Customer lifetime value goes by many names and abbreviations including CLV, lifetime value, user lifetime value, LTV and CLTV.  Although its designations are far-reaching, they all share one general definition:

“The net present value of the cash flow relationship with a customer.”

More specifically:

“Customer lifetime value (CLV) […] 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. Customer lifetime value (CLV) can also be defined as the monetary value of a customer relationship, based on the present value of the projected future cash flows from the customer relationship.”

Customer lifetime value (or CLV) attempts to assess the true, long-term value and/or profitability of each client/customer.  The purpose of this metric is to help businesses identify how much to invest in the development of each account.

Advantages of Measuring CLV

Calculating CLV provides a multitude of benefits, including:

1. The valuation of a customer relationship

   Knowing the monetary value of customers over the duration of the relationship allows you to better assess current and future profitability.

   The insights gained from this valuation enable more effective investment decisions about customer acquisition costs.
   
   

2. Helps to determine the level of spend/investment for each new customer

   Measuring CLV allows you to develop a more accurate sales & marketing budget.

   When you know the CLV, it makes it easier to justify more expensive account development activities early in the relationship with the customer.
   
   

3. Forecasts potential future value of customer relationships

   The CLV formula not only estimates current value of a client, but also takes into account the potential value of a client.
   
   

Methods of calculation

1. Using historical data:

   If you have historical data available, take different groups of customers (recruited for example five years ago), and analyse their average profit contribution. This is a relatively simple calculation and the result is factual, not speculative.

   To calculate:

   • Take a group of customers with similar characteristics.
   • Ensure they were all recruited at approximately the same time (i.e. the same month).
   • Record/estimate the revenue achieved and the cost incurred for this group over a specified time period.
   • Calculate their seasonal/annual contribution.
   • Ideally apply the cost of capital into the equation.

   To work out a rough figure for lifetime value use this external calculation tool.

2. The projective approach

   If you do not have historical data or the marketplace is rapidly changing, use your understanding of recent market conditions to project current transactional data from your customer segments into the future.

   To calculate:

   • Take segments of customers (for example those purchasing in last 6 months, last 12 months, 18 months, etc).
   • Estimate their average contribution using whatever data you have available.
   • Estimate their long-term loyalty and expected contribution.
   • Ideally apply the cost of capital into the equation.
     
     

When to use a lifetime value calculation

1. When you are calculating customer acquisition costs.

   Using incentives to attract customers may mean that the campaign won't deliver a return on investment in its first year, but will increase the profitability of the business in future years as long as a calculated proportion of the new customers that are recruited remain loyal.

   Consider the following:

   • What percentage of the average customer lifetime value should you invest in new customer recruitment?
   • Which customer types will prove most profitable to recruit?
   • How cost effective would it be to try and reactivate lapsed customers?
   • How should the budget be allocated across different customer sectors?
   • If 20% of your customers deliver 80% of the brands profits, can a lifetime value calculation identify which are likely to be most profitable and focus the campaign on their recruitment?
2. To support customer retention programmes.

   Marketers have traditionally viewed customer profitability as something that is achieved over time; their long-term or lifetime value. Book clubs, banks, catalogues and credit cards are examples of companies that use it.

3. When selecting the incentive/offer and calculating its budget.

   When looking at incentive budgets get an understanding of how long a typical customer tends to be loyal to the brand and what sort of profit they bring in over time, and therefore what budget can be allocated to recruit them.