What Is a Customer Worth? Understanding Customer Lifetime Value
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The document explores Customer Lifetime Value (CLV), emphasizing its significance in understanding the economic value of customers over their relationship with a business. It outlines the components necessary to calculate CLV, including transaction profits, retention rates, and customer segmentation, providing guidance for businesses on effective marketing and retention strategies. Additionally, it highlights the potential pitfalls of oversimplifying CLV calculations and encourages businesses to consider both acquisition and retention costs for more accurate insights.
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What Is a Customer Worth? Understanding Customer Lifetime Value
- 1. Understanding Customer Lifetime Value
- 2. ©Copyright 2013. CTS Service Solutions. All Rights Reserved. By Adam Toporek July 22, 2013 On November 29, 2011, we posted Understanding Customer Lifetime Value: A Non-Geek’s Guide, an extensive look at the non-academic approach to Customer Lifetime Value. This SlideShare presentation breaks the CLV concept down step-by-step.
- 3. What Is Customer Lifetime Value and Why Is It Important?
- 4. Customer Lifetime Value (CLV) attempts to determine the economic value customers bring over their “lifetime” with the business.
- 5. At the heart of understanding CLV lies the recognition that a customer does not represent a single transaction but a relationship that is far more valuable than any one- time exchange.
- 6. Understanding CLV is incredibly important for customer service professionals and for businesses of all types. Why? Because if you don’t know what a client is worth, you don’t know what you should spend to get one or what you should spend to keep one.
- 7. Why a Non- Geek Guide to Customer Lifetime Value?
- 8. Often, statistically sound approaches are not feasible. Sometimes the back of the napkin is all we have. The Customer Lifetime Value calculation can be an extremely complex undertaking.
- 9. Breaking Down CLV Let’s begin by taking a look at the major components of Customer Lifetime Value…
- 10. Calculating The Profit of an Average Transaction
- 11. Unit Contribution Margin The tendency when thinking about the lifetime value of a customer is to focus on the revenue the customer brings in over their lifetime. However, focusing on revenue will almost always overstate the value of the customer.
- 12. Marginal Profit The more accurate way to measure is to focus on what is known as the Unit Contribution Margin, which we’ll call marginal profit for short. customersthatstick.com
- 13. Take Starbucks for Example… If a customer buys a $5.00 latte, that transaction has costs associated with it. The milk, the cup, the coffee, the lid, and the flavoring all add to a variable cost that is incurred for that latte transaction. customersthatstick.com
- 14. Marginal Profit of a Latte $5.00 latte -$0.50 cup -$0.50 lid -$0.25 milk -$0.25 flavoring $3.50 Marginal Profit
- 15. Marginal Profit – Step 2 The next step is figuring out the average of all of the company’s transactions. You want to figure out the number of each different type of transaction and calculate an average profit profile per customer. Average
- 16. Labor might not always be a variable cost. If your company’s labor is constant and does not depend on the number of units sold, labor may not be included in the calculation. Note…
- 18. Retention Rate (RR) We begin by calculating the retention rate. Take the number of customers from last year who are still customers this year. i.e. if you had 100 customers last year and 45 are still doing business with you this year, then your retention rate is 45%. Current Retained Customers ÷ Customers from Last Year
- 19. Customer Lifetime Using your retention rate of 45%... CL = 1/(1-.45) = 1.8 Your Customer lifetime is 1.8 years Customer Lifetime (CL) = 1÷(1-RR)
- 20. The Last Piece Is Your Discount Rate…
- 21. Discount rate is the interest rate you borrow at in your business. The concept is based on the time value of money, the premise that a dollar today is worth more than a dollar tomorrow.
- 22. The longer you calculate your customer lifetime to be, the more important the discount rate becomes and the more inaccurate your model becomes when you ignore the rate. Just Remember…
- 23. Now That You Have the Parts: Understanding Customer Segmentation
- 24. At the heart of customer segmentation is the belief that all customers are not created equal and that understanding the differences among customer segments is key to effectively acquiring and retaining customers.
- 25. How would I group my customers if I wanted to customize my marketing, retention, or product offerings? Ask Yourself One Simple Question:
- 26. Where To Begin?
- 27. Break down the segments based on differentiated products or services. For example, if your department provides distinctly different services to both small businesses and individuals, you may consider calculating a Customer Lifetime Value for each segment.
- 28. If your business does not have obvious divisions, you should consider what factors have the most impact on customer buying characteristics – or segment on behavior itself.
- 29. customersthatstick.com Start with your gut… If you know your business, you probably have an innate sense of what types of customers act what way. Try to fill in the blanks in this statement…
- 30. Customers who _____ tend to _____.
- 31. Using CLV Technically, the calculation of Customer Lifetime Value should include acquisition and retention costs.
- 33. customersthatstick.com Take your marketing expenditures for a period and divide by the number of new clients in the same period. What Does It Cost to Get a Customer In the Door?
- 34. Try to find a period that is relevant for you and your business based on how you approach your marketing and make sure to account for the lag time between marketing and acquisition.
- 36. • Perks for longevity • Discounts for existing customers • Freebies for certain buying behaviors Start with Obvious Hard Costs PS: Make sure to average the cost out across the entire customer base.
- 37. If you send your sales staff to a customer service seminar, is that a retention cost? Think About Your Soft Costs If you redesign the help section on your web site, is that a retention cost?
- 38. One question that should help determine if a soft cost belongs in the retention “bucket” is this: What is our primary reason for incurring these costs?
- 39. If customer satisfaction, retentio n or any similar customer service- based sentiment is the primary reason, it is probably safe to consider the expenditure a retention cost.
- 40. If you are segmenting your customer base, you will need to apply these calculations for each segment, not the customer base as a whole. A Final Note on Acquisition and Retention
- 41. Tying It All Together Now that you have your CLV and a grasp on your marketing and retention costs, it is time to put the two together.
- 42. An Example… Customer Lifetime Value and Acquisition
- 43. customersthatstick.com The owners of a golf pro shop determine that most of their customers come from two zip codes, one to the east and one to the west. The owners decide to calculate the CLV separately for each zip code. They discover that the CLV for the eastern customers is 4 times the CLV for the western customers.
- 44. They also find that the eastern zip code is 30% of their customer base but 80% of their profit. The western zip code represents 70% of their customer base and 20% of their profit.
- 45. The pro shop owners have been spending their marketing dollars evenly between east and west. Calculating the CLV for each segment made it obvious that their marketing dollars were not being allocated effectively.
- 46. Final Thoughts Computing Customer Lifetime Value can be one of the most eye-opening and rewarding exercises in business. Knowing your CLV can help you truly understand the value and effectiveness of your marketing and retention expenditures.
- 48. We hope that you can derive true value from a back of the napkin approach to CLV, but you should realize the limitations of using such a non-scientific approach. Each business is different, but there might be a time where you feel the need to get your geek on. If so, here are some more resources dedicated to CLV.
- 49. customersthatstick.com 1. An infographic on calculating Lifetime Value from Kissmetrics 2. Modeling Customer Lifetime Value from Gupta et al (An academic tract on the subject. PDF link.) 3. Customer Lifetime Value calculator from Harvard Business Review Publishing 4. Customer Lifetime Value overview from Wikipedia (i.e. Getting Your Geek On)
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