Customer lifetime value simply helps businesses understand the importance of customer retention. It is crystal clear that the revenue depends on the customers and how long they are willing to stay with a company. Whether we talk about the small, medium, or large enterprises, they are all aware that the profit comes from their customers. Therefore, knowing your customer’s worth is knowing your profit.
What is customer lifetime value?
Customer Lifetime Value (CLV/CLTV) is the data point that tells you the net profit contribution of the customer over time. The Marketing Accountability Standards Board (MASB) defines Customer Lifetime Value as the present value of the future cash flows attributed to the customer during their entire journey.
How to calculate customer lifetime value?
A simple formula to calculate CLV is multiplying annual revenue per customer by the average lifespan of the customer minus the customer acquisition cost.
Customer Lifetime Value = (Annual revenue per customer * average lifespan of the customer) – Customer acquisition cost.
The above formula can give a clear picture of profitability in a perfect marketing environment. However, we all know the environment is not stable, nor is marketing perfect. That’s why this simple formula will not give an accurate picture for an organization to make financial decisions accurately. Complications can arise when functions like discounts, repeat purchases, word of mouth, satisfaction, competition, economy, retention, churn, etc. are added to the equation.
Large enterprises face complications in calculating the customer lifetime value. That is the reason every organization adds its functions to the basic formula to calculate the CLV, based on the company’s revenue structure, internal environment, and external environment.
Lloyd Melnick & Wendy R. Beasley, in the book Understanding the Predictable, said:
Your CLTV calculation is not a fact; it’s a prediction. Predictions will vary from reality and you need to plan around the fact that your CLTV may be lower or higher. You should look at CLTV as a range rather than a discrete value. You should constantly monitor reality versus your CLTV prediction so you can improve your CLTV Model.
Investing in the right customer segments
Let’s start with a simple question.
What if your organization did not know customer lifetime value? In that case, you would not know how much revenue a customer bought in his/her average lifespan, and therefore you couldn’t know how much to invest in that customer during the timeframe. The investment in the products and services will not generate expected returns, and this can bring a company to a standstill.
John Wanamaker’s famous saying: “Half the money I spend on advertising is wasted; the trouble is I don’t know which half,” clearly underlines the importance of investing wisely in your customers.
By knowing which customers are profitable and provide a continuous inflow of revenue, marketers can spend the marketing budget on the right customers. So, we can safely say that CLV/CLTV is one of the important KPIs for marketers. The growth of marketing depends on improved customer lifetime value, although it’s not an easy metric to calculate.
Company-wide CLV implementation is a major process change. Platform and budget limitations can divert the attention of the management to focus on other metrics and ignore CLV.
But if you know customer lifetime value, there are three important things you can do to increase profitability:
- Optimize your products or services throughout the customer journey
- Create effective customer segmentation to increase Customer Experience
- Increase retention and create customer loyalty
Gallup research has found that customers who are fully engaged represent a 23 per cent premium in terms of share-of-wallet, profitability, revenue, and relationship growth. The research looked at engagement in specific industries and found:
- Companies that successfully engage their B2B customers benefit from 63 percent less customer attrition, 55 m percent more share-of-wallet, and 50 percent greater productivity.
- Retail banking customers who are fully engaged bring 37 percent more annual revenue to their primary bank than actively disengaged customers.
- Hotel guests who are fully engaged spend 46 percent more per year than actively disengaged guests.
Retail banking is going through a tremendous change because of revenue drought. Banking is looking beyond individual products to the total customer relationship and creating a robust frame of reference to manage and measure their progress.
Finding your frame of reference
A study conducted by Forrester Consulting found that experience-driven businesses which focus on investing broadly in CX across the customer life cycle report 1.6 to 1.9-times higher year-over-year growth in customer retention, repeat purchase rates, average order values, and customer lifetime value compared to other companies. Many organizations are implementing and experimenting to boost CLV using the latest technologies and changing their business model to focus more on increasing CLV.
Let’s take a look at a few examples.
Pegasystems Inc. announced Next-Best-Action Designer, an intuitive AI configuration wizard that makes it fast and easy for business users to optimize CX across all channels. The AI configuration makes the CLV projections, ranks the best possible actions for each unique customer in any given situation, and then acts on it.
NeuroMetrix, Inc. (NURO), a health technology company, did extensive consumer research and in-market validation to create a new business model just to increase CLV. The company expects to see improved economics through reduced customer acquisition costs, distribution channel savings, and higher retention rates, resulting in increased CLV.
Oracle CX solution provides cloud technology to the companies to master their CX as part of their digital transformation experience, resulting in a 94 per cent greater annual increase in CLV, compared to businesses that struggle with digital transformation.
With active sports betting now becoming legalized, creating a loyalty model along with a pay subscription can result in higher CLV. Flashtalking, a data-driven advertising company, emphasizes personalization in gambling by focusing on the journey stage, audience segment, context, user circumstance, and time.
Retina, a venture-backed startup brings the power of machine learning and artificial intelligence to the single most valuable metric for marketers: CLV. Using the latest innovations in machine learning and AI, Retina delivers the predicted lifetime value.
Final thoughts
Customer experience initiatives can make a huge impact on the profitability of the company. A 288 per cent increase in CLV was achieved by immersing Adobe employees at all levels in customers’ realities, emphasizing the end-to-end customer life cycle, and resolving customers’ top issues. Defining, calculating, measuring and increasing CLV not only gives a boost to profitability but also saves companies from dying out early in their life-cycle.