Customer Life-me Value Can a Customer Be Worthless to Your Brand?
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A few years back, I was living in the UK when my cell phone stopped working.
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I went to the store to get a replacement.
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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
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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.
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I tried to explain that I really needed a phone and had to leave for a flight, but was told -‐
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“But sir, all of these people are ahead of you; they are just as important.”
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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
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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
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What went wrong?
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Egalitarian – those who believe every customer is equal – marke<ng & sales are not limited to B2C companies.
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We once consulted for a Fortune 500 B2B company with a massive sales force.
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The sales force had just done an analysis that showed that 8% of the company’s B2B customers were 93% of its revenues
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But the sales force treated every B2B customer equally.
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What would happen if one of the 8% were to defect to another company?
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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
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Customer Profitability Calcula<ng the Value of the Customer
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Companies look at their performance in the aggregate – in other words, past ac<vity.
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A common phrase within a company is something like “We had a good year, and the business units delivered $400,000 in profits.”
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When customers are considered, it is oden an average such as “We made a profit of $2.50 per customer.”
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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.
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Rather than measuring the “average customer,” we can learn a lot by finding out what each customer contributes to our bo"om line.
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Customer Profitability The difference between the revenues earned from and the costs associated with the customer rela<onship during a specified period
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The overall profitability of the company can be improved by trea<ng dissimilar customers differently.
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So when we think about customers, we need to think in three different <ers
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Tier One – Reward Your most valuable customers are the one you most want to retain. They get more a"en<on.
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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
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Tier Two – Grow The customers is the middle – with middle to low profits associated with them – might be targeted for growth.
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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
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Tier Three – Fire If you can recognize this group beforehand, it may be best not to acquire them in the first place.
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How do we calculate Customer Profitability?
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(Revenue from a customer) -‐ (Cost to serve each customer) Profitability for the Customer
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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.
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Ader you calculate the value, you sort the customers based on profits.
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Once you have the sorted list, you plot the percentages of total profits vs total percentage of total customers.
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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.
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Customer Life-me Value
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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.
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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.
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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.
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Customer Life<me Value (CLTV) addresses both of these issues and is probably the most important metric to learn in marke<ng.
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Even if you don’t use CLTV, everyone in marke<ng should understand the concepts of value-‐based marke<ng.
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One of the biggest mistakes marketers make is confusing customer profit with CLTV.
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Customer Profit measures the past while CLTV looks forward.
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CLTV shapes managers’ decision but is much more difficult to quan<fy than customer profit.
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Customer profit is calculated through careful repor<ng and summarizing the results of past ac<vity; CLTV involves forecas<ng future ac<vity.
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CLTV is the present value of the future cash flows a"ributed to the customer rela<onship.
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CLTV – The Math
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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)
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To best understand this metric, think of CLTV as the Net Present Value of a customer.
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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)
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So how does this work?
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Margin is easy to calculate – how much profit do you make on each product/service you sell?
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Cost, on the other hand, is a bit more difficult
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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…
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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.
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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).
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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)
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Looks really complicated doesn’t it?
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Let’s try an example
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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
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Margin = $19.95 Cost = $1.50 AC = $6/12 Churn Rate = 0.995% Discount Rate = 0.01
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Remember – we are just taking the profit in each <me period for the value of the money.
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Now, I am sure you are all asking 1 ques<on – “What is the correct length of <me to use for calcula<ng CLTV?”
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I have seen company’s calculate CLTV over 85 years – the natural “life<me” of a customer, which is wrong.
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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.
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The best prac<ce is 3 – 5 years.
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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.
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Cohort & Incubate Which Customer is More Valuable – New or Exis<ng?
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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.
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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.
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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.
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We call this the “cohort and incubate” approach.
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How do we calculate Cohort & Incubate?
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(Total Cash Flows from the Cohort) / (Number of Customers) Average CLTV for the Cohort
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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.
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An Example
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In 1993, 6,094 customers of a cruise ship line were tracked (incubated) for a period of 5 years.
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The total net present value of the cash flows from these customers was $ 27,916,614.
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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.
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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
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Cohort and Incubate works best when customers are sta<onary – changing slowly over <me.
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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.
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Value Based Marke-ng Marke<ng Based on the Value of the Customer
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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.
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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?
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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
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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
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Why do you think that is?
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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.
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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.
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What Makes a High-‐Value Customer?
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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.
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In banking, a high-‐value customer has a poruolio of services – cash deposits, credit cards, auto loans, and perhaps a mortgage.
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To best manage this customer, you have to ensure – first and foremost – that they don’t leave
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Secondly, up-‐sell and cross-‐sell addi<onal products and services. Sell deep to high-‐value customers.
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Selling bundles of services to high-‐value customers has the advantage of crea<ng lock-‐in
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What is lock-‐in?
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Lock in means that there is a significant switching cost to the customer if they want to change to a compe<tor.
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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.
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Customer Service and Service Recovery are extremely important to retain high-‐ value customers.
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