Today’s Session
Customer Lifetime Value (CLV)
Definition
• Customer lifetime value (CLV) or CLTV, lifetime customer value (LCV), or user
lifetime value (LTV) is the projection of the net profit attributed to the entire future
relationship with a customer
• The prediction model can have varying levels of sophistication and accuracy
• It can range from a simple method to the use of complex predictive
analytics techniques
Definition
• It is defined as the Rupee value of a customer relationship, based on the present
value of the projected future cash flows from the customer relationship
• It encourages firms to shift their focus from quarterly profits to the long-term
health of their customer relationships
• Customer lifetime value is an important number because it represents an upper
limit on spending to acquire new customers
Philip Kotler’s definition
Customer lifetime value (CLV) describes
the net present value of the stream of
future profits expected over the customer's
lifetime purchases
Purpose
• One of the major uses of CLV is customer segmentation, which starts with the
understanding that not all customers are equally important
• CLV-based segmentation model allows the company to predict :
1. the most profitable group of customers
2. understand those customers' common characteristics
3. and focus more on them rather than on less profitable customers
Purpose
• CLV-based segmentation can be combined with a Share of Wallet (SOW) model to
identify "high CLV but low SOW" customers with the assumption that the
company's profit could be maximized by investing marketing resources in those
customers
• Customer Lifetime Value metrics are used mainly in relationship-focused
businesses, especially those with customer contracts
• Examples include banking and insurance services, telecommunications and most of
the business-to-business sector
Inputs
Average Cost of Marketing
Gross Margin
Referral Value Unit of time
Response Rate
Discount Rate (WACC)
Retention Rate Cost of Acquiring New Customer
Some examples
• When margins and retention rates are assumed constant, the following formula
can be used to calculate the lifetime value of a customer relationship
• This model has only three parameters:
(1) constant margin (contribution after deducting variable costs including retention
spending) per period,
(2) constant retention probability per period, and
(3) rate of discounting
Formula
CLV= GC* [ r / (1+d-r)]
where
• CLV is the Customer Lifetime Value
• GC is yearly gross contribution per customer
• r is the retention rate
• d is the discounting rate
Some examples
• Simple ecommerce example
• (Avg Monthly Revenue per Customer * Gross Margin per Customer) ÷ Monthly
Churn Rate
• The numerator represents the average monthly profit per customer, and dividing
by the churn rate sums the geometric series representing the chance the customer
will still be around in future months
• For example: Rs100 avg monthly spend * 25% margin ÷ 5% monthly churn = Rs 500
LTV
Some examples
A Retention example
• CLV (customer lifetime value) calculation process consists of four steps:
• forecasting of remaining customer lifetime (most often in years)
• forecasting of future revenues (most often year-by-year), based on estimation
about past products purchased and price paid
• estimation of costs for delivering those products
• calculation of the NPV (net present value) of these future amounts
• Pl note:
Forecasting accuracy and difficulty in tracking customers over time may affect CLV
calculation process
Retention Model
• Retention models make several simplifying assumptions and often involve the
following inputs:
• Churn rate: the percentage of customers who end their relationship with a
company in a given period. One minus the churn rate is the retention rate
• Discount rate: the cost of capital used to discount future revenue from a customer.
• Contribution margin
Retention Model
• Retention cost: the amount of money a company has to spend in a given period to
retain an existing customer. Retention costs include customer support, billing,
promotional incentives, etc.
• Period: the unit of time into which a customer relationship is divided for analysis.
A year is the most commonly used period
• Pl note:
Customer lifetime value is a multi-period calculation, usually stretching 3–7 years
into the future. In practice, analysis beyond this point is viewed as too speculative
to be reliable. The number of periods used in the calculation is sometimes referred
to as the model horizon.
Advantages of CLV
• Management of customer relationship as an asset
• Monitoring the impact of management strategies and marketing investments on the
value of customer assets
• Determination of the optimal level of investments in marketing and sales activities
• Encourages marketers to focus on the long-term value of customers instead of investing
resources in acquiring "cheap" customers with low total revenue value
• Implementation of sensitivity analysis in order to determine getting impact by spending
extra money on each customer
Advantages of CLV
• Optimal allocation of limited resources for ongoing marketing activities in order to
achieve a maximum return
• It is a good basis for selecting customers and for decision making regarding
customer specific communication strategies
• Measurement of customer loyalty (proportion of purchase, probability of purchase
and repurchase, purchase frequency and sequence etc.)
• The disadvantages of CLV do not generally stem from CLV modelling per se, but
from its incorrect application.
Red flags
• Segment inaccuracy
• Constant discount rate
• Constant retention rate
• Over-values current customers at the expense of potential customers
• It is the output of a model, not an input
Different ways
to calculate
LTV
C1 C2 C3 C4 C5
Expenditure 200 400 300 150 275 ? (s)
per visit (Rs)
Class Exercise
No. of 4 3 5 6 3 ? (c)
visits/week
Av billing/week 800 1200 1500 900 825 ? (a)
(Rs)
t= average 15 years m=av gross ?
customer margin per
lifespan customer
lifespan Rs
r= customer 65 Simple LTV: Customized Traditional LTV: Av LTV= ?
retention rate 52(a ) X t = ? LTV: m (r/1+i-r) =?
% t(52XsXcXp) =?
p= profit 20
margin per
customer %
i= rate of 10
Class Exercise
C1 C2 C3 C4 C5 Average
Expenditure 200 400 300 150 275 265 (s)
per visit (Rs)
No. of 4 3 5 6 3 4.2 (c)
visits/week
Av billing/week 800 1200 1500 900 825 1045 (a)
(Rs)
t= average 15 years m=av gross 163020
customer margin per
lifespan customer
lifespan (Rs)20
r= customer 65 Simple LTV: Rs Customized Traditional LTV: Average LTV; Rs
retention rate 815100 LTV: Rs 173628 Rs 235473 408067
%
Any questions please?
