Q 376. Some Lean Six Sigma projects in sales and marketing focus on customer retention. Customer Lifetime Value (CLV) is a key metric for such projects. Explain CLV along with an example.

 

 

Note for website visitors - Two questions are asked every week on this platform. One on Tuesday and the other on Friday.

• All questions so far can be seen here - https://www.benchmarksixsigma.com/forum/lean-six-sigma-business-excellence-questions/
• Please visit the forum home page at https://www.benchmarksixsigma.com/forum/ to respond to the latest question open till the next Tuesday/ Friday evening 5 PM as per Indian Standard Time. Questions launched on Tuesdays are open till Friday and questions launched on Friday are open till Tuesday. 
• When you respond to this question, your answer will not be visible till it is reviewed. Only non-plagiarised (plagiarism below 5-10%) responses will be approved. If you have doubts about plagiarism, please check your answer with a plagiarism checker tool like https://smallseotools.com/plagiarism-checker/ before submitting. 
• The best answer is always shown at the top among responses and the author finds honorable mention in our Business Excellence dictionary at https://www.benchmarksixsigma.com/forum/business-excellence-dictionary-glossary/ along with the related term

Customer Lifetime Value (CLV) is the financial metric of profit margin, which a company expects to earn in the entire tenure of its overall business relationship, with its average customer.

 

This is very important metric for a Sales and Marketing professional owing to following reasons:

 

1. Cost of retaining an old customer far out weighs the benefit of acquiring an new customer

2. The profit margin gets significantly higher if we invest in retaining a customer. 

 

CLV should take into account following costs while doing the computation

 

1. Cost of acquisition of the customer

2. Cost incurred on Sales and Marketing Expenses

3. Operating expenses, i.e. cost incurred on manufacturing the product.. (Raw materials + labor etc.).. In service industry direct costs

4. Cost incurred on customer retention

 

Following picture depicts how CLV is calculated.

 

 

First we calculate the Lifetime Value of the customer with following formula

 

Lifetime Value = Average number of Transactions X Average Value of Sale X Overall Customer Retention Period

 

Since we also have to take into account various costs associated with it.. we finally do the following calculation

 

Customer Lifetime Value = Lifetime Value Customer X Profit Margin achieved

 

Example: if the average value of sale for a retail customer is 100 USD (in an XYZ ECommerce Company) and the average number of transactions that a customer does in a year is 10 and over 5 years, then the Lifetime Value is

 

Lifetime Value = 100 X 10 X 5 = 5,000 USD

 

After taking into account all the expenses, if the profit margin is 40% then;

 

Customer Lifetime Value  = 5,000 X 40%

                                                      = 2,000 USD

 

Following factors contributes to Customer Lifetime Value:

 

1. Churn Rate of the customer

2. Customer Loyalty

3. How scalable Sales and Marketing teams are?

 

How can we increase CLV?

 

1. Optimize the Onboarding of a customer

2. Doing Effective Communication

3. Implementing a Loyalty Program to retain loyal customers

4. Retargeting old customer who probably shifted to other brand/company earlier.

 

What is CLV?
Customer Lifetime value ( CLV) also well known as Lifetime Customer Value ( LCV ) or Lifetime Value( LTV) is a predictive forecast of the net profit that the business can expect from the lifetime of an existing customer though business relationships . To explain in an elaborative way, it is like a monetary value to customer relationship with the brand/company, where present cost/ value counted vis-a-vis the future revenue that will come into account if the customer continues to maintain loyalty to the brand /company.

CLV serves as important aspect to ensure steady cash flows in the company and that can yearn profit for the Organisations . The key aspect to CLV is customer relationships & customer service which can improve the CLVs and thereby increase revenue OR have a recurring revenue in the Organisation

Let's take an example to understand the concept a little better . I would like to cite an example from one of my past organisations in Telecom industry

For any new acquisition a certain amount of money is spent by the organizations .

    Let's assume Cost of acquisition here of a particular customer with a Tele communication Service Provider is 500 INR.

Here the cost incurred by company are

• Telecom backend staff cost who ensures validation checks of Distribution of SIMs
• Runner cost 
• Warehouse Database maintenance cost 
• Background & Address verification team Cost
• Activation team cost 

So a company has nearly invested 500 INR for onboarding a particular customer . Now the customer has taken a post paid plan which is a recurring monthly cost of 499 INR for 90 days .

