Customer Lifetime Value – Concept and Application

What is Customer Lifetime Value?

Customer Lifetime Value (CLV) is the value that a company derives from a customer during the “Time” a customer does business with the company (where Time = total time when customer purchased product or service from the company), calculated at present time (adjusting time value for money). This definition is a lot broader and does not count for several hidden costs or revenue that may be included in the total value derived and varies according to the industry.

Why Should Businesses Really Care About CLV?

Almost every market is saturated and new opportunities to grow business are hard to come by. Businesses in different industries are struggling to get new clientele. This entire scenario is significantly adding to the cost of acquiring a new customer. Similarly, the race to offer better products and services is also making it hard for traditionally run for-profit organizations to retain customers. Every company, big or small, puts in a lot of investment to market its products and services. In order to appreciate the number of customers a company has and understand the need to retain them, it should exactly know the true customer lifetime value.

CLV and Categorization of Customers

Every customer does not offer the same lifetime value. In order to determine a customer’s lifetime value, companies need to assess them on the basis of recent interaction, frequency and monetary value. A customer who has recently made a purchase from a company has a different value than the one who did not buy anything for a long time. Frequency is defined by the number of times a customer purchases a company’s products within a given time. Monetary value defines the dollar value of purchases made. These three points form the basis of calculating CLV of a customer for any company.

Pareto Principle                                                                

This law states that 80% of your business comes from only 20% of the total customers. This ratio may not be exact but it pretty much defines the logic that a few of the customers are responsible for a major chunk of the business generated. We should never assume the other 80% of customers as unimportant. Instead, businesses need to devise well targeted promotional campaigns which would advocate increased product use and push some of these 80% low business yielding customers into 20% high business yielding customers.

How CLV Helps Business Development?

The concept of customer lifetime value helps sales and marketing teams establish customer segments that need to be given higher priority. They will be able to identify and differentiate customers based on their demands. The efforts of acquiring customers will be directed towards customers in each segment with higher CLV. Besides profiling and exerting well directed marketing efforts, companies would be able to offer bespoke products and services to upsell and cross-sell to customers with greater CLV.

How to Calculate CLV?

As discussed before, customer lifetime value calculations may slightly differ from one industry to another. Shared below are examples of CLV calculation for Insurance and SEO industries.

Example of CLV Calculation in Insurance Industry

The CLV is calculated in insurance industry by taking into consideration the following cost components.

PVCLV = P – C – ABC

Where

PVCLV = Present Value of Customer Lifetime Value

P = Premiums Paid by Customer to the Insurance Company (Revenues)

C = Cost of Claims or Reimbursements (Payments made to customers)

ABC = Activity Based Costs

Whereby, Activity Based Costs are the cost of claims or reimbursements and vary from one customer to another.

Example of CLV for SEO

Two examples have been shared to differentiate between CLV calculated for onetime customer versus CLV for a customer with repeated purchases over a period of one year.

Customer A (SEO)

In the first example, Customer A acquires a onetime service for improving the onsite factors of SEO. The customer is not interested in retainer’s contract. The company charges a onetime cost of $ 1000.

CLV for Customer A = $ 1,000 (Onetime SEO Onsite Fee) – All costs incurred to acquire the customer

Customer B (SEO)

In second example, Customer B signs a one year SEO contract with a company. The company will charge $ 500 per month. Assuming that the customer does not renew the contract, the CLV for one year will be:

CLV for Customer B = $ 6,000 ($500 X 12) (SEO Fee Charged per month for one year) – Cost of Acquiring that customer (Marketing, Admin & All Other Costs)

How Customer Retention Adds to CLV?

The entire discussion of customer lifetime value is futile if organizations fail to learn anything from it. The purpose of determining CLV is to let companies assess the importance of each customer retained for the maximum possible amount of time. However, these CLVs derived above can also be added to company revenues if the customers have been successfully retained for maximum possible time. Let us have a look at different strategies which would help companies in winning back lost customers and retaining them in order to increase the chances of materializing maximum CLV.

Winning Back Lost Customers – Short Term Strategies

Accept Responsibility

Organizations today need to realize that the customers of this era are the most empowered in the history of mankind, making it impossible for them to get away with mistakes. Companies need to inculcate in their customer service staff the importance of accepting a mistake committed by the company.

Find The Reason & Fix It!

Once a company representative accepts the mistake and takes the blame, it is time to find the reason. Find the reason and fix it. Ask the customer if there is anything else that can to be done to overcome the mistrust developed.

Remain Connected

Special attention should be given to unhappy customers. A call after a week or two to know if they are satisfied with the company’s products or services, is a cost effective way to retain them.

Retaining Customers – Long Haul

Short term strategies only act as firefighting mechanisms. In order to remain relevant and viable, companies need to make structural changes of transformational nature which are capable of standing the test of times. Long term strategies are important in order to retain customers and build customer loyalty which is invaluable.

Customer Feedback

Complaints and customer feedback is often taken as a way to resolve issues. Customer feedback can serve as a knowledgebase for businesses upon which they can build better products and services. Introducing new products and services definitely helps companies diversify and successfully compete in multiple sub-segments of the market. However, customer feedback helps them improve their current products and services, increasing their market penetration and in the long run guarantees more satisfied customers.

Product or Service Differentiation

In current times, customers have accessibility to large amounts of information. Today’s customers research and make well informed decisions before choosing to buy a product. Each feature of a product or service is compared. In this kind of environment where companies are working hard to survive, innovation is the key. Senior management needs to keep asking these questions. Why should customers buy from us? What makes us different? What are our competitors doing? Are we offering something new? Where will we stand in the market after five years with our current portfolio of products or services?

Focus On Customer Journey

Customer journey is the total number of interactions that a customer has with a company in making a purchase. This journey needs to be smooth with easy to understand choices made available to customers. Every company must map the customer journey and ensure the touch points provided to customers add to their convenience. Similarly, the journey must also improve each customer service moment of truth by eliminating unnecessary processes or bottlenecks.

Always Inform About Changes

There are times when companies need to cut on costs, restructure services or make changes to the products offered to customers. Ideally, customers should be communicated well in advance about the changes which are being made. It is always better to convey a decision taken by the management in advance instead of giving them unpleasant surprises which may result in the loss of a large number of clients.

Customer Loyalty Programs

Develop loyalty programs to reward loyal customers. These programs must be valued by the customers. There are many examples of customer loyalty programs launched which have helped improve customer retention rates. Starbucks has successfully launched several customer loyalty programs which have truly paid the dividends. For example, “My Starbucks Rewards” loyalty program gives customers a free food item or beverage on their birthday. Or, they can also get a free food item or beverage once they have earned 12 Stars.