In order to compete effectively today, an organization must truly understand its customers and treat them as individuals. In order to do that, customer differences must be understood. Based on a customer's value, an organization can determine how much time and investment should be allocated to that customer. The key to keeping each customer is determining that customer's needs. If an organization acknowledges that each customer is unique, then it follows that some customers are more valuable than others. Customer lifetime value (LTV) expresses the stream of expected future profits, net of costs, on a customer's transactions, discounted at some appropriate rate back to its current net present value. But, profit on a customer's relationship with an organization is not just based on that customer's future purchases. An astute organization will also realize that each customer provides additional value through referrals of other customers, knowledge of other customers' tastes and preferences (as well as their own) and help in designing new products or services.

LTV is not a quantity that can be precisely calculated for any particular customer. Regardless of the sophistication of the modeling methods, it is not possible to factor in all of the variables, including nonquantifiable ones, such as the help a customer provides in designing a product. The purpose of LTV is to compare customers, and as information technology makes increasingly sophisticated modeling possible, LTV will become more accurate.

Nevertheless, there are definite benefits to be realized from modeling LTV. In addition to understanding the average customer's valuation and the leverage that different variables (such as customer retention) may have on the company's overall value, LTV can also be used to create a reliable rank-ordering system which allows a firm to differentiate its customers by their individual valuations and to allocate more marketing effort to retaining the most valuable customers. Because customers are individually different and have individually different values to a company, LTV provides the most accurate picture of a customer's value.

A company can calculate their customers' values individually and then rank-order them into five equal groups, or quintiles. Each quintile would represent 20 percent of the company's customers. A bar chart displaying actual valuation of the customers in each quintile is illustrated in Figure 1. In this example, it is clear that the bulk of this company's business is delivered by the top 20 percent of its customers.

The actual range of customer valuations is an important factor that can be used to determine a company's strategy to keep its most valuable customers. Some types of businesses have steeper customer valuation "skews" than others; and in order to develop the appropriate strategy, a company needs to know whether it has a flat or steep skew. A airline would typically have a steep skew (a small percentage of travelers accounting for a very large proportion of revenues and profits) while a hamburger chain would have a relatively flat skew. (See Figure 2.)

Businesses with relatively steep customer valuation skews will obtain the most benefit from marketing initiatives (such as key account sales programs or frequency marketing plans) that emphasize the importance of its best customers.

The customer base of every company has a natural skew that can be pictured by calculating individual customer values and then arranging them in rank order. This skew can be somewhat influenced by tracking customers more precisely by including additional variables, such as customer referrals or family and corporate relationships, in the value calculation or by providing incentives or disincentives for certain kinds of customer behavior.

The transition from aggregate-market competition to customer-driven competitive will be more cost efficient for firms with steeper customer valuation skews.

n order to compete effectively today, an organization must truly understand its customers and treat them as individuals. In order to do that, customer differences must be understood. Based on a customer's value, an organization can determine how much time and investment should be allocated to that customer. The key to keeping each customer is determining that customer's needs.

If an organization acknowledges that each customer is unique, then it follows that some customers are more valuable than others. Customer lifetime value (LTV) expresses the stream of expected future profits, net of costs, on a customer's transactions, discounted at some appropriate rate back to its current net present value. But, profit on a customer's relationship with an organization is not just based on that customer's future purchases. An astute organization will also realize that each customer provides additional value through referrals of other customers, knowledge of other customers' tastes and preferences (as well as their own) and help in designing new products or services.

LTV is not a quantity that can be precisely calculated for any particular customer. Regardless of the sophistication of the modeling methods, it is not possible to factor in all of the variables, including nonquantifiable ones, such as the help a customer provides in designing a product. The purpose of LTV is to compare customers, and as information technology makes increasingly sophisticated modeling possible, LTV will become more accurate.

Nevertheless, there are definite benefits to be realized from modeling LTV. In addition to understanding the average customer's valuation and the leverage that different variables (such as customer retention) may have on the company's overall value, LTV can also be used to create a reliable rank- ordering system which allows a firm to differentiate its customers by their individual valuations and to allocate more marketing effort to retaining the most valuable customers. Because customers are individually different and have individually different values to a company, LTV provides the most accurate picture of a customer's value.

A company can calculate their customers' values individually and then rank- order them into five equal groups, or quintiles. Each quintile would represent 20 percent of the company's customers. A bar chart displaying actual valuation of the customers in each quintile is illustrated in Figure 1. In this example, it is clear that the bulk of this company's business is delivered by the top 20 percent of its customers.

The actual range of customer valuations is an important factor that can be used to determine a company's strategy to keep its most valuable customers. Some types of businesses have steeper customer valuation "skews" than others; and in order to develop the appropriate strategy, a company needs to know whether it has a flat or steep skew. A airline would typically have a steep skew (a small percentage of travelers accounting for a very large proportion of revenues and profits) while a hamburger chain would have a relatively flat skew. (See Figure 2.)

Businesses with relatively steep customer valuation skews will obtain the most benefit from marketing initiatives (such as key account sales programs or frequency marketing plans) that emphasize the importance of its best customers.

The customer base of every company has a natural skew that can be pictured by calculating individual customer values and then arranging them in rank order. This skew can be somewhat influenced by tracking customers more precisely by including additional variables, such as customer referrals or family and corporate relationships, in the value calculation or by providing incentives or disincentives for certain kinds of customer behavior.

The transition from aggregate-market competition to customer-driven competitive will be more cost efficient for firms with steeper customer valuation skews.

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