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Personalized Customer Lifetime Value

  • February 01 2001, 1:00am EST
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Customer relationship management (CRM) provides business returns based on its ability to generate more customers, retain current customers and increase the value of customers. CRM represents the most viable model for business improvement.

Without impacting the marketing budget, a consumer goods production company increased the number of its marketing programs a hundredfold. The result of this added "complexity" was a profit increase of 200 percent. The addition of a CRM-ready data warehouse and the analytical tools and business processes that go with it allowed for more focused marketing execution. To attain results like this, marketing programs must include a strong customer understanding and orientation. An element of the customer that is often neglected due to the somewhat complex nature of its calculation is customer profitability or customer lifetime value (CLV). This becomes one of the most highly used customer attributes for marketing programs. CLV, if carefully calculated with widespread organizational buy-in, becomes the first metric to turn to for all customer planning and touches.

Many have calculated a CLV for their customer base and use that CLV as an indicator of the value of a customer. However, one number for the organization is not good enough anymore. Without consideration of the individual nature of the CLV, you are likely to continue attracting and keeping customers that look exactly like the customers you currently have ­ the good and the bad ­ in the same relative proportions. It is essential to remember that each customer actually has many customer lifetime valuations, and they are all dynamic. Furthermore, a customer's participation in a certain program can yield an entirely different set of expected future CLVs for that customer. CLVs comprising only future profits and those that do so based on controllable events are the most valuable. The past is only interesting as a predictor of the future. The formula looks like this:

CLV = Present Value (future profits from customer in n years)


CLV = Present Value (Revenues - cost of goods sold - cost of customer acquisition - direct customer carrying costs)

There are three major components to the formula: revenues, length of the relationship and expenses.

Revenues. Future revenues are largely based on recent past revenues. With a few years of data and more sophistication, formulas beyond regression of past behavior that incorporate more subtle aspects of customer behavior can be used to determine future revenues.

Length of the Relationship. Retention modeling can be used to understand leading indicators for customer drop off. Calculating CLV for different estimated customer lifetimes shows the value of keeping the customer for longer periods; this shows the potential CLV. Most organizations that do this valuable exercise are amazed at the potential CLV of their customers and how it grows over time.

The goal becomes keeping the customers with highest CLV as long as possible and reverse engineering the attributes of those high CLV customers for use with prospects, thereby increasing overall CLV. Retention modeling usually accompanies CLV modeling.

Expenses. The major difficulty in computing CLVs is not in computing customer income; it's on the expense side of the ledger. It is difficult to determine how to "charge back" company expenses to individual customers. As indicated in the formula, the most effective way to do this is to take a product approach to the charge back.

The trick is getting from cost of goods sold (COGS) back to cost of the product sold through a given channel on a given day and then attaching the cost to the customers who purchased the pro-duct through that channel on that day.

For example, the $10,000 cost for a 10-day product promotion is allocated to COGS for that product. This breaks out to $1,000 per day. If five channels are involved in the promotion, that's $200 per channel per day. If a given channel sold 10 of the products to 10 different customers, each customer can absorb $20 COGS. So begins the process of taking a product cost back to customer cost in order to accurately assess CLV.

Uses of CLV are varied. Marketing will use CLV to focus its efforts on those customers with high potential CLV. Customer service may use CLV to prioritize customers and focus aggressive response and follow-up for high CLV customers who represent the largest potential to the company. If there is only room for one value on the screen when a customer calls in, let it be the customer's CLV.'s customer-specific pricing trial balloon was pulled in quickly last year because of customer outrage. However, it is just a matter of time until this particularly sensitive element of customer interaction is afforded the same privilege as other elements such as rates, risk profiling, discount offers, standard frequent shopper discounts, perks, priority seating, support prioritization, etc. When the time comes, CLV will be leading the way.

The CRM-ready data warehouse provides the data foundation for the calculation of individual CLV. It is where the integrated view of cross-functional data such as sales, product costs, customer contacts and other financials can be generated and the CLVs stored along with the customer record.

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