Customer Lifetime Value

Customer Lifetime Value (CLV) is one of those business metrics that creates a sense of excitement in the minds of quantitative/analytical marketers on a never-ending quest to quantify marketing performance and mathematically prove its value to skeptical accounting and finance colleagues (or even more discerning Chief Financial Officers).

There is — in fact — an irrational need on behalf of some marketers to go overboard when attempting to validate their existence to others in the business (and/or marketing research) community such that things can easily get out of hand. Constructive narratives can end up by the wayside in favor of quantitative acrobatics for the sake of proving a moot point: Marketing matters (and it matters because we can do complex math, including algorithms!).

For those who understand the fundamental reality that to be in business is to be marketing, discounting marketing simply because its numerous benefits to the firm are difficult at times to measure or devaluing its worth because it can not be quantified like rocket science — or worst of all — employing scientific methods to describe basic concepts for the sake of elevating a discipline’s status is unhelpful and I dare say, destructive. I will settle this debate once and for all — anyone who feels that marketing does not matter or ought not matter unless every aspect of it can be quantified as a matter of rocket science ought to stop marketing immediately and observe the demise of business. For everyone else, below is a practical definition of CLV including a conceptual model around calculating it, devoid of PhD jargon (because no senior executive decision maker is ever solving PhD level math):

Customer Lifetime Value (CLV) measures the value of a customer to the firm over the lifetime of the customer’s revenue producing relationship with the firm (which may be counted as any period of time including but not limited to hours, days, weeks, months or years) minus any cost(s) associated with acquiring and maintaining such a customer relationship.

Based on the above definition, one conceptual model for calculating CLV may be represented as such:

CLV = ( R1 – CAC ) + ( [ R2 – CRC ] * L )

The elements of the above formula are as follows:

CLV: Customer Lifetime Value.

R1: Initial revenue amount generated as a result of the first-ever customer transaction with the firm. For the case of having an example to work with, let’s say this amount is $100.00.

CAC: Customer Acquisition Cost. This represents the cost associated with acquiring the customer who produced R1 above. One way to determine this cost is to factor all tactical costs associated with earning the customer’s business divided by the number of customers earned as a result of the aforementioned tactics. So, if the firm spent $1,000,000.00 in tactics designed to attract 30,000 customers, each of those 30,000 customers cost $33.33 to acquire.

R2: Subsequent revenue generated as a result of the customer’s continued loyalty with the firm resulting in additional transactions. This amount can be an average in cases where there are various price points related to numerous products involved or a steady number in the case of a service contract, for example. In this case let’s say this amount is $20.00.

CRC: Customer Retention Cost. This represents the cost associated with retaining the existing customer — from the cost of customer service to the cost of support or back-end web development or new feature additions specific to retention efforts. This amount can be an average in cases where numerous efforts are required to retain a customer or a steady number in the case of a singular effort. In this case, let’s say this amount is $8.00.

L: Lifetime. This period of time can vary depending on the span of time the average customer continues to do business with the firm. For example, if the firm mandates an annual contract, the lifetime value can represent one year whereas in situations where there is high turnover (monthly subscriptions) the value can be set to represent one month. In all cases, the L value is 1 * whatever span of time is determined best representative of the customer lifetime cycle. In this case, let’s say L is represented by a monthly period of 1 over a 12-month period, therefore L in this case would be 12.

Applying the above values to the CLV formula results in the following:

CLV = ( $100 – $33.33 ) + ( [ $20 – $8 ] * 12 )

CLV = $66.67 + $144

CLV = $210.67

Applied to the original assumption that $1,000,000.00 was spent in tactics designed to attract 30,000 customers, the CLV of those 30,000 customers over a period of twelve months (measured in revenue) would be $6,320,100.00 and from here, other mathematical acrobatics could be accomplished to appease quant jocks.

Aside from demonstrating the value of marketing tactics on the firm’s bottom line, however, a more important point must be realized from this process:

Customer Lifetime Value demonstrates that the true value of a customer must not be measured at the initial point of sale but rather over a mutually beneficial long-term relationship wherein true value continues to be provided by the firm, realized by the customer and rewarded with continued revenue producing loyalty on behalf of the customer. It is far more important to understand the ramifications of a long-term customer experience (CX) centered orientation required to ensure such long-term customer relationships than it is to demonstrate the math necessary to calculate CLV. Without meaningful, mutually beneficial long-term customer relationships, CLV can be an irrelevant — if not misleading — metric.

For sticklers concerned about the importance of profit over revenue, a modified version of the above formula might be calculated as such:

CLV = ( [ R1 – O1 ] – CAC ) + ( [ ( R2 – O2 ) – CRC ] * L )

The elements of the above formula are as follows:

CLV: Customer Lifetime Value.

R1: Initial revenue amount generated as a result of the first-ever customer transaction with the firm. For the case of having an example to work with, let’s say this amount is $100.00.

O1: Overhead costs associated with generating said revenue. In this let’s say this amount is $25.00.

CAC: Customer Acquisition Cost. This represents the cost associated with acquiring the customer who produced R1 above. One way to determine this cost is to factor all tactical costs associated with earning the customer’s business divided by the number of customers earned as a result of the aforementioned tactics. So, if the firm spent $1,000,000.00 in tactics designed to attract 30,000 customers, each of those 30,000 customers cost $33.33 to acquire.

R2: Subsequent revenue generated as a result of the customer’s continued loyalty with the firm resulting in additional transactions. This amount can be an average in cases where there are various price points related to numerous products involved or a steady number in the case of a service contract, for example. In this case let’s say this amount is $20.00.

O2: Overhead costs associated with generating said revenue. In this let’s say this amount is $4.00 (less overhead resources required for existing vs. new customers in this example).

CRC: Customer Retention Cost. This represents the cost associated with retaining the existing customer — from the cost of customer service to the cost of support or back-end web development or new feature additions specific to retention efforts. This amount can be an average in cases where numerous efforts are required to retain a customer or a steady number in the case of a singular effort. In this case, let’s say this amount is $8.00.

L: Lifetime. This period of time can vary depending on the span of time the average customer continues to do business with the firm. For example, if the firm mandates an annual contract, the lifetime value can represent one year whereas in situations where there is high turnover (monthly subscriptions) the value can be set to represent one month. In all cases, the L value is 1 * whatever span of time is determined best representative of the customer lifetime cycle. In this case, let’s say L is represented by a monthly period of 1 over a 12-month period, therefore L in this case would be 12.

Applying the above values to the CLV formula results in the following:

CLV = ( [ $100 – $25 ] – $33.33 ) + ( [ ( $20 – $4 ) – $8 ] * 12 )

CLV = $41.67 + $96

CLV = $137.67

Applied to the original assumption that $1,000,000.00 was spent in tactics designed to attract 30,000 customers, the CLV of those 30,000 customers over a period of twelve months (measured in profits) would be $4,130,100.00 representing over 3X Return on Tactical Investment (ROTI) in profits.