Customer Lifetime Value

Customer Life-me Value Can a Customer Be Worthless to Your Brand?

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

A few years back, I was living in the UK when my cell phone stopped working.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

I went to the store to get a replacement.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

I got to the store at 8:55 am to find there was already a long line, and when the store opened at 9, I told them that I had a flight to catch to Madrid and needed a phone. h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

I was politely but firmly told that I had to wait my turn and it would be 45 minutes before I could see a representa<ve.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

I tried to explain that I really needed a phone and had to leave for a flight, but was told -­‐

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

“But sir, all of these people are ahead of you; they are just as important.”

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

I had been a loyal customer for many years and as a result of this interac<on, when I got back from Madrid, I canceled my cell service, data plan and other services with the same company. h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

While the customer service rep in the store had given the “right” answer, the result was the loss of a high-­‐value customer who defected to a compe<tor. h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

What went wrong?

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Egalitarian – those who believe every customer is equal – marke<ng & sales are not limited to B2C companies.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

We once consulted for a Fortune 500 B2B company with a massive sales force.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

The sales force had just done an analysis that showed that 8% of the company’s B2B customers were 93% of its revenues

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

But the sales force treated every B2B customer equally.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

What would happen if one of the 8% were to defect to another company?

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

A be"er approach is to realize that all customers are not equal and develop a marke<ng and sales strategy grounded in this reality. h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Customer Profitability Calcula<ng the Value of the Customer

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Companies look at their performance in the aggregate – in other words, past ac<vity.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

A common phrase within a company is something like “We had a good year, and the business units delivered $400,000 in profits.”

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

When customers are considered, it is oden an average such as “We made a profit of $2.50 per customer.”

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Although these can be useful metrics, they some<mes disguise an important fact that not all customers are equal and worse yet, some are unprofitable.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Rather than measuring the “average customer,” we can learn a lot by finding out what each customer contributes to our bo"om line.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Customer Profitability

The difference between the revenues earned from and the costs associated with the customer rela<onship during a specified period

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

The overall profitability of the company can be improved by trea<ng dissimilar customers differently.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

So when we think about customers, we need to think in three different <ers

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Tier One – Reward

Your most valuable customers are the one you most want to retain. They get more a"en<on.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Tier One – Reward

Look for ways to reward them in ways other than simply lowering your price.

These customers probably value what you do the most and may not be price sensi<ve. h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Tier Two – Grow

The customers is the middle – with middle to low profits associated with them – might be targeted for growth.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Tier Three – Fire

The company loses money on servicing these people. If you cannot easily promote them to the higher <er of profitability, you should consider charging them more for the services they currently consume. h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Tier Three – Fire

If you can recognize this group beforehand, it may be best not to acquire them in the first place.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

How do we calculate Customer Profitability?

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

(Revenue from a customer) -­‐ (Cost to serve each customer) Profitability for the Customer

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Now doing this for every customer may not make sense, so you may have to abandon the no<on of individual customers and work with meaningful groups of customers instead.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Ader you calculate the value, you sort the customers based on profits.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Once you have the sorted list, you plot the percentages of total profits vs total percentage of total customers.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Here we have a clear illustra<on that if they were no longer to serve the least profitable 20% of customers, they would be $28 million be"er off.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Customer Life-me Value

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

This metric is the most advanced that we will cover in this course and value-­‐ based marke<ng strategies oden require industrial-­‐strength infrastructure to achieve the strategy.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

As a first step, most organiza<ons oden start by looking at plain sales revenues so that marke<ng effort and the sales force are directed at the customers with the most revenues.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

The problem is that this does not include the cost of serving the customer, which might be considerable, and the customer’s revenues today do not accurately tell us about the value of the customer in the future.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Customer Life<me Value (CLTV) addresses both of these issues and is probably the most important metric to learn in marke<ng.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Even if you don’t use CLTV, everyone in marke<ng should understand the concepts of value-­‐based marke<ng.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

One of the biggest mistakes marketers make is confusing customer profit with CLTV.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Customer Profit measures the past while CLTV looks forward.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

CLTV shapes managers’ decision but is much more difficult to quan<fy than customer profit.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Customer profit is calculated through careful repor<ng and summarizing the results of past ac<vity; CLTV involves forecas<ng future ac<vity.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

CLTV is the present value of the future cash flows a"ributed to the customer rela<onship.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

CLTV – The Math

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

AC Mn Cn p N (1 – r)

= Acquisi<on Cost = Margin Produced by the Customer in each <me period = Cost of marke<ng & serving the customer = Probability the customer will not defect in a year = Total number of years or <me periods = Discount rate (because money is worth less in the future)

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

To best understand this metric, think of CLTV as the Net Present Value of a customer.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Time Period 0

Time Period 1

Time Period 3

Time Period 2

Time Period 4

(M – C) = Margin – Cost in a Specific Time Period (Profit) x (1 – c) = Probability that the Customer Will Stay (c = Churn Rate) (1 + r) = Discount Rate (Profit in the future is worth less)

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

So how does this work?

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Margin is easy to calculate – how much profit do you make on each product/service you sell?