Eventually the company gets a revenue turnover of 1497INR which is way more from 500INR which was initially spent on acquisition . Here the customer is judged to be profitable, and acquisition of additional similar customers  are acceptable. 

Likewise its important for the company to retain this customer as this customer in future would yield enhanced revenue.So they have special retention offers from time to time rolled out for high revenue generating customers

 

One of the major focus for telecom is to improve CLV through retention plans & relationships (Ex : Free Netflix , Amazon, Zee+ subscription for 1 year with 599INR recharge  or 499 INR post paid plan for 1 year , Birthday wish published on Newspapers for High Value customers  , Differentiated customer service for High value customers)

In order to further build loyalty, telecom also focuses on conversion of any prepaid customer to postpaid which would yield higher , recurring revenue in future

So the crux is , companies need to evaluate, predict the financial forecast of a customer & thereby ensure retention wherever there are high CLV. Higher the CLV, higher the indicator of market fit , higher the brand loyalty & higher the recurring revenue from the existing customer

 

Therefore CLV in Telecom is calculated :

Customer acquisition cost multiplied by Customer average recharge frequency or Postpaid plan then finally divided by the Life span of the customer with the company.

 

 

Customer lifetime value (CLV) is the metric that indicates the total revenue a business can expect from a customer account throughout the business relationship with an organization.

 

It is an important metric to measure growth at any company.  It is really important to know CLV in relation to cost to acquire, companies can measure how long it takes to recover the investment required to earn a new customer which includes cost of business development, sales and marketing.

This metric considers a customer's revenue value during the predicted lifespan of customer with company.  Businesses use customer lifetime value to segregate customer into segments for them to prioritize. Longer a customer continues in a relationship with the company, the greater their lifetime value will be as all the effort and money in setting up a customer will get distributed over the life cycle.

 

Customer Lifetime Value is Important for business:

1.         It identifies specific customers which contribute the most revenue to the business. This allows company to serve these existing customers with products/services they like and appreciate, resulting in them spending more money at your company. 

2.         It helps in boosting customer loyalty and retention. When a company optimizes its CLV and Strives to provides value by means of excellent customer support, products, or a loyalty program — it leads to increase in customer loyalty and retention.

3.         It helps you target your ideal customers.  By knowing CLV, a company knows the lifetime value of a customer, also know how much money they spend with your business over a period of time. Knowing this will help to develop a customer acquisition strategy which targets customers who will have more potential to spend in your business.

4.         CLV reduces customer acquisition costs. Cost of acquiring new customer is significant expense a company has to spend.   CLV helps business identifying and nurture the most valuable customers that are on company’s customer list. This helps in earning higher profit margins, increased customer lifetime values, and reduced customer acquisition costs.

Formula to calculate CLV

Customer Lifetime Value = (Customer Value* or revenue generation * Average Customer Lifespan)

*Customer Value = Avg Purchase Value * Avg Number of Purchases

 

Example

A Manufacturing company has decided to outsource it Accounts Payable work to this Large IT/ITES organization.  The work which service provider will do and charge its client will be on FTE basis.  If the deal is for a period of 3 years and based on FTE model in the first year 100 FTEs are given.  Every year service provider will provide an efficiency of 6% and there will be cost of living adjustment(COLA) for 4%.  Cost of one FTE on an annual basis is USD 20,000.

Total revenue for the 1^st year will be 20,000*100= USD 2,000,000

Second Year- Cost FTE(1.04%*20,000) FTE Count(100-6%*100)

Total revenue for the 3rd year will be 20,800*94 = USD 1,955,200

Second Year- Cost FTE(1.04%*20,800) FTE Count(94-6%*100)

Total revenue for the 3^rd year will be 21,632*89 = USD 1,925,248

 

Total customer value will be USD 2,000,000 + USD 1,955,200 + USD 1,925,248 = USD 5,880,448

 

Customer Lifetime Value:

Customer Lifetime value (CLV) is used in different terms like Lifetime Customer Value (LCV), Lifetime Value (LV) which is net profit contributed to the future relationship with a customer.

 

CLV can also be defined as the monetary value of a customer relationship based on the present value and the projected future cash flows from the customer relationship.

