The concept of CLV (Customer Lifetime Value)

1. Introduction Based on more than 30 years of experience from creating and implementing loyalty strategies it is both our conviction and proved experience that CLV is the best basis of decisions concerning the market and customer strategy. The reason being that CLV is a economic concept where managers base their market investment decisions on calculations of both the short and long term results of different alternatives. Further that CLV is suitable to be the main nominator in a business case concerning the predicted result of both the actual strategy and defined future alternatives. Finally it is a proven concept being used for decades in say the mail order business and other direct marketing companies. 2. CLV definition CLV is defined as: The net value of all net payments from the moment the marketing efforts start towards a potential customer and until the customer definitely stops being a customer in the company. CLV can be calculated for potential customers, existing customers and past customers. Research has shown that there is not always just one CLV for a specific customer. Thus in connection with customer WinBack there will be two different CLV: the First CLV (the CLV before defection) and the Second CLV (the future CLV if winning back the customer). If a customer defects, then the company has to calculate a second CLV in order to decide whether to invest in winning back the customer or not. 3. The formula of CLV The formula of CLV can mathematically be defined as follows:

CLV =

NPt (1 + r ) t

CLV =

NPt (1 + r ) t

(for a single period)

(for multiple periods)

The formula states that we divide the total of expected net profit in each period by a discounting factor. The factor can be defined from the companys rate of credit interest. Then the figures from all periods are added, resulting in the customers CLV. As shown by the formula, CLV depends on three main factors: 1. The rate of interest used 2. The net profit in each period 3. Customer lifetime

4. The objectives of calculating CLV The calculation of CLV can be made in a very simple way, for example based on general assumptions (rules of thumbs) and by using average numbers. Alternatively, the calculation can be made in a very sophisticated way using statistical methods or even software simulation, calculation of individual customer CLV etc. The best way to decide how to use CLV will depend on what your objective is in calculating CLV. Is it: * To illustrate for employees, in general terms, that some customers are more profitable than others? * To demonstrate the expected result of a new campaign? * To make a business case for a strategic company change? * To analyse, plan, decide and implement a strategy? * To evaluate the customer asset of a company? The best way to calculate CLV in a given situation will also depend upon the knowledge and acceptance of ROI driven customer management and marketing within the company. Further tt will depend on the quality of customer data, whether there is an internal customer database or not and how customers are defined. 5. Examples of CLV In practise the CLV of an average customer in different market sectors are calculated to be: * Telecom (post paid mobile subscription): 100 $ * Auto (Cadillac): 332.000 $ * Pizza: 8.000 $ * Insurance: 5.000 $ * Retail (grocery): 20.000 $ The above mentioned CLV are all examples of average figures which will differ very much from customer to customer and customer segment to customer segment. As an example different insurance customers might differ from having a CLV of say segment A: 30.000 $ and segment D: 1.000 $. The exact value of customers in segment D. might further differ from being say 3.000 $ for the most profitable quartile in this group and being 2.000 $ (a negative ROI) for the less profitable quartile in the group. Please notice that many customers and customer groups have a negative CLV. The large difference of different customers and customer groups CLV makes it very important to decide market investment on the basis of CLV. Of course it will be more profitable to invest say 100$ in acquiring a new customer with a CLV of 500$ than a new customer with a CLV of 75$. Further to invest in developing an existing customer with a future CLV of 1.000 $ to become a Total Customer than acquiring a new customer with a CLV of 500 $. The key point is that management by using CLV in the decision process has the possibility of making decisions based not only on sales figures and product turn over but based on an evaluation of the short term and long term profitability of individual customers and customer groups.

