Notes

What is CLV

Today, I would like to talk about CLV(Customer Lifetime Value). First of all, customers are the key asset of any business. Without customers, there is no business. More and more companies are starting look in to the customer loyalty, and they will try best to enhance the relationship with their customers.

CLV is the net present value contributed by an individual customer from a longtime period representing the customer relationship with business. It uses the history data to project the future value. Companies can determine how much it cost to acquire a new customer by evaluating CLV, and they can also make decision with marketing alternatives by comparing CLV in different scenarios.

The formula to calculate CLV:

CLV = [$M-$R]*[(1+d)/(1+d-r)]

  • $M: Contribution per period from active customers (Sales Price – Variable Costs)
  • $R: Retention Spending per period per active customer
  • d: Discount rate per period
  • r: Retention rate  (Fraction of current customers retained each period)

Source: Cutting Edge – Marketing Analytics, Chapter 1, R Venkatesan

In the formula, we call the first part [$M-$R] Short-term Margin, and the second part [(1+d)/(1+d-r)] Long-term Multiplier. The short-term Margin indicates the value contributed by the customers in the first period.

The formula above is applicable for companies collected payment before the services or products are provided. If the payment is by credit card or after the services or products provided, the formula will have a change, which indicates the first period short-term margin loss:

  • CLV(credit) = CLV-[$M-$R]
  • =[$M-$R]*[(1+d)/(1+d-r)]-[$M-$R]
  • =[$M-$R]*[(1+d)/(1+d-r)-1]
  • =[$M-$R]*[r/(1+d-r)]

Source: Cutting Edge – Marketing Analytics, Chapter 1, R Venkatesan

In examples of this notes, we assume all the companies collect the payment before the services and products are provided.

Let’s go through some examples to understand how to calculate the CLV and how to apply it into marketing alternatives selection.

Example 1:

Company A collect monthly membership fee $120 from customers. The variable cost per month per customer is $20. The company spend an average $10 to retain customers every month. The customer retention rate is 90%, and the discount rate is 1%.

Let’s calculate the CLV for Company A base on the information above:

  • $M = $120-$20 = $100
  • $R = $10
  • r = 90%
  • d = 1%
  • CLV = [$M-$R]*[(1+d)/(1+d-r)]
  • =[$100-$10]*[(1+0.01)/(1+0.01-0.9)]
  • =$90*[101/11]
  • =$826.36

So, the CLV of this company A is $826.36 indicating the value contributed by an individual customer through a long time period, which means company A should not spend more than $826.36 to acquire a new customer.

Example 2:

The marketing manager of Company A had a meeting with his 4 team members. Team member 1 suggested to raise the membership fee to get more return. Team member 2 suggested to cut marketing spending to get more margin from the market. While, team member 3 indicated that higher membership fee or lower marketing spending may result in lower retention rate, and suggested to raise the marketing spending to retain more customers. And Team member 4 said why not raise the membership fee with the marketing spending on retention increased together.

The marketing manager made a summary from the meeting:

Original Alternative 1 Alternative 2 Alternative 3 Alternative 4
$M 100 Increase Same Same Increase
$R 10 Same Decrease Increase Increase
d 0.01 Same Same Same Same
r 0.9 Decrease Increase Increase Same

The marketing manager tell his team members to do market research and provide him the data below:

Original Alternative 1 Alternative 2 Alternative 3 Alternative 4
$M 100 120 100 100 120
$R 10 10 5 15 15
d 0.01 0.01 0.01 0.01 0.01
r 0.9 0.85 0.85 0.95 0.9
CLV 826.36 694.38 599.69 1430.83 964.09

It is obvious that Company A might get more upfront value(short-term margin) through higher membership fee or lower marketing spending. However, the long-term multiplier plays a critical role in the CLV to tell the marketing manager to pay attention into the retention rate changed by other marketing activities.  Finally, team member 3 ‘s suggestions was accepted.

Conclusion:

CLV is a very important metrics to value the customer relationship. Companies can both evaluate how much to acquire a new customer and make decision for marketing alternatives by calculating the CLV.

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