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Cost, on the other hand, is a bit more difficult

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

On the cost side, we need to understand all touches of the customer with the call centers, web site, customer service, marke<ng communica<ons, maintenance, and so on…

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Time Period 0

Time Period 1

Time Period 3

Time Period 2

Time Period 4

The Cost of the Customer to the Company in Time Period 0 is the Acquisi<on Cost. Since they are not a customer yet, there are no margins or service costs – so no profits to calculate.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Time Period 0

Time Period 1

Time Period 3

Time Period 2

Time Period 4

Once the customer becomes a customer, we start calcula<ng their value to the company. We take the profit generated from the customer (M) and subtract it from the cost of maintaining/serving the customer (C). We mul<ply it by the probability of the customer leaving within a year (1 – c).

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Time Period 0

Time Period 1

Time Period 3

Time Period 2

Time Period 4

Once we have the top side of the equa<on, we take the amount that money will devalue over the life of the customer, or discount rate – (1 + r)

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Looks really complicated doesn’t it?

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Let’s try an example

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

An Internet Service Provider (ISP) charges $19.95 per month. Variable costs are about $1.50 per account per month. With marke<ng spending of $6 per year, their a"ri<on is only 0.5% per month. At a monthly discount rate of 1%, what is the CLV of a customer? h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Margin = $19.95 Cost = $1.50 AC = $6/12 Churn Rate = 0.995% Discount Rate = 0.01

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Remember – we are just taking the profit in each <me period for the value of the money.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Now, I am sure you are all asking 1 ques<on –

“What is the correct length of <me to use for calcula<ng CLTV?”

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

I have seen company’s calculate CLTV over 85 years – the natural “life<me” of a customer, which is wrong.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Customer Life<me Value is not about the life of the customer, but the length of <me that a customer will stay with your brand.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

The best prac<ce is 3 – 5 years.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

While a customer may stay with a brand much longer than that, it is be"er to focus on a shorter <me period for decision making so that you have reliability, not incredibility.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Cohort & Incubate Which Customer is More Valuable – New or Exis<ng?

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

One way to project the value of future customer cash flows is to make the assump<on that the customers acquired several periods ago are no be"er or worse that new customers.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

To prove that, we go back and collect data on a cohort of customers all acquired at the same <me and break down their cash flows over specific periods.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

The next step is to discount the cash flows for each customer back to the <me of acquisi<on to calculate the CLTV and then average the CLTVs together to produce an es<mate CLTV of each new customer.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

We call this the “cohort and incubate” approach.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

How do we calculate Cohort & Incubate?

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

(Total Cash Flows from the Cohort) / (Number of Customers) Average CLTV for the Cohort

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

If the value of customer rela<onships is stable across <me, the average CLTV of the cohort sample is an appropriate es<mator of the CLTV of newly acquired customers.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

An Example

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

In 1993, 6,094 customers of a cruise ship line were tracked (incubated) for a period of 5 years.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

The total net present value of the cash flows from these customers was $ 27,916,614.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

These flows included revenues from the cruises taken (6,094 customers took 8,660 cruises over 5 years), variable cost of the cruises and promo<onal costs.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

The total 5-­‐year net present value of the cohort on a per customer basis was $4,581 per customer.

$27,916,614/6,094 = $4,581

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Cohort and Incubate works best when customers are sta<onary – changing slowly over <me.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

When the value of rela<onships changes slowly, we can use the value of incubated past rela<onships as the predic<ve value of new rela<onships.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Value Based Marke-ng Marke<ng Based on the Value of the Customer

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Value-­‐Based Marke<ng drives significant performance gains and firms that bridge the marke<ng divide focus on customer value in all marke<ng ac<vi<es.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

An Example of Direct Mail Offers Low to Medium CLTV + Low to Medium Response Rates are not sent a mailing

From a ROMI point of view, these customers are slow on the take rate, so why waste marke<ng dollars here?

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

An Example of Direct Mail Offers High CLTV + Low Response Rates are also not sent a mailing

The cost of the mailing is not jus<fied

Our focus, as marketers, must be on the medium to high CLTV + Medium to High Response Rate customers

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

An Example of Direct Mail Offers No-ce

Highest Expected Response Rate + the Highest CLTV get the 2nd most expensive offer

Highest Expected Response Rate + Medium CLTV get the 3rd most expensive offer

While the Lowest CLTV don’t get an offer at all

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Why do you think that is?

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Those that have the lowest CLTV are coming anyway so they get the lowest, most cost effec<ve offer. They are coming because they value your product but don’t respond to the “offers”; so it would be a waste targe<ng them.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

By focusing this single strategy on a value-­‐basis, we cut our marke<ng costs in half – since we now focus on less than 50% of the poten<al customer base, but the impact is significantly higher because we are focusing on profitability.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

What Makes a High-­‐Value Customer?

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

This is one of the most important ques<ons to ask your business and you may need focus groups, surveys and analysis to answer it.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

In banking, a high-­‐value customer has a poruolio of services – cash deposits, credit cards, auto loans, and perhaps a mortgage.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

To best manage this customer, you have to ensure – first and foremost – that they don’t leave

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Secondly, up-­‐sell and cross-­‐sell addi<onal products and services. Sell deep to high-­‐value customers.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Selling bundles of services to high-­‐value customers has the advantage of crea<ng lock-­‐in

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

What is lock-­‐in?

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Lock in means that there is a significant switching cost to the customer if they want to change to a compe<tor.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

But you need to be careful of customer lock in backlash – poor service can result in nega<ve customer sa<sfac<on (CSAT) that results in mass defec<ons when a compe<tor enters with a low-­‐switching cost alterna<ve.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled

Customer Service and Service Recovery are extremely important to retain high-­‐ value customers.

h"p://emagine-­‐group.com

Brand Focused, Socially Ac<ve, Digitally Enabled