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Lifetime Value of your Customers: A Metric to Drive your Business Desicions

5 April 2016

Customer Lifetime Value is a helpful indicator which, unfortunately, is still little known or applied. However, do you think that an employee of a small café would treat her customer differently if she knew that instead of a few dollars a week, this customer was in fact representing $14,000 of income during his lifetime relationship with the company? Sure!

 

Customer Lifetime Value (CLV)

Customer Lifetime Value (CLV), sometimes called “customer capital”, is the present value of the anticipated future cash flows attributed to the customer during his/her entire relationship with the company minus the cost of products and services and marketing costs. This metric differs by customer or by customer type, and is often calculated per cohort (a group of customers who share an attribute or a set of attributes).

 

Applications and Insights

There are several advantages to measuring CLV. Here are some examples:

 

Examples

 

Calculating CLV

The calculation can be quite laborious and also means you should know the cost of new customer acquisition. We can address it on the basis of the lifetime value of customers to acquire or the lifetime value of existing customers. Other elements required for this calculation are not always obvious, such as actual management costs associated with each client group, customer retention rate, customer acquisition cost and so on. True financial formulas are complex, and are similar to those used to calculate NPV (Net Present Value) of a project, but other simpler formulas also exist.

 

Case Study: Starbucks[7]

 

Step 1: Average your variables and list constants:

–       Average customer sales per visit: $5.90

–       Number of visits per week: 4.2 visits

–       Average customer sales per week: $24.30

–       Average customer lifespan (how long someone remains a customer): 20 years

–       Customer retention rate: 75%

–       Profit margin per customer: 21.3%

–       Average gross margin per customer lifespan: $5,382.94

–       Interest rate used to determine the present value of future cash flows (usually between 8% and 15%): 10%

 

Step 2: Calculate CLV using different methods

 

Method 1:

52 weeks X sales per week ($24.30) X customer lifespan (20)

= $25,272

 

Method 2:

Customer lifespan (20) X 〔52 weeks X sales per visit ($5.90) X visits per week (4.2) X profit margin (0.213)〕

= $5,489

 

Method 3:

Gross margin (5,382.94) X customer retention rate (0.75) / 〔1 + interest rate (0.1) – customer retention rate (0.75) 〕

= $11,535

 

Using an average of the three CLV equation results, Starbucks’ customer value is $14,099. You should decide which method is the most applicable to your business model. An average of several equations, similar to these Starbucks calculations, helps to reduce the risks.

 

Examples of Decision

 

In short, determining the lifetime value of your customers is a valuable source of information to maximize your company’s profits. However, if the calculation is incorrect, subsequent decisions may be inefficient and even harmful to your business. Learn more about our tools to calculate your customer lifetime value and find out how we can assist you to optimize it.

 

Sylvie Grégoire, MBA, CRHA

President, Totem Performance organisationnelle

[1] Bain & Company

[2] Marketing Metrics

[3] Prédire la valeur d’un client: tout est question de modèle! (tribune) La Rédaction, 3 février 2015, 10:43

[4] www.stratello.com/wp-content/uploads/2015/01/141211_Aria_Infographic_jf.png

[5] www.stratello.com/wp-content/uploads/2015/01/141211_Aria_Infographic_jf.png

[6] Craig Adkins of Zappos in the article “15 Ways for Companies to Increase Customer Lifetime Value” by Graham Charlton

[7] www.optimisation-conversion.com/infographies/comment-calculer-la-valeur-vie-client-ltv-life-time-value

[8] Chris O’Shea, “Do you know the lifetime value and cost of acquisition of your customers?”, Bdc.ca

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