Customer Lifetime Value

Overview

Estimating the lifespan and economic value of each and every customer.

Larry Vincent
Associate Professor
of the Practice of Marketing

Presented to:
FT MBA Core
November 21, 2023

CRM

Forget average customers

Who are your highest value customers?

What makes a good customer?

Preference

• Offerings perfectly aligned with customer needs
• Customers prefer your offerings to those of a competitor

Propensity

• Likelihood of being loyal / low churn-risk
• Willingness to recommend you to their friends and colleagues
• Openness to buying your higher-valued / premium-priced offerings

Potential

• Permission to address other under-served needs
• Advocates for the brand

Who’s best?

Betty

• 2021 Sales: $2,264
• Visits every day
• Dines in for ~1 hour
• Drip coffee & pastry
• Gives staff birthday cards

Don

• 2021 Sales: $1,679
• Visits 3-4x / week
• Usually w/someone
• Very specific latte order
• Successful real estate agent

Joan

• 2021 Sales: $826
• Visits 1-2x / week
• Dines in, friends sometimes
• Orders variety of beverages
• Follows and posts pics

Customer profitability

The difference between revenues earned from the customer relationship and any associated costs over a specific period.

What counts as “associated costs”?

• Direct cost of goods sold
• Indirect service costs
• In some instances, labor costs
  (i.e., dedicated account rep)
• May also include activity-based costs
• Differs from company to company; can also differ
  per period of customer lifetime

Customer experience

The degree to which customers are satisfied and enjoy their buying journey.

NPS

Customer buying journey

Common experience metrics

• Customer satisfaction (CSAT)
• Churn
• Intent to purchase/repurchase
• Net Promoter Score (NPS)

Customer management

Customer
Lifetime
Value

CLV’s parts

Required components

• Customer profit (Contribution)
• Retention rate
• Cost of capital (Discount factor)
• Customer acquisition cost (CAC)

Thinking in cohorts

Year 1

 

Thinking in cohorts

Year 1

Year 2

 

Thinking in cohorts

Year 1

Year 2

Year 3

Retention and churn

Retention mechanics

Calculating lifetime

How long should we expect to keep a customer in a cohort that averages an 80% monthly retention rate?

Calculating lifetime

How long should we expect to keep a customer in a cohort that averages an 80% monthly retention rate?

Present value of future Tuesdays

A company has an 18% annual cost of capital (1.5%/month). $100 contribution each future month is worth less than the $100 received at the start.

Hands-on

Model assumptions and nuances

• Customer lifetime is finite (parents need children’s diapers for a limited period of time)
• Retention rates are based on historical averages
• Sales volume fluctuates year-over-year (by periodic repurchase rates)
• Marketing costs are line item tied to customer journey
• Very specific connection between customer and specific product; how should we handle a customer who purchases multiple products from P&G?

A simpler solution

CLV simplified

Required assumptions

• Constant profit margin
• Constant retention rate
• Constant discount rate
• Value estimated over infinite time horizon

Simplification

Approaches

Base method

\[ \text{CLV} = m * \left(\frac{r}{1 + i - r}\right) \]

\[ m = \text{Contribution}\\ r = \text{Retention Rate}\\ i = \text{Discount Rate} \]

Initial margin method

\[ \text{CLV} = m * \left(\frac{1 + i}{1 + i - r}\right) \]

\[ m = \text{Contribution}\\ r = \text{Retention Rate}\\ i = \text{Discount Rate} \]

Hands-on

When to use

Exclude present period
of contribution

Include all periods
of contribution

Acquisition costs

• Acquisition costs should only be deducted for new customers acquired in the forecast period
• Don’t deduct legacy acquisition costs for existing customers
• Ratios of LTV to CAC are used widely to manage costs and evaluate acquisition investments

Ratios

Delta Analysis

Delta analysis

Takeaways

• Strategic Decision-Making Tool: A long-term view that helps you make strategic decisions about resource allocation, marketing investment, and customer segmentation.
• A Profitability and Growth Enhancer: Helps you acquire, develop, and retain customers who bring most value. Leads to more sustainable profitability and growth.
• Customer Relationship Management: CLV is key metric in CRM. Leads to long-term relationships with customers and helps design personalized marketing and service strategies that satisfy high-value customers.
• Better ROI Measurement: More accurate measure of return on investment (ROI) for marketing campaigns and initiatives. Allows for better budgeting and more effective marketing strategies that contribute to bottom line.
• Innovation Driver: Encourages managers to innovate and improve products, services, and customer experiences by creating a customer-centric culture.