Page 157 - Marketing Management

134 PART 3 CONNECTING WITH CUSTOMERS

Measuring Customer Lifetime Value

The case for maximizing long-term customer profitability is captured in the concept of customer
46
lifetime value. Customer lifetime value (CLV) describes the net present value of the stream of fu-
ture profits expected over the customer’s lifetime purchases. The company must subtract from its
expected revenues the expected costs of attracting, selling, and servicing the account of that cus-
tomer, applying the appropriate discount rate (say, between 10 percent and 20 percent, depending
on cost of capital and risk attitudes). Lifetime value calculations for a product or service can add up
to tens of thousands of dollars or even into six figures. 47
Many methods exist to measure CLV. 48 “Marketing Memo: Calculating Customer Lifetime
Value” illustrates one. CLV calculations provide a formal quantitative framework for planning
customer investment and help marketers adopt a long-term perspective. One challenge, how-
ever, is to arrive at reliable cost and revenue estimates. Marketers who use CLV concepts must
also take into account the short-term, brand-building marketing activities that help increase
customer loyalty.

Cultivating Customer Relationships

Companies are using information about customers to enact precision marketing designed to build
strong long-term relationships. 49 Information is easy to differentiate, customize, personalize, and
dispatch over networks at incredible speed.

marketing
Memo Calculating Customer Lifetime Value

Researchers and practitioners have used many different approaches for Gupta and Lehmann illustrate their approach by calculating the CLV of
modeling and estimating CLV. Columbia’s Don Lehmann and Harvard’s Sunil 100 customers over a 10-year period (see Table 5.3). In this example,
Gupta recommend the following formula to estimate the CLV for a not-yet- the firm acquires 100 customers with an acquisition cost per customer of
acquired customer: $40. Therefore, in year 0, it spends $4,000. Some of these customers de-
fect each year.The present value of the profits from this cohort of customers
over 10 years is $13,286.52.The net CLV (after deducting acquisition costs)
T 1p t - c t 2r t
CLV = a - AC is $9,286.52, or $92.87 per customer.
t=0 11 + i2 t Using an infinite time horizon avoids having to select an arbitrary time
horizon for calculating CLV. In the case of an infinite time horizon, if margins
where p t = price paid by a consumer at time t, (price minus cost) and retention rates stay constant over time, the future CLV
of an existing customer simplifies to the following:
c t = direct cost of servicing the customer at time t,
q t
i = discount rate or cost of capital for the firm, CLV = a mr = m r
r t = probability of customer repeat buying or being “alive” at time t, t=1 (1 + i ) t (1 + i - r)
AC = acquisition cost, In other words, CLV simply becomes margin (m) times a margin multiple
[r/(1 + i – r )].
T = time horizon for estimating CLV.
Table 5.4 shows the margin multiple for various combinations of r
A key decision is what time horizon to use for estimating CLV. and i and a simple way to estimate CLV of a customer. When retention rate
Typically, three to five years is reasonable. With this information and is 80 percent and discount rate is 12 percent, the margin multiple is about
estimates of other variables, we can calculate CLV using spreadsheet two and a half. Therefore, the future CLV of an existing customer in this
analysis. scenario is simply his or her annual margin multiplied by 2.5.

Sources: Sunil Gupta and Donald R. Lehmann, “Models of Customer Value,” Berend Wierenga, ed., Handbook of Marketing Decision Models (Berlin, Germany: Springer
Science and Business Media, 2007); Sunil Gupta and Donald R. Lehmann, “Customers as Assets,” Journal of Interactive Marketing 17, no. 1 (Winter 2006), pp. 9–24; Sunil
Gupta and Donald R. Lehmann, Managing Customers as Investments (Upper Saddle River, NJ:Wharton School Publishing, 2005); Peter Fader, Bruce Hardie, and Ka Lee,“RFM
and CLV: Using Iso-Value Curves for Customer Base Analysis,” Journal of Marketing Research 42, no. 4 (November 2005), pp. 415–30; Sunil Gupta, Donald R. Lehmann, and
Jennifer Ames Stuart,“Valuing Customers,” Journal of Marketing Research 41, no. 1 (February 2004), pp. 7–18; Werner J. Reinartz and V. Kumar,“On the Profitability of Long-
Life Customers in a Noncontractual Setting: An Empirical Investigation and Implications for Marketing,” Journal of Marketing 64 (October 2000), pp. 17–35.