What is the lifetime value of a customer?
Marketing executives in businesses all over the USA are concentrating on getting the most out of customer lifetime value. It’s another way of saying they’re trying to derive the highest customer net profit over the entire time that the customer remains committed to the company’s brand.
In customer experience (CX) programs, a primary goal is to strive for customer retention. There’s a steadfast belief that the loss of ongoing net profit after established customers disappear isn’t replaceable with new ones. Why?
- In the first instance, the revenue in the early stages of a new customer is generally not close to an entrenched one.
- In the second instance, adding and maintaining a new customer involves costs far above meeting the needs of a long-term loyalist.
- Thirdly, there’s no guarantee that the new customer will convert to a regular buyer of the brand.
Put these together and it’s no contest. There’s little doubt that if you can keep extending your average customer’s life cycle, you will be doing your net profit and ROI a considerable favor. The rest of this article will impress on you why the CLV concept is genuinely a mover and shaker in modern business life.
How do you measure customer lifetime value?
There are four steps, with the right software, to calculate CLV accurately and keep the calculations updated:
- Derive the Average Net Profit per customer purchase (hereon referred to as ANP).*
- Establish the Purchase Frequency Rate for that customer (PFR).**
- ANP x PFR = Customer Value (CV).
- CV x Period (in rate units) = CLV.
*Purchase Value – Cost of goods sold – Overhead allocation.
**Configure rate in terms of a specific time unit, like per month or year.
Here’s an example where ANP = $120 on a purchase value of $700; PFR is 4x a month, and the client’s proven or expected lifespan = 2 years
- CV = 120 x 4 = $480
- CLV = $480 x 24 = $11,520
What does a new customer’s buying power look like in comparison to losing a loyal customer?
Many companies say, “So what if the customer leaves? Look at all the new ones coming through the door.” Are they right? Is a new customer replacement a suitable response to customer churn and watching a viable CLV disintegrate?
- Consistent customer buying over a long time is the lifeblood of any business. Loyalty has to be built; it doesn’t just happen overnight.
- Developing loyalty costs money. It’s a far cry from the low cost of maintaining a committed buyer that believes in the brand.
- The customer journey over time is bombarded by multiple threats and distractions, not least of which come from competitors. Therefore, to reiterate our above observation, “there’s no guarantee that the new customer will convert to a regular buyer of the brand.”
CLV connects to an extended look at customer journeys from the first purchase until the last. From this vantage point, the company can assess the CLV breakeven period per customer, and if the costs connected to that make sense.
A case study on Customer Lifetime Value
I am connected to a dating company as a consult, and these are the exact numbers extracted from its database:
- It cost a dating site $400 to solidify one-in-two-hundred site visitors as a paying subscriber (i.e., acquisition cost).
- Revenue increased the more a subscriber (customer) dated.
- Initially, customers on average brought in a net profit of $20 (ANP) from $30 revenue monthly (i.e., based on an average of 1 date per month = PFR).
- Customer Value (CV) was also equal to $20 (ANP x PFR= $20 x 1).
- The breakeven period was twenty months (i.e., $400/$20).
- Against this, the average lifespan of its customer base was one year. It translated into falling short of breakeven by eight months. That wasn’t an enticing proposition.
The goal of every business is to shorten the CLV breakeven period to a realistic number and extend the lifetime value of a customer well beyond that to get a reasonable ROI. In our case study, the dating site was a year from startup, so breakeven was the first and foremost objective. Management put its mind to, and succeeded in improving all the metrics as follows:
- The company made its promotions more persuasive to get the 1 in 200 looking a little better. It required a focus on getting more closures while spending less on social media advertising. The two actions combined improved its cost per customer by 5% from $400 to $380.
- It spent more marketing money and gave special discounts to get subscribers to date more, lifting the PFR to 1.5 times monthly.
- As a result, the Average Net Profit (ANP) dropped significantly to $14. However, with the improved purchase frequency rate, the Client Value (CV) jumped to $21 monthly (i.e., $14 x 1.5 for a 5% gain).
- At the same time, the extra expenditure boosted the customer’s life period by 20% from a year to 14.4 months. CLV looked a lot better with additional time added on.
- The above changes resulted in the CLV breakeven period falling from twenty months to 15 months (i.e., a 25% improvement) and only negative two weeks outside of the adjusted customer life expectancy. The calculation to derive this is $380/21 = Acquisition Cost/ Client Value = 15 months.
- Previously the gap between CLV breakeven and actual recovery was negative eight months, so this represented a vast improvement.
As you can see, once all these things mesh, small improvements in each get the numbers looking right and the CLV realistically close to an ROI-centric zone.
Why is Customer Lifetime Value as a customer experience metric important?
CLV is like a strobe light that shines on:
- Revenue aligned with keeping customers longer.
- Expenditure incurred in maintaining customer loyalty.
- New customer acquisition costs.
- The cost of customer churn.
In all cases, CLV boils down to dollars and cents and, therefore, very different from Net Promoter Score (NPS) that only indicates the level of customer satisfaction at a point of time.
Because CLV is a concept that covers a long time in most cases, it emphasizes the importance of mapping customer journeys and looking at touchpoints analytically. CLV gives a bigger dimension to CX by making businesses aware of a customer’s worth – especially once considered loyal. It nullifies the tendency to take your customer for granted and makes you appreciate the cost of losing customers balanced against gaining new ones.
CLV orientations are particularly useful when customers are on the record as buyers for many years. The longer they are there, the higher is the cost of ignoring their needs. Sogolytics is a company that routinely works with clients trying to integrate CLV into their marketing plans alongside NPS and other customer feedback techniques. They understand the customer experience arena, and how CLV fits into it as a platform for improving ROI. If you feel you’re losing customers at a faster rate than gaining new ones, check out SoGoCX and turn around the trend.