How to Guide: Calculate Customer Lifetime Value

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Is your organization pouring out a large budget for sales & marketing activities and not seeing the returns? Is your organization focused solely on short term cash flows rather than long term …

Is your organization pouring out a large budget for sales & marketing activities and not seeing the returns? Is your organization focused solely on short term cash flows rather than long term profits? Is your organization unaware of how to calculate the potential profit of each client you bring in the door? If you answered yes to any of these questions, learning what customer lifetime value (CLV) is and how to calculate it may benefit to your organization.

CLV is a crucial metric that most organizations overlook mainly because its definition and purpose are not entirely known. Understanding the monetary value each customer represents to your organization can help you budget correctly for your business needs, strategically plan your marketing initiatives and improve long-term relationships with your customer base.

This brief 5-page guide details the definition of CLV, the advantages of calculating CLV and the standard formula for calculating CLV.

To obtain this document, visit us at http://www.demandmetric.com/register

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  • 1. How-To Guide © 2013 Demand Metric Research Corporation. All Rights Reserved. Calculating Customer Lifetime Value By Kristen Maida, Research Analyst October 2013 EXECUTIVE SUMMARY Is your organization pouring out a large budget for sales & marketing activities and not seeing the returns? Is your organization focused solely on short term cash flows rather than long term profits? Is your organization unaware of how to calculate the potential profit of each client you bring in the door? If you answered yes to any of these questions, learning what customer lifetime value (CLV) is and how to calculate it may benefit your organization. Common sense tells us that the longer a customer is in relationship with a company, the more profitable that customer relationship is. However, many companies put the emphasis on new customer acquisition and not enough effort is made to retain existing customers. This is a mistake, because the financial impact of retaining customers is substantial: companies can increase profits by as much as 100% by retaining just 5% more of their customers. For these reasons¹, CLV is a crucial metric that most organizations overlook mainly because its definition and purpose are not entirely known. ¹ “Zero Defections: Quality Comes to Services”, Frederick F. Reichheld and W. Earl Sasser, Jr., Harvard Business Review, September, 1990.
  • 2. How-To Guide © 2013 Demand Metric Research Corporation. All Rights Reserved. Understanding the monetary value each customer represents to your organization can help you budget correctly for your business needs, strategically plan your marketing initiatives and improve long-term relationships with your customer base. This How-To Guide details the definition of CLV, the advantages of calculating CLV and the standard formula for calculating CLV. WHAT IS CUSTOMER LIFETIME VALUE? Customer lifetime value goes by many names and abbreviations including CLV, lifetime value, user lifetime value, LTV and CLTV. Although its designations are far-reaching, they all share one general definition: “The net present value of the cash flow relationship with a customer.” - http://www.zurb.com More specifically: “Customer lifetime value (CLV) […] is a prediction of the net profit […] attributed to the entire future relationship with a customer. The prediction model can have varying levels of sophistication and accuracy, ranging from a crude heuristic to the use of complex predictive analytics techniques. Customer lifetime value (CLV) can also be defined as the dollar value of a customer relationship, based on the present value of the projected future cash flows from the customer relationship.” - www.wikipedia.com Customer lifetime value (or CLV as we will refer to it for the remainder of this guide) attempts to assess the true, long-term value and/or profitability of each client/customer. The purpose of this metric is to help businesses identify how much to invest in the development of each account.
  • 3. How-To Guide © 2013 Demand Metric Research Corporation. All Rights Reserved. ADVANTAGES OF MEASURING CLV Calculating CLV provides a multitude of benefits. In our opinion, the most important advantages of identifying CLV are:  Valuation of a Customer Relationship – Knowing the dollar value of customers over the duration of the relationship allows you to better assess current and future profitability. The insights gained from this valuation enable more effective investment decisions about customer acquisition costs.  Evaluates Proper Investment for Each Customer – Measuring CLV allows you to develop a more accurate sales & marketing budget. When you know the CLV, it makes it easier to justify more expensive account development activities early in the relationship with the customer.  Forecasts Potential Future Value of Customer Relationships – The CLV formula not only …