6. Market strategy decisions and CLV Customer Lifetime Value (CLV) is a key factor in estimating the future economic results of an investment in increased customer loyalty, particularly if the company wants to manage and maximise the profitability of customers during the whole customer life cycle. Over the last decade, business managers and marketers have become increasingly interested in learning about the correlation between customer loyalty and customer profitability. This has led to, among other things, an increase in the amount of loyalty research (for example the causes of customer churn or defection), as well as the implementation of many loyalty programmes and CRM initiatives. Despite this interest most managers still have a number of unanswered questions, like: * Who are the most loyal customers and who are the most disloyal? * Who are the profitable customers and who are the non-profitable customers? * How do we calculate the yield from an investment in an increased customer loyalty degree? * How much do we have to invest in acquiring a new customer? * How much do we have to invest to retain an existing customer? * How much do we have to invest to develop defined customers into 'total' customers? * How much do we have to invest to win back defined defected customers? * How do we allocate the marketing budget to optimise the economic effect? 7. How to calculate CLV The calculation of CLV includes both cost and income from the defined customer or customer group. The period of calculation depends on the management perspective and the company strategy. It is recommended to make a CLV calculation of both the short term (say 2-3 planning periods) economy and the more long term (say 5-10 planning periods). The definition of a planning period might differ from one market sector to another. Thus a period might be a year in say Financial service industry while it might be quarters in Telecom. Below in figure 2. is shown an example of the calculation of CLV in a Telecom. Acquisition costs (subsidies, sales provision, etc.) Variable annual costs (billing, call centre, etc.) Annual subscription fee Annual revenue from voice (in and out) Annual revenue from data/conference calls, etc. -1,000 -600 +1,200 +840 +125

---------------------------------------------------------------------------------------------------------Result for year 1 = Result for year 2 = Result for year 3 = Customer lifetime value = CLV can be calculated with or without a tool say a CLV model and/or a CLV system. +565 +1,565 +1,565 +3,695

8. CLV models and CLV systems A CLV model in this context is defined as: A flow chart showing the drivers of loyalty and profitability, the inter-relationship between those drivers, and the weight of different drivers and their inter-relationships. They range from very simple models showing some main elements to detailed flow charts with many correlations and formulae defined on the paper. A CLV system in this context is defined as: An IT-based program to be used to predict the CLV results of different loyalty strategies and marketing activities. The CLV system might be a simple software tool (say an Excel spreadsheet) to create simulations or it might be a complex computer program running as part of the customer database in the mainframe computer. There are different CLV models that are developed in accordance with the characteristics of different sectors. For example, a CLV model for a financial company will differ from one for a Telecoms company, an Auto dealer, a Computer company, a Retailer, or a Mail order company. It is possible to use a standardised CLV model (sector prototype model) or to develop a tailormade CLV model adapted to special company specifications. 9. CLV as basis of management decisions Here are some examples of how managers can use CLV in their decision process. Defining objectives In the same way as defining a company objective in terms of growth, turnover, new sales and net profit, it is possible to define company objectives using CLV. It could be stated that CLV has to be increased by 10% from $100 million to $110 million over the next three years. This objective is a more exact measure of the company economic development than the traditional objectives like the annual turnover. Alternative market strategies For example, CLV could be used to calculate the profitability of an unchanged acquisition strategy compared with an alternative future strategy based on customer retention and development. The consequence of different target groups, different market budget allocations, different pricing policies, different customer retention rates, different sales channels, different segments and marketing with or without a loyalty programme could also be evaluated using CLV. The consequence of decreasing or increasing customers satisfaction A large number of companies analyse customer satisfaction, company image, buying intentions and so on. The problem is, however, to convert research conclusions into predictions of consequences, and into decisions based upon those consequences. As an example: What will the consequence be if customer satisfaction decreases from 90% to 88%? How will it effect the customer retention rate? How will it effect cross-selling opportunities? How will it effect customer short term and long term profitability? Market communication There is an old saying: "I know that half of my advertising costs are wasted. I just wish I knew which half". There is still some truth in that today. A company can achieve much better results (such as awareness and image) by choosing target groups, communication channels, and even the message to be delivered using CLV.

Customer service Generally it is most profitable to invest in customer services in areas where there is the highest positive correlation with customer satisfaction. Services like hotlines, upgrading and invitation to events could be defined and targeted to customers who have the highest CLV (and not the highest actual turn over). Loyalty programmes The future profit from an investment in a new loyalty programme including the results of different forms of customer rewards (discounts, exclusive offers, special service, upgrading etc.) could be learned by calculating CLV, both with and without a loyalty programme. This could be further refined by calculating CLV as a result of two different loyalty programmes. Managing the Sales force CLV could be used to help decide which sales districts to focus on (what is the potential CLV in a given district?), how to allocate sales resources, how to reward sales agents (say a higher bonus for selling to customers with a high potential CLV or acquiring new customers with a high CLV), how to run sales competitions (say rewarding the sales agent with the highest number of Total customers instead of the highest annual sale) and so on. Marketing Campaigns Generally it is most profitable to invest the marketing budget in campaigns that focus on customer groups, potential customer groups and a group of defected customers with a CLV above average. Cross-selling campaigns can be targeted at customers who have been defined and selected using CLV. Reactivating inactive customers Instead of trying to reactivate all inactive customers the efforts should be directed towards those customers who have a potential CLV about average. Complaint Management If a customer makes a complaint about a serious problem then a simple CLV index (or preferably an individual CLV score) will help front-line employees to decide what action to take immediately and how much to invest in solving the problem. The index (rating individual customers or groups of customers) might be shown on the computer customer page in a call centre. Win back Some defected customers are worth winning back and others are not. The CLV will differ significantly from customer to customer. As mentioned above a customer often has a different CLV before defection and after recovery (Win Back), the Second CLV often being better than the First CLV. The annual report Except for general statements like: Customers are our most valuable asset, We expect increasing numbers of customers in future etc., the Annual Report seldom informs shareholders about the future value of the company customer base. CLV is a way of doing this. Mergers and selling or buying companies If a company calculates its CLV for all its customer groups (potential customers, existing customers and defected customers) - or at least its CLV for existing customers - it will have an exact picture of its most valuable assets: its market position and its existing customers. Those figures could be used as part of the valuation that's needed for mergers, company purchase and company sales. In the same way CLV is useful in the business case for the

