The Meaning of Life

Customer Lifetime Value or CLV is almost as elusive a concept as the meaning of life itself. A better marketing question would be, “What is the meaning of Lifetime Value?” CLV is a concept by which the company determines how much profitable revenue the company is likely to yield from the customer throughout that customer’s total interaction with the company from today forward. The short conceptual version of this is: How much profit can the company yield from the customer for the customer’s entire “life” with the company? 

When building and maintaining a customer database, it is important to consider this concept to maximize the potential profitability of each and every prospective customer. CLV is a relatively new business science discipline. In The Journal Of Marketing 1952, E.G. Brown wrote an article describing “Repeat Purchase Behavior,” which some believe is the seedling from which CLV has grown. Previously, both marketers and businesses were content with the business model that called for perpetual customer acquisition.

While bringing in new customers over and over again was a strategy that succeeded, it was not an optimal strategy and is now considered a flawed strategy. Companies didn’t consider that each new customer usually only made one purchase. Business conceptualizations became more prevalent as business and the world grew more sophisticated. Concepts that considered “proportion of purchase,” “probability of purchase,” “probability of product re-purchase,” “purchase frequency,” “purchase sequence,” “multiple aspects of purchase behavior,” and “customer loyalty” became what is now known as the discipline of CLV.

Once the business world caught onto the concept of CLV, practices such as “Customer Service” and theories such as “Customer Satisfaction” have grown to paramount importance. Companies have learned that by maximizing the potential of each customer, the return on investment is greater than if they focused exclusively on customer acquisition. This brings us to the current debate in CLV, which focuses on the difference between maximizing profitability and maximizing return on investment, which are two different metrics.

CLV is the measurement of a customer’s entire worth to a business. If a company were to assign a CLV ranking to each of their customers, they would instantly know how much of the company’s profits were directly attributable to each customer. Now the company would be able to offer their most valuable customers incentives and offers that reflect the customer’s value to the company. By marketing to the most valued customers, the company is drastically increasing the chances for ROI. 

CLV is used to maximize the allocation of marketing resources for businesses. By increasing the probability of success based on the customer’s past performance, percentage of success increases exponentially.
The metrics that are used to measure Customer Loyalty, which is different from CLV, can be found in Customer Relationship Management, A Databased Approach by V. Kumar and Werner Reinartz.  There are three basic methodologies to Customer Loyalty, which many database marketing strategists and theorists consider flawed for measuring future customer value.

The RFM Approach is based on Recency, Frequency and Monetary value. This approach accounts for customers who bought most recently, most frequently and spent the most money as the highest Lifetime Value Customers. Conversely, the customers who hadn’t bought in a long while, didn’t buy many times and spent the least amount of money were the customers least likely to respond to a direct marketing initiative. This process has been tested over time and remains consistent. The RFM approach has historically worked well in a high-volume business.

The PCV approach is based on Past Customer Value. This approach is rooted in the belief that the customer’s past performance is a window into customer’s future performance. There is a complicated algorithm used to calculate the Past Customer Value, but it is loosely based on extrapolating customer’s past performance to ascertain the future performance. This approach does not account for Customer Satisfaction and Customer Service and is considered outdated.

The third basic approach is that of SOW. (No this is not a Statement of Work, but rather a Share of Wallet.) Again, there is a complicated algorithm used to calculate SOW, but basically, Share of Wallet measures the amount of customer’s total spending you are capturing in any particular category.  If your customer has $40,000 per year for discretionary spending, and he comes to your restaurant 10 times per year and spends $2,000.00 per year with you, you have earned 5% of his total expenditures, or a 5% Share of Wallet.

Unlike the three methodologies above, CLV includes the consideration of probable customer activity in the future, as well as the marketing dollars necessary to retain the customer in the future. CLV is all about what the customer buys, how much the customer buys, and how much it costs the company to make that sale.  The purpose of calculating customer value is to design strategies that maximize ROI.  It is critical to be able to determine whether a customer will purchase in the future and to be able to estimate the expected value of profit that the customer will yield.

Are you maximizing the profitability potential of each and every customer?  What steps can you take to ensure maximum profitability or maximum ROI?  Database maintenance is a great place to start.