Customer Lifetime Value

The Customer Lifetime Value (CLV) is a key figure from business administration. The Customer Lifetime Value is the value that a customer represents for a company over the entire period of his or her customer base. It includes all monetary revenues (also: customer profitability; CP for short) that the customer has generated for the company, as well as those that will potentially be generated in the future.

Customer Lifetime Value Definition

The term “customer lifetime value” is often used to describe the transition from transaction marketing to customer relationship management.[1] The value of individual transactions is receding into the background, while the benefits of measures to maintain customer relationships are increasingly measured in terms of calculations coming from the areas of investment calculation and B2B. The CLV is based on the net present value method, which takes into account the return on a variable from the beginning of the investment.

Extension of the model for customer acquisition and customer care[Edit]
The CLV can also be used as an extended model to depict various phases of customer acquisition and customer care in order to tailor marketing campaigns to specific customer requirements. For this purpose, the duration of the customer base is divided into different cycles. For example: First customer contact, relationship building, individualization, cross-selling or retargeting. How the individual phases are structured depends on the objective of the survey. Various options are available here, so that, for example, new customer acquisition, existing customer care or customer equity can be used as a modern factor for the entire customer base. The latter aspect forms the theoretical basis for calculating the CLV, so that the overall significance of a customer for the company is regarded as an investment with an expected return.[2]

Calculate Customer Lifetime Value

The Customer Lifetime Value can easily be calculated in just two steps:

Step 1: Recording of the characteristic values

T is the duration of the business relationship. eT are the expected deposits of an individual customer. aT are the costs incurred for customer care. i is the calculation interest rate that takes the duration of the entire customer relationship as the calculation variable. Average values for the entire customer cycle are often used here. With other models, aspects such as sociodemographic factors (income, social milieu or other reference values) or the data provided by the customer can be included in the calculation as information values.

Step 2: Calculate CLV

The general formula for calculating the CLV: CLV = total T at event T0 * (eT – aT/ (1 + i)*T)

Simplified Example
Assume that the CLV of a customer of a mobile phone provider is to be calculated. The duration of the business relationship T is assumed to be 10 years. Accordingly, the calculation interest rate is 10%, i.e. 0.1 for inclusion in the formula. Every two years, the customer buys a new smartphone worth EUR 400 (eT). The manufacturer spends EUR 50 (aT) per year on customer care in the form of correspondence, telephone calls and e-mail. Since eT and aT are values that must refer to the period of the customer’s existence, they are calculated in advance: 5 * 400 results in 2000 Euro, and 50 * 10 results in 500 Euro. Now the values are inserted into the CLV formula.

CLV= (2000 – 500 / (1 + 0.1)*10)

Accordingly, the CLV of the customer amounts to 148.51 euros per year. Optionally other aspects can be included. If, for example, the customer has recruited another customer, this can be included in the calculation. Values such as the resale rate or cross-selling promotions can also be used. Basically, there are different models for calculating the customer lifetime value.

The CLV is partly based on estimated values, although based on the revenues generated, which, in principle, hold an uncertainty. In particular, the reference to possible sales is problematic because there is a fundamental imponderability of the forecast. The potential turnovers can be considerably smaller than assumed or even fail to materialize. The more purchase history is included, the more likely it is that the predictions will be correct and that practically useful values will result from the calculation of the CLV. It is important how the underlying data is generated and collected. Tracking in e-commerce, for example, must be able to assign all transactions to a single customer in order to achieve a useful database for the CLV. This also affects important aspects such as data protection or privacy in the course of the calculation. Therefore, the reference to the purchase history or other reference values must be anonymous.

Importance for online marketing and relationship marketing[edit]
In e-commerce, the costs for customer relationship management can be kept relatively low compared to stationary retail. Email, social media, organic search and related measures in particular can represent cost structures that result in a high CLV. According to a study from 2013, search engines obviously have a high CLV per se, as users often use search engines to search for products, services and brands. The CLV value here is on average about 50 % higher than for paid searches.

Email marketing is particularly interesting for young companies and start-ups because high CLV values can also be expected in this area due to the low costs for shipping. In general, start-ups should be able to keep an eye on performance with the help of the CLV, especially at the beginning of the business, in order to be able to set the monetization as high as possible.The ways and means to achieve a high CLV value are manifold. They range from personalized offers, improved customer service, sponsorships and loyalty programmes to the reduction of costs for acquisitions, logistics or other internal processes.