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Customer Lifetime Value (CLV)

“The CLV is the total margin generated by the average customer over the length of time the customer purchases from the company, minus both the initial cost of acquiring the customer and the cost of customer support programs over the length of the relationship, discounted to reflect the Net Present Value of future dollars”.

 

This might seem complicated but it’s important to be aware of all of the factors that are involved in defining the CLV.

 

Simply stated the CLV shows how much a customer is worth. This helps management make better decisions. For example, it indicates how much can be spent to acquire a new customer and it changes the way marketing plans and budgets are prepared.

 

In this, as in many management situations, it’s good to remember Peter Drucker’s comment

 

“If you don’t measure it you can’t manage it”

 

To calculate the CLV you need actual or best estimates of the following, accuracy isn’t the overriding consideration; these are not accounting figures – close enough will do nicely:

 

  • How long the average and loyal customers are retained
  • The number of actual customers referred
  • The average yearly purchases
  • The average margin on the purchases
  • An estimate of yearly purchase increase.
  • Average cost of acquiring a new customer
  • Yearly cost of existing customer support

 

Most businesses operate in more than one market, or geographic, or demographic sectors. The CLV should be calculated for each logical sector (market segmentation) so that management can compare each one and so be better able to allocate resources and where necessary work to increase the CLV of the poorer performers.

 

Make sure that you account for all of the costs involved in acquiring a new customer, both expenditures and staff time. Divide this figure by the number of new clients gained in the same period – often a horrifying figure especially if you exclude new clients from referrals.

  

                                Average Customer retained for 2 years Chart #1
Years Sales Margin Acquisition Customer Margin
    % $ cost support  
1 1000 45 450 200 100 150
2 1100 50 550   100 450
3 1000 45 450 200 100 150
4 1100 50 550   100 450
5 1000 45 450 200 100 150
6 1100 50 550   100 450
Totals 6300   3000     1800

Chart #1 shows that the CLV of a customer retained for 2 years is $450 and that 3 customers together would generate $1,800 over 6 years.

                                  Loyal Customer retained for 6 years Chart #2
Years Sales Margin Acquisition  Customer Margin
    % $ cost support  
1 1000 45 450 200 100 150
2 1100 50 550   100 450
3 1210 50 605   100 505
4 1331 50 666   100 566
5 1464 50 732   100 632
6 1610 50 805   100 705
Totals 7715   3808     3008

*Sales increase by 10% per year
1st year margin reduced because of the costs of entering a new customer into the system

 
It’s easy to see that the longer a customer stays with you the more profitable the customer is, in this example almost twice as profitable. Loyal customers stay longer than average customers.

 

Please note that if decisions are to be made based on future dollars (e.g. how much to spend to acquire a new customer) then it’s necessary to calculate the current value of future dollars, the Net Present Value

 

But this is only part of the story; the big payoff from loyal customers is the likelihood that they will refer more potential customers than will the average customer. It’s kind of a multi-level-marketing effect. Each referred customer might refer others and they in turn will refer others. Many companies have experienced dramatic growth because of WOM (word of mouth) – customers acting as advocates for the company.

  

Value of Referrals

 

The CLV of the individual customer ($450 for the average customer and $3008 for a loyal one) is only part of the Lifetime Value story. Properly managed your customers can become your best (and least cost!) sales force; loyal customers can become advocates for your company.

 

Charts #3 & #4 illustrate the difference in value to the company of an average and a loyal customer. The comparison in your company will reflect your company’s operation and costs, and while different from this illustration will still show that your loyal customers are worth far more than others.

                                         Value of Referrals Chart #3
Average Customer Loyal Customer
Years retained 2   6  
Referrals per Year 1   2  
Total referrals 2   12  
CLV per customer *450   *450  
Total value 900   5400  
                          Combined CLV Basic + Referrals Chart #4
Average Customer Loyal Customer
Basic CLV 450   3008  
Value of referrals 900   5400  
Total value 1350   8408  

Chart #4 shows the combined value of the basic CLV and the value of referrals. Clearly the value of referrals is suspect as is any assumption based on future projections. This being so many companies, while valuing the contributions made by referrals, do not include them in decisions about future expenditures, they use the basic CLV. However, companies that have organized referral programs and history success in generating them are more likely to include at least some contribution from referrals in their future spending plans.

 

 

 

 

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