 

CLV is an important metric for the business that encourages to shift their focus from current profits to the long-term customer relationship

 

It is always compared on the spending to acquire the new customers. One of the elements to understand is calculating payback of advertising spent in marketing

 

Purpose of CLV is to assess the financial value for lifetime of each customer.

 

CLV uses the concept of present value of the customer to cashflows attributed to the customer relationship. Its important because CLV helps to under customer segmentation

 

Below formula to help calculating the Customer Lifetime Value

Customer Lifetime Value = Margin(Retention Rate/1+Discount Rate-Retention Rate)

 

CLV has three main parameters

1.       Cost Margin per period

2.       Constant retention probability per period

3.       Discount Rate

 

Businesses are focused more in retaining the existing customers which is less expensive than getting a new customer when we compare cost of customer acquisition (COCA)

 

Lets say for example:

Acquiring new customer costs you $100 and lifetime value is $150, then it is said profitable concept and acquiring similar customers will be a focus and acceptable

Customer Lifetime Value is a metric used to measure how a customer is associated with product/brand over a period i.e Customer Loyalty towards a brand.

Firstly calculate the Lifetime Value = Average Value of a Product * Number of Transactions * Average Customer Retention Period. Then Customer Lifetime Value = Lifetime Value * Profit Margin

Example: A popular detergent company decides to sell the product with the profit margin of 20%.
A customer buys detergent powder costs Rs.250 per month and regularly buying it for 10 years.

Let us see what will be Lifetime value based on our above example, average cost per product * average no of times bought * average no. of years i.e. ((250*12) *10) = Rs.30,000. Thus the Lifetime Value will be Rs 30,000 for a customer.

Now calculate Customer Lifetime Value, apply the values to Lifetime Value multiplied by profit margin of a product i.e Rs.30,000 * 20% = Rs 36,000.

To conclude, this metric considers a Customer Lifetime Value and compares the value to the company's predicted customer loyalty.

Customer Lifetime Value is one of the very crucial metrics in Marketing and Sales which is used heavily to arrive at AD budgets , Branding exercises etc

 

We can arrive at CLV with following elements Let’s assume the following:

·         Profit created by the customer at the end of Financial  year = Rs 25,000

·         Number of years the customer has been in the system – 4

·         Cost to acquire the customer = Rs 10,000

The customer lifetime value of this customer would be:

Annual profit earned from the customer  ie Rs 25000 X No of years customer being retained ie 4 years less Customer acquisition cost  in terms of Ads and marketing expenses ie Rs 10000 retention value

25000 x 4 = 1,00,000 – 10,000 = 90,000 is the CLV

Edited June 25, 20214 yr by EKA PILLAI
typo

CLV is a measurement of how valuable a customer is to your business with an unlimited time span across the whole relationship as opposed to just the first purchase. It is a very important metric  while making important decisions regarding sales, marketing, product development, and customer support.

 

This metric helps one to identify and understand a reasonable cost per acquisition and underline the importance to retain the existing customers than finding new ones, keeping your CLV high can be essential to your business’s success and will result in more loyal customers.

 

Therefore, understanding CLV enables businesses develop appropriate strategies to acquire new customers and retain existing ones, while maintaining profit margins.

 

Formula for measuring CLV is Customer revenue - the costs of acquiring and serving the customer = CLV.  Let us take an example with the following assumptions :

1. Profit generated by the customer each year = INR 1,0000
2. Total number of years that they are associated with the brand as customer = 5 years
3. Cost spent to acquire the customer = INR 2,0000

The customer lifetime value of this customer would come out to be:

INR 1,0000 (annual profit from the customer) X 5 (number of years that they are a customer) - INR 2,0000 (acquisition cost) = INR 3,0000 = CLV.

That is, $1,0000 X 5 – $2,0000 = $3,0000

 

CLV can be measured through the following ways:

1. By Identifying the touchpoints where the customer creates the value
2. By Integrating records to create the customer journey
3. By measuring revenue at each touchpoint
4. Sum together over the lifetime of that customer
    

Customer Lifetime Value (CLV) is a metric that shows the total revenue any business can expect from a single customer account throughout their business relationship. This metric considers a customer’s revenue value and compares it to the company’s predicted customer lifespan.

