Dr.

Amit Shrivastava

Customer Life-Time Value

 • Utility – Why CLV?

• Concept – What is CLV?

• Operationalization – How to calculate CLV?

• Managerial implications

Learning
Outcome
  THE FOUR PRINCIPLES OF MARKETING
 Selectivity and Concentration
 Customer Value
 Differential Advantage
 Integration

Customer Life-
Time Value
  Selectivity – Marketers must carefully choose targets for the firm’s efforts
 It is dangerous to dissipate limited resources over too many alternatives
 Selectivity element is fundamental to recommend which market to target
 Small firms that allocate their slender resources on specific target market often
gain leverage over their competitors (Ex: Vasan Eye Care)

 Concentration – The firm should concentrate resources against those targets

Selectivity and  Concentration involves risk – The firm will fail in chosen options – the not chosen
options will be successful to others
Concentration  Therefore, Marketing is entrepreneurial in nature (Ex: Samsung)
  The firm’s success depends on providing value to customers
 Customer value should design the firm’s products and investment decisions
 The customer does not just buy the product, she buys the value, the exchange delivers
 Customer value is a moving target – Environment change, customer accumulate
experience and their needs evolve (Ex: Dell Computers)

Customer Value
  Differential advantage asserts the firm offers a value the customer don’t get elsewhere
 It’s a cluster of benefits offered to a sizable market that is able to recognize and willing
to pay
 The differential advantage should be able to avoid competitive parity
 A differential-advantage based on organization-process like – good customer
relationship, willing ness to serve culture may be even more sustainable.
 The difference must make customer recognize, value the advantage and willingness to

Differential pay (Ex: Four Seasons, Las Vegas)

Advantage
  The firm must carefully integrate and coordinate all design and executional elements to
deliver value
 Poor advertising can ruin an excellent product
 Improper pricing can cause havoc with sales forecasts
 Examples of insufficient integration –
 Corporate vs Business Units
 Control vs Trust
 Operating in silos
Integration  Defending internal turf at the expense of market share and position (Ex: Unit A &
Unit B)
  Sales – It’s cliché – Revenue is life blood of an organization
 Sales is the only channel to do that …and obviously a customer is the only source of
revenue
 Competition adds another layer of complexity while the companies are struggling to
maintain the profitability – Product commoditization
 This concept moves beyond the marketing concept of designing and delivering value to
measuring the value that customers bring to the firm
 Crucial link between the value delivered and value captured

Customer Life-  Customer lifetime value is a measure of customer profitability over time
 CLV can be defined as “a measure of a customer’s aggregate profit to the firm over the
Time Value total time that the customer deals with the firm”
 CLV is calculated as a single number, which summarizes the net profit/loss position of
the customer during the total relationship with the firm
 It is calculated on per customer basis, but is more usually determined for an the average
customer within a particular market segment as assets
 A firm will calculate multiple CLV’s for different customer - Segments
  When customer makes the purchase – the firm earns sales revenue
 If sales revenue is higher than costs – The firm makes profit margin – The
annual value the customer brings to the firm
 Many customers (both B2C and B2B) purchase the firm’s products for several
successive years
 Each year the firm receives revenue, accrue costs and earn a profit margin.
 The firm accounts the profit margin earned in each of the successive years by
Customer Life- using a discount rate.
Time Value  CLV also includes customer defection or retention.
 Retention Rate is number of customers at the end of the year divided by
number of customers at the start of the year. (Ex: Pharma Industry)
  Customers are increasingly being viewed as assets that bring value to the firm. To
nurture these assets, firms focus on three customer management strategies:
 Asset acquisition—attracting new customers to the firm
 Asset maximization—maximizing the value the firm extracts from each customer
 Asset retention—retaining existing customers for the long term.

 A customer’s lifetime value is dependent on three different factors:

Operationalization  The cost to acquire the customer.

 The annual profits the customer generates for the firm
 Contribution Margin = Sales Revenue – Variable Cost
 Gross Margin = Sales Revenue - COGS
 The number of years the customer is likely to purchase from the firm
 The Basic CLV Formula
 CLV = m * L - AC
 where m is the contribution margin generated from a customer in a year
 L is the expected purchasing life of a customer
 AC is the up-front cost of acquiring a customer.
 Understanding total revenue  Total Revenue = 3840  m = Revenue – VC = 1920 – 480 = 1440
Visits / Month = 4
 Cost of acquisition = 500  L = 2 Years
Visits / yr = 48
Rev / Transaction = 40  Service cost / transaction=10  AC = 500
Rev / yr = 40*48  = 1440 * 2 – 500 = 2380
Life span = 2 Yrs
 CLV = 2380/-
Assumptions:
• The profits generated from a customer are the same in each period
• The formula does not take the time value of money into account
  In each year, the firm earns a portion of its CLV.
 In the first year, it earns CLV (1)
 CLV (1) = m * r / (1+d)
 The profit margin (m), the firm earns in year 1
 r (Retention Rate) – The probability that a customer at the start of the year will be
a customer at the end of the year
 d (Discounted Rate) – The firm’s cost of capital
Time Value of
Money into  To calculate customer’s total CLV – The CLV contribution for each successive year
to be added
CLV Analysis  Assume that – Profit margin (m), discount rate (d), retention rate is constant year to
year
 With these assumptions, CLV equals the profit margin (m) multiplied by margin
multiple
 The margin multiple = r/(1 + d - r)
 C L V = m * r / (1+ d - r) - AC
  The ranges of values of discount rate (d) (8% to 20%) and retention rate (r)
(60% to 90%) are quite large - They cover most cases
 Improving retention rate (r) has a greater impact on the margin multiple than
reducing discount rate
 When retention rate (r) is 90%, reducing discount rate (d) from 20% to 8%
improves the margin from 3.00 to 5.00
 When discount rate (d) is 12%, increasing retention rate (r) from 60% to 90%
increases the multiple margin from 1.15 to 4.09 – well over three times

Insights  All things equal – The firm is better of increasing retention rate (r) then reducing
discount rate (d)
Time Value of Money into CLV Analysis
The discounted expected contribution margins across the years in the customer’s lifetime yields the expression:

C L V = m * r / (1+ d - r) - AC

Calculation:
• m = $ 50
• AC = $ 20
• The RR (r) = 90%
• Discount Rate (d) = 12%
• L (Expected purchasing life of the customer) = 10

• CLV = $50 * ([1 +.12]/[1 +.12 – .9]) – $20 = $234.55

• CLV without Discounting = m*L – AC
• $50 * 10 - $20 = $480
• Assumption:
• The formula assumes that the profits generated from a customer are the same in each period
CLV Analysis – Managerial Implications
• To decide which type of customer (or customer segment) would be more profitable to target
• To decide when to scale up or scale down marketing expenditures for a particular customer – Profitability pyramid to
rank their customers
• To decide when to fire a customer
• To decide how much to spend to acquire a new customer, retain an existing customer, or try to cross-sell or up-sell
additional products to existing customers
Thank You