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Lifetime Value of your Customers: A Metric to Drive your Business Desicions

5 April 2016

Customer Lifetime Value is a helpful indicator which, unfortunately, is still little known or applied. However, do you think that an employee of a small café would treat her customer differently if she knew that instead of a few dollars a week, this customer was in fact representing $14,000 of income during his lifetime relationship with the company? Sure!

 

Customer Lifetime Value (CLV)

Customer Lifetime Value (CLV), sometimes called “customer capital”, is the present value of the anticipated future cash flows attributed to the customer during his/her entire relationship with the company minus the cost of products and services and marketing costs. This metric differs by customer or by customer type, and is often calculated per cohort (a group of customers who share an attribute or a set of attributes).

 

Applications and Insights

There are several advantages to measuring CLV. Here are some examples:

• CLV helps to see if all your customers are in fact high-value customers. Indeed, a customer or a customer group might appear to be high value on the surface, bringing in interesting revenue to the company. But this customer may be very expensive to acquire or to retain compared to another customer who initially appeared less profitable.
• CLV helps to take operational and marketing decisions that will optimize your business performance. For example, this indicator reveals how each $1 spent in customer retention can generate revenue. Studies show that even a 5% increase in customer retention can lead to an increase in profits of 25% to 95%, and it costs 6 to 7 times more to acquire a new customer than to retain an existing one.[1] Where does your company stand?
• The probability of selling to an existing customer is 60% to 70%. The probability of selling to a new prospect is 5%-20%.[2] It is worth measuring how much a company must spend to increase the lifetime value of current customers versus attempting to acquire new ones.
• How many of your customers are in fact unprofitable? A study shows that, on average, 25% of customers are unprofitable, thus calculating CLV may improve the performance of marketing strategies by about 33%.[3] Do the math. Pear Analysis calculated that 20% of customers are unprofitable, 60% are profitable and 20% are top performers generating maximum revenue. So, you can allocate your expenses and energy to the right customers.
• 68% of clients say coupons generate company loyalty. So, for example, CLV shows how spending $1 in coupons impacts your company’s CLV.[4]

 

Examples

• Amazon uses a specific marketing strategy designed to attract customers and to boost individual customer value through high personalization of offers and a “loss leader” approach (a loss leader is often a popular good or service that is sold at a low price or below its market cost to stimulate other sales of more profitable, high-margin goods or services). Sure, implementing a computer system to support this method, maintaining the database, as well as lost profits on these loss leaders is expensive, but it certainly is worthwhile thanks to an increase in the frequency and volume of purchases. Nearly 85% of clients report that personalization of products and services impacts customer retention and loyalty.[5]
• Zappos, an online shoe retailer, offers a 365-day return policy, and free two-way shipping. The company calculated that the cost of such policy is largely offset by the increase in CLV.[6]
• After creating a CLV model, Farmers saw a 20% improvement in overall marketing ROI, and a 100% improvement in direct mail ROI.

 

Calculating CLV

The calculation can be quite laborious and also means you should know the cost of new customer acquisition. We can address it on the basis of the lifetime value of customers to acquire or the lifetime value of existing customers. Other elements required for this calculation are not always obvious, such as actual management costs associated with each client group, customer retention rate, customer acquisition cost and so on. True financial formulas are complex, and are similar to those used to calculate NPV (Net Present Value) of a project, but other simpler formulas also exist.

 

Case Study: Starbucks[7]

 

Step 1: Average your variables and list constants:

–       Average customer sales per visit: $5.90

–       Number of visits per week: 4.2 visits

–       Average customer sales per week: $24.30

–       Average customer lifespan (how long someone remains a customer): 20 years

–       Customer retention rate: 75%

–       Profit margin per customer: 21.3%

–       Average gross margin per customer lifespan: $5,382.94

–       Interest rate used to determine the present value of future cash flows (usually between 8% and 15%): 10%

 

Step 2: Calculate CLV using different methods

 

Method 1:

52 weeks X sales per week ($24.30) X customer lifespan (20)

= $25,272

 

Method 2:

Customer lifespan (20) X 〔52 weeks X sales per visit ($5.90) X visits per week (4.2) X profit margin (0.213)〕

= $5,489

 

Method 3:

Gross margin (5,382.94) X customer retention rate (0.75) / 〔1 + interest rate (0.1) – customer retention rate (0.75) 〕

= $11,535

 

Using an average of the three CLV equation results, Starbucks’ customer value is $14,099. You should decide which method is the most applicable to your business model. An average of several equations, similar to these Starbucks calculations, helps to reduce the risks.

 

Examples of Decision

• Identify maximum acceptable customer acquisition costs. A general guideline for business is that CLV should be 2.5 to 3 times new customer acquisition cost.[8]
• Stop or maintain services to certain customers or work on the optimization of costs based on the value.
• Change customer experience based on their respective value (e.g. a priority customer service line, a VIP support team, etc.)
• Optimize the conversion rate of customers with a higher lifetime value potential or implement customer retention strategies consistent with customer value.
• Invest little or no effort in customers with little or no profitability.
• Implement a commission-based compensation system linked to the potential value of the customers acquired by each salesperson (large short-term sales may be less paying than sales to customers with a higher CLV).
• Implement customer loyalty programs consistent with CLV.

 

In short, determining the lifetime value of your customers is a valuable source of information to maximize your company’s profits. However, if the calculation is incorrect, subsequent decisions may be inefficient and even harmful to your business. Learn more about our tools to calculate your customer lifetime value and find out how we can assist you to optimize it.

 

Sylvie Grégoire, MBA, CRHA

President, Totem Performance organisationnelle

[1] Bain & Company

[2] Marketing Metrics

[3] Prédire la valeur d’un client: tout est question de modèle! (tribune) La Rédaction, 3 février 2015, 10:43

[4] www.stratello.com/wp-content/uploads/2015/01/141211_Aria_Infographic_jf.png

[5] www.stratello.com/wp-content/uploads/2015/01/141211_Aria_Infographic_jf.png

[6] Craig Adkins of Zappos in the article “15 Ways for Companies to Increase Customer Lifetime Value” by Graham Charlton

[7] www.optimisation-conversion.com/infographies/comment-calculer-la-valeur-vie-client-ltv-life-time-value

[8] Chris O’Shea, “Do you know the lifetime value and cost of acquisition of your customers?”, Bdc.ca