Using Customer Lifetime Value to to Improve Marketing Investment Decisions

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The profits generated during the retention phase of a customer relationship are often referred to as customer lifetime value or customer retention equity. Intuitively, we know that Customer Lifetime Value (CLV) is an important metric for every company. It represents the value of your organization’s relationship with the customer. 
 
While CLV has tremendous financial implications, it also serves to facilitate marketing investment decisions. As with any investment portfolio, you want to invest more in assets that produce a higher yield. It makes sense to invest more of your marketing dollars in customers that are more profitable and prefer to buy from you, cost less to serve, and recommend your services thereby helping to reduce new customer acquisition costs. 
 
CLV helps you determine in which existing customers to invest and which types/profiles of customers produce the highest CLV. You can use these profiles to acquire new customers that best resemble your existing high value customers. Using CLV insights, you can identify both existing and prospective high value customers and shape your marketing to uniquely meet their message, offer, and channel.

How do you calculate CLV? There are various approaches but here is a simple way to calculate customer retention equity or CLV:

  • Determine the average retention rate of your customer base.
  • Compute the average expected duration of a relationship with a customer using this retention rate.
  • Determine the average per period margin and costs that are associated with retaining this customer.
  • Multiply the period net profits by the number of periods the relationship lasts.

Here’s an example:

  • Suppose for the past four years your retention rate for a set of customers has been 60%, 61%, 62%, and 61% over a 4 year period. This equates to an average retention rate of around 61% (i.e., 61 = (60+61+62+61) / 4).
  • Analysis reveals that the expected relationship duration for the average customers is 1/(1-average retention). (1/1.61). In this case that is 2.56 years.
  • After analyzing the historical data over the same 4 year period, the firm has determined that the average margin is $7500 and the average costs over this period $750. This equates to a net margin of $6750
  • Expected retention equity is $17,280 ($6750*2.56).

Calculating customer retention equity demonstrates why it makes sense to invest in keeping customers. It’s a very interesting way to get a handle on your customer portfolio and to segment your customers. By improving revenue per customer and customer retention, while lowering cost to acquire and serve, you can positively impact CLV.

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