merger between two companies. The merger will influence both the acquisition rate and the retention rate and then the future value of the new company. 10. Can any organisation use CLV? The main question will of course now be: Can any company in any market sector use CLV? The answer is that the CLV methods (with minor adaption) can be used in almost any sector by almost any company. While this article mentions only companies, other organisations like associations can also benefit from using CLV. It is possible to calculate the CLV of different kinds of memberships in the same way that the CLV of different kinds of customers is calculated. CLV can be used in both B2B and B2C for making decisions based upon customer loyalty and profitability. The CLV method does not assume a special repeated buying pattern. Whether in a sector (say retail) where a customer buys often (say once a week), or a sector with a very short customer life cycle (say mobile phone subscriptions) or in a sector with a very long life cycle (say a mortgage company) it is still possible to use CLV. In a sector with a very short life cycle the time definition is adapted from years to quarters or to months and then the same way of calculating CLV is used. In some markets calculating CLV might be difficult. Examples would be companies marketing durable consumer goods (like houses, cars and furniture). In those sectors it is often difficult to maintain the relationship with the customer and to update the customer data regularly. The solution could be to combine the primary product with other products and services, both from a strategic marketing point of view and for the purpose of CLV. An example would be a real estate company combining the sale of a house with financing, insurance, regular follow-ups for valuation or advice on maintenance. Another example will be a car dealer marketing financial products, car service and special offers like winter tyres. Some transactions might be looked upon as once-in-a-lifetime sales (for example a cruise passenger visiting a store on a distant island). In this situation the store owner might look on the cruise company or the travel guide (directing passengers to the store) as being the customer and invest in building relations with them. He would then calculate CLV per cruise company and/or per travel guide. Within the banking sector there is another kind of problem. Due to the long life cycle of the customer, the profitable deals come near the end of the cycle, but the bank has to invest in the new customer while he is still unprofitable. A child, student, or young married couple does not generate much profit. The bank has to wait patiently for many years - possible ten years before the customer reaches his potential for generating profit. The more profitable, high volume products like car loans, house loans and pensions don't enter the picture until the relationship is quite advanced. The bank has to calculate the future CLV to really get an idea of how much to invest in acquiring and keeping the new customer. The same applies whether we are talking about a private customer, an independent business man, a shareholder or CEO. There is also a special situation within the insurance business and the credit card business because of the risk of high customer costs in the future: for example, a house burning down or a credit card loan not being paid off. The problem is due to the special characteristic of risk products. However, it is still possible to use CLV in deciding the right marketing strategy, developing and implementing the loyalty programme etc. CLV can at least predict average values for different customer segments and customers with different profiles. It is similar to the systems already used for credit scoring, but in a more sophisticated way.

It is quite plain from the above examples that it is not possible to make just one CLV model that is suitable for all sectors and companies. But that is not the point. The main message to bear in mind about CLV is: Think about which elements are most important in the different types of the Customers Lifetime cycle, the Lifetime, the Value and Customer Lifetime Value. Then decide how to influence the drivers of loyalty and profitability and analyse the weight of the main drivers. Finally, combine the elements into a CLV model and start making the right decisions. It's not important whether the model is only a simple 'dummy' model to begin with, or a sophisticated IT-based model (software solution). The important thing is to get started on making decisions on the 'best basis of decision' - and that's in our experience CLV!

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