Research shows that in industry, students have been barraged by an ongoing stream of news and facts, stretched over years, if not decades across what motivates customers to buy. Its ‘customerising’, gearing a company up to focus exclusively on your customers that matters, you need to build a customer-driven company, the results speak for themselves a company that focuses on its customer’s needs will embrace customer loyalty, increased performance and a healthy bottom line.
In marketing, customer lifetime value (CLV) (or often CLTV), lifetime customer value (LCV), or user lifetime value (LTV) is a prediction of the net profit attributed to the entire future relationship with a customer. The prediction model can have varying levels of sophistication and accuracy, ranging from a crude heuristic to the use of complex predictive analytics techniques.
CLV has a central strategic importance for a company, and more and more managers are discovering that their most important asset is not the company’s inventory but its customers… that matters!
The Pareto Principle states that, for many events, roughly 80% of the effects come from 20% of the causes. When applied to e-commerce, this means that 80% of your revenue can be attributed to 20% of your customers. While the exact percentages may not be 80/20, it is still the case that some customers are worth a lot more than others, and identifying your “All-Star” customers can be extremely valuable to your business.
Taking CLV into account can shift how you think about customer acquisition. Rather than thinking about how you can acquire a lot of customers and how cheaply you can do so, CLV helps you think about how to optimize your acquisition spending for maximum value and not minimum cost.
Some seasoned entrepreneurs may say “break even” or some other number is the most important metric, but I believe “lifetime value” is perhaps the most significant measure to benchmark. I also know it is one of the most overlooked and least understood metrics in business, even though it is one of the easiest to figure out.
Why is this particular number so important? Mainly because it will give you an idea of how much repeat business you can expect from a particular customer, which in turn will help you decide how much you’re willing to spend to “buy” that customer for your business.
Once you know how often a customer buys and how much he or she spends, you will better understand how to divide your resources in terms of customer retention programs and other services you’ll need to keep your customers, and importantly – keep them happy!
Once you have some idea of the lifetime value of your customer, you have two options in deciding how much to spend to acquire him or her:
1. Allowable acquisition cost: This is the amount you’re willing to spend per customer per campaign — as long as the cost is less than the profit you make on your first sale. This is a shorter-term strategy that makes the most sense when cash flow is a concern.
2. Investment acquisition cost: This is the cost you’re willing to spend per customer knowing that you’ll take a loss on an first or even later purchase. But you have the cash flow and other resources to absorb your initial marketing investment with this longer-term strategy.
The point is that you’ll never know how to develop an optimal marketing budget unless you know what the return on your investment needs to be. This knowledge is vital because it will help you make marketing decisions based on the reality of your own numbers and not the promises of some new media program.
Knowing lifetime value also lets you see how, or if, you can discount. It will help you avoid the potentially disastrous effects of discounting when your business needs cash flow to survive. In addition, you will find innovative ways to build value upfront and create offers that drive enough volume to support and eventually increase your overall lifetime value number.
So take some time to work the numbers in the very simple lifetime value equation, especially if you’re still in the planning stages for your business. Remember to build in some variation and see if your current plans support the numbers you come up with. If so, that’s great. If not, that’s also great because you’ve determined on paper what you need to change to make your numbers work.
Investing to earn the loyalty of your customers often requires trade-offs—you must decide which of the many investments you could potentially make will result in the greatest return. A clear understanding of your company’s loyalty economics will help you make those decisions. It will give you a quantitative basis for investments in long-term customer assets and provide a defense against the short-term, sub-optimal, “quarterly earnings” mind-set that often tempts leaders to generate “bad profits.”
It is possible to calculate loyalty economics with great precision, if you have the resources and the tools to do so. If not, you can also make rough estimates that can help guide decision-making. This page describes a relatively simple way to get reasonable, rough estimates of the potential value that can be created by improving your company’s Net Promoter score and earning the loyalty of more of your customers
Share of wallet and number of products purchased: calculate how the annual purchases of your promoters, passives and detractors vary. This will help you estimate revenue differences. If you have actual revenue per customer, you’ll be able to estimate more precisely, of course.
In the end, it’s the lifetime value numbers that will determine the ultimate success of your company.