing upon acquiring many customers and how cheaply this can be done, CLV helps in thinking about how to optimize acquisition spending in terms of maximum value than that of minimum cost.

Method of calculating CLTV is divided between historic and predictive CLV:

Historic CLV (Good indication of CLV). This is the sum of gross profit from an individual customer’s historic purchases

Predictive CLV (Great Indication of CLV). This is a predictive analysis of customer’s transaction history and several behavioral indicators which will predict the lifetime value of a customer. The more accurate this equation is, the more precise will be the value with every interaction and purchase.

Why is Customer Lifetime Value Important?

  1. Generate real ROI over customer acquisition: CLV helps in maintaining focus on those channels that offer the most profitable customers. Optimizing marketing channels in terms of CLV contribution to your brand instead of gross profit on initial purchases. Focusing on CLV will change the economics of customer acquisition strategy. Businesses will be able to pay more for customer acquisition as it will not be held back by profit generated by a single purchase but, from several purchases that took place over time.
  2. Enhancing retention marketing strategy: A marketing campaign value should not only be valued upon instant revenue being generated.it should be valued upon the impact it holds over average CLV of those segment of customers being targeted.
  3. Create effective messaging, nurturing and targeting: Segmenting customer base on CLV can improve the relevance of marketing through personalized messages. A useful variable can be those types of products that are marketed to customers from different segments.
  4. Improving behavioral triggers: Organizing data in natural clusters, businesses can determine behavioral triggers that incentivize its best customers so as to convert them in customers. After analyzing results, replicating this behavior is important to make customer make their initial purchase.
  5. Improve output through customer support: Focus on most valuable customers more. Pareto’s principle applies well that 20% of customers tend to generate 80% of revenue. CLV will help in deciding to allocate customer service resources. This will be useful in improving margins along with fostering strong relationships through improved services in important segments.

How to Calculate Customer Lifetime Value

Historic Customer Lifetime Value

Historic CLV is the sum of gross profit from historic transactions of a particular customer. All gross profit values are summed up to transaction N (N is the last transaction). If a business has access to the transactional data of every customer, this can be calculated in Excel formula or can get it calculated automatically with software.

CLV (Historic) = (Transaction1+Transaction2+Transaction3…+TransactionN) X AGM

Where,

AGM = Average Gross Margin

Customer Lifetime Value calculation based upon net profit ultimately provides the final profit, an individual customer is contributing to the business. This considers cost associated with customer services, acquisitions, cost of returns, marketing tools, etc.  However, calculating individual customers can be very complex especially when the figures need to be updated constantly. Gross margin CLV will provide insights about actual profitability of customers to date.

Predictive Customer Lifetime Value

Predictive CLV algorithms tend to provide a more accurate value of CLV by predicting the total value an individual customer will give to the business in the entire lifetime. In simple words,

‘CLV is the NPV of the sum of all future revenues from a customer less all costs associated with that customer.’

In practice, this can be very hard to attain because of the requirements of updated discount rates. Predictive CLV can be calculated in different ways like Simple and Detailed.

Simple

CLV = ((T x AOV) AGM) ALT

Where:

  • T = Average monthly transactions
  • AOV = Average order value
  • ALT = Average Customer Lifespan (in months)
  • AGM = Average gross margin

Let’s call the above equation gross margin contribution per customer lifespan (GML).

Detailed

CLV = GML (R/1+D-R)

Where:

  • R = monthly retention rate
  • D = monthly discount rate

Customer Lifetime Value Case Studies

According to Peter Drucker, the aim of a business is to create and keep its customers. This somewhat sums up to customer lifetime value. Below mentioned are some case studies of different industries related to CLV.

Starbucks

Increasing customer satisfaction is one of the most effective ways to boost CLV. Bain & Co. experienced that a 5% increment in customer satisfaction can reach 25% to 95%. In the similar study, it was seen that it costs about 6 to 7 times more for new customer acquisition than retaining existing customers. Starbucks customer satisfaction is reported to be as high as 89% and because of this; its CLV has been calculated to be $14,099.

Amazon

According to Consumer Intelligence Research Partners, owners of Amazon Kindle spent approximately $1,233 every year in buying items from Amazon in comparison to $790 per year for other customers. Amazon closely considers CLV and Amazon Prime have been created to compete efficiently over price and increase CLV. According to Consumer Intelligence Research Partners, in 2013, Amazon Prime members spend $1,340 annually which facilitates the process of getting the most from profitable segments.

Advantages of Customer Lifetime Value

Save Money. Retaining old customers is cheaper than finding new customers. Additionally, implementing new channels for finding new customers can be expensive as well.

Improved Marketing. Customer Lifetime Value marketing allows focusing on customers. This allows carting product benefits instead of its features.

Generate sales. Customers are warmed up from regular interactions. Through CLV you can make them know about the latest promotions as well.

Encourage brand loyalty. Regular contact foster brand loyalty and a free gift will always benefit both the customer and the business.

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