Marketing and sales functions have begun exploring an equation called customer lifetime value (CLV) to consider the future profit potential of existing and possible new customers. Equipped with this information companies can more intelligently and prudently offer differentiated service levels in proportion to how much it may earn from each customer.
This is according to Gary Cokins, strategist for performance management solutions at SAS, leaders in business and analytical intelligence software.
"CLV is a forward-looking view of wealth creation. It treats each customer, or segment of similar customers, as an investment instrument, similar to an individual stock in a portfolio. There can be winners and losers," Cokins told delegates at SAS Institute's recent conference on Business Intelligence at the Gordon Institute of Business Science.
CLV links customer revenues to organisational profits. These should never be assumed to always go in the same direction because high maintenance customers with a relatively higher cost-to-serve can be unprofitable, regardless of their sales volume. CLV can be defined as the net present value of the likely future profit stream from an individual customer. This involves multi-period discounted cash flow (DCF) investment evaluation mathematics, not just for a single period.
"This mathematics is trickier than measuring historical customer profitability levels, because you need to consider factors other than what happened in the past. It recognizes that due to the age and job career cycles customers pass through that a customer's future value can be substantially different from how profitable they may be today. CLV also considers the probability of losing some customers.
"By using DCF mathematics, businesses can equate the future stream of profits into a single expected profit value, stated in today's money. An appeal of CLV is that it focuses on the customer as the influencer of a company's long term profitability, rather than the products and service-lines (although they are inclusive in the CLV equation)," Cokins explains.
Another appeal of CLV is that it can also be applied to evaluate which new customers, not just existing ones, to target and attract through marketing campaigns. Most importantly, it answers questions about how much the company can afford to spend on acquiring new customers based on their CLV.
Calculating CLV can be difficult, and many organisations wonder if it is worth the effort.
"CLV is understandably perceived as difficult to calculate with any degree of certainty. It is also perceived as hard to use. Hence, those managers that know that customers generate different profit levels relative to their sales typically only have confidence in a customer's current profitability," he says.
So, is it feasible to measure CLV and is it practical to try?
"For some companies, periodic customer profitability reporting with activity-based costing (ABC) systems can be a sufficiently good surrogate for the CLV measure," says Cokins.
"Companies with ABC systems have proven they can reliably report and score customer profitability information."
There are conditions where CLV is more or less applicable. CLV works better in financial institutions, airlines or hotels, where there the costs of acquiring, retaining or 'winning back' customers is high. It is also appropriate in business-to-consumer (B2C) sectors where consumers pass through life-cycles with varying preferences.
CLV is also more applicable for organisations with a database of customer profiles and their transaction history data. It is less applicable if they work through B2B sales channels that preclude a direct relationship with end-consumers.
According to Cokins, the two main purposes for applying CLV data are to score and prioritize customers in order to formulate different tailored marketing strategies or treatment levels for different customer segments, and to trigger a profit lift with a deal or an offer.
"Customer profitability and CLV are useful to tailor a proposition to individuals based on timely transactional data about that individual," he concludes.
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