how to calcualte LTV

1. How-To Guide
© 2013 Demand Metric Research Corporation. All Rights Reserved.
Calculating Customer Lifetime
Value
By Kristen Maida, Research Analyst
September 30, 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.
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2. How-To Guide
© 2013 Demand Metric Research Corporation. All Rights Reserved.
¹ “Zero Defections: Quality Comes to Services”, Frederick F. Reichheld and W. Earl Sasser, Jr.,
Harvard Business Review, September, 1990.
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.
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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 estimates current value of a client, but
also takes into account the potential value of a client. With a
numeric value for potential revenues, your organization can more
accurately forecast potential total cash flow for future months
and/or years.
§ Emphasizes the Importance of Cultivating Long-Term
Relationships – an understanding of CLV helps put the focus on
client retention within your organization. Inherently, CLV
encourages businesses to move past the short-term expense and
instead view customer relationships through the lens of long-term
profitability. Thus, nurturing customer relationships to eventually
obtain these potential profits becomes an integral theme in client
retention long-term.
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4. How-To Guide
© 2013 Demand Metric Research Corporation. All Rights Reserved.
STANDARD FORMULA FOR CALCULATING CLV
While most organizations have a slightly customized way of calculating
CLV, all of the calculations tend to use this underlying standardized
formula:
𝑪𝑳𝑽 = 𝑴 ×
𝑹𝑹
𝟏 + 𝑫𝑹 − 𝑹𝑹
M = gross profit margin per customer lifespan ($)
RR = the percentage of customers that repurchase/renew for your
product/service over a certain period of time (%)
DR = the interest rate used to calculate the current value of future cash
flows (%)
This is the traditional model used to calculate CLV. As mentioned above,
most organizations customize this model to suit their needs and some
organizations use more advanced models that require in-depth calculations
and the assistance of a specified tool.
ACTION PLAN
1. Identify the constants for your CLV formula – Find the values of M,
RR & DR (defined above) for your organization.
2. Calculate CLV for your customer(s) – Download our Customer
Lifetime Value Calculator to easily input your constants and complete
your computations. You can repeat the calculation of this formula for
each type of buyer persona you have to determine patterns in spending
and how to use your budget properly for each type of customer.
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5. How-To Guide
© 2013 Demand Metric Research Corporation. All Rights Reserved.
3. Highlight the customer patterns - Use our Buyer Persona Template
and Buying Process Stage Template to highlight the customer patterns
you assessed from your calculations. Including this information in
these templates will build collateral for your sales & account
management teams in order to cultivate the most beneficial customer
relationship and derive the most profit from each customer.
4. Consider CLV when planning - Utilize our Marketing Strategy Plan
Methodology and Sales Enablement Plan Methodology along with
your newly discovered qualitative CLV data to strategize and plan for
the proper marketing & sales strategies for your organization.
BOTTOM LINE
Customer lifetime value is an indispensable metric that can serve the
long term monetary and strategic goals of your company. Since many
organizations are unaware of the importance of this metric, understanding
the purpose and advantages to CLV will put your company ahead of the
curve when it comes to retaining and nurturing your customer
relationships for the benefit of your bottom line.
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1,000+ other reports, guides, tools, templates and training courses.