Customer Life Time Value: Tricky Case of Calculating Customer Life Time Value (LTV)
What is your customers’ worth?
Why do you need to care about their lifetime value?
Does it matter?
Every marketer’s dilemma is “which half of my marketing spend” is working and understanding customer lifetime value is a crucial part of marketing team’s role. Customer Lifetime Value can be defined as the profit that the company gains on each and every transaction that a customer makes during their association with the company.
Every company needs to understand the customer lifetime value for its customer base for a number of reasons.
- It helps the marketing team in estimating the budget for new customer acquisition.
- Provides the marketing team with a model to understand who the most valuable and least valuable customers are.
- Marketing team can plan retention or loyalty programs to retain the most valuable customers.
- By having a positive relationship with the most valuable customers, the company will benefit as it will get word-of-mouth marketing and new customers from referrals.
- It will also help in identifying least profitable customers and decide whether to encourage them to spend more through specific promotions or lose them if you are bleeding money on them.
Once you have a customer, it is easier to get them to buy again. The hardest customer to get is the one who has never bought from you before. As an estimate, it costs five times more effort to attract a new customer than to bring one of your past customers back to you.
However, calculating customer life time value is tricky and can lose profitable customers in the short-term or keep the least profitable customers in the long-term. So, what are the components of lifetime value?
- Average Period (p): the time that a customer sticks with the company. This can be once in a lifetime for expensive holidays or buying a home, couple of years for a service provider like cell phone or decades for grocery store in a suburb.
- Number of Transactions (n): how many transactions does a customer do in a month, quarter or year?
- Average Spend per Transaction (s): how much does the customer spend per each transaction?
For example, let us look at a telecom service provider. Let us assume that an average customer sticks with the service for 2 years and they pay the bill monthly. Customer A spends $100 a month and customer B spends $50 a month
|Customer A||Customer B|
|Period (P)||2 years||2 years|
|Number of Transactions (N)||24 (2 x 12)||24 (2 x 12)|
As you can see in the table above, Customer A is more valuable than Customer B. Now, the marketing team can focus on customers whose value is above certain limit or below certain number. Marketing team can plan various campaigns to retain valuable customers. Instead of constantly working on acquiring new customers, you can now begin to focus on keeping your existing customers longer and selling to them repeatedly.
In the real world, the math is not as simple as shown above. There are numerous uncertainties surrounding the period, number of transactions and the average spend. How can you predict a customer’s next year spend? How do you know if a customer will not terminate his relationship next month? The marketers can only guess-estimate!
This does not mean that the model cannot be used, the lifetime value should be baselined and refined every quarter so that the marketing spend can be optimized and return on investment can be improved.
- Mr. Chaitanya Mudunuri is the CEO at Ray Business Technologies, www.raybiztech.com. He has years of experience in CRM space and is also a known speaker for his innovative ideas to enhance profits. He is an MBA from University of Oxford.