This is a prediction model which have varying levels of complexity and accuracy, from experimental to the use of complex predictive analytical techniques.

Below is one of a simpler example to understand the CLV formula

Assumptions:

·       Profits generated by Customer A each year = $1000

·       Number of years since they are customer of the brand = 5 years

·       Cost to acquire the customer = $2000

The CLV of this customer would be:

Annual profit x # of years they are customer – acquisition cost

$1000 x 5 - $2000 = $3000

 

Another detailed example of CLV formula with more complexity by changing the initial assumptions:

 

·       Annual revenue per average customer = $2000 per annum

·       Product costs associated with Avg customer’s purchases = $500 per year

·       Firm spends additional $100 an year per customer for Customer Services

·       Annual retention rate or loyalty rate = 80%

·       Average costs to acquire new customer = $1000

 

In such a case, we have similar challenge to the previous example but the information needs to be modified from above data to feed into the CLV formula.

As a first step, we will calculate the averahe annual profit per customer by deducting the two sets of costs i.e. product & service costs from the annual revenue.

$2000 - $500 - $100 = $1400

The acquisition costs here are $1000 but we don’t have the average lifetime of the customer in years. We have the Annual retention rate. This is a common situation in workplace as it is relatively easy from customer databases to calculate the retention rate. So we will now convert a retention rate to the avg number of years that the customer will deal with firm.

100% divided by (100% minus the annual retention rate) or (1/1-annual retention rate)

So for 80% loyalty rate, the average customer lifetime will be:

100% / (100% - 80%) = 100% / 20% = 5 years avg customer lifetime period

Now we have all inputs for simple customer lifetime value formula, we can calculate CLV as:

 

$1400 (profit) X 5(years) = $1000 (acquisition) = $6000

Customer lifetime value (CLV) indicates how much revenue a customer will bring to your brand throughout their entire time as a paying customer. In a glance, the CLV gives an idea of the brand’s overall value and how much a brand is worth. The CLV also helps in segmenting customers into repeating and non-repeating.

The CLV calculation formula can be illustrated as follows:

For example, for an online store that specializes in cutlery, the average order value is Rs. 150 and the frequency of purchase is twice every year. Also, the average lifetime of the product is three years. Applying the above formula, the CLV is Rs.100.

 

Customer lifetime value (CLV) is one of the key metric to be tracked as part of a customer experience program. CLV is a measurement of how valuable a customer is to your organization. This metric helps you understand a realistic cost per acquisition.

 

Customer lifetime value also called as a lifetime value.  It is the profit margin a business expects to earn over the total of their business relationship with the normal customer.

Many organization take a short time approach by overseeing this valuable metric. It is always important to optimize the lifetime value of existing customer which is essential for a company to sustain a viable business model. 

 

It is a financial projection and requires a business to make informed assumptions. To calculate CLV, a business owner must estimate the value of the average number of transactions, average sale and the duration of the business relationship with a customer. This historical data helps to calculate their customer lifetime value.

 

Calculate customer lifetime value

 

Multiply the Average Value of Sale, Number of Transactions and Retention Time Period

 

Lifetime Value = Average (Value of Sale) ×  No of Transactions × Retention Time Period

 

Or simply

 

Customer Lifetime Value = LTV X Profit Margin

 

Customer Lifetime Value Example

For example the average sale for the flower bouquet shop is $500, and the average customer shops with them five times per year for three years.

 

To calculate LifeTime value:

 

    Lifetime Value = $500 × 5× 3
                                = $7500

 

Profit margin is 20% then,

Customer Lifetime Value becomes = $500 × 5× 3× 20%

 

Customer Lifetime Value =$1500

 

This calculation explains that the customer lifetime value of the average flower bouquet shop customer is $1500. As a retailer, this value is used to project cash flow and to understand how many customers you must acquire and retain to reach desired profitability.

 

Customer lifetime value (CLV) is the metric that indicates total revenue a business can reasonably expect from a single customer account throughout the business relationship, and it is one of the key metrics that any organization must measure and focus upon to maximize to stay relevant in competition.

 

 

Businesses use customer lifetime value to know which customer segments are most valuable to the company and where they shall put their efforts proportionately to yield maximum return to business. The longer a customer buys something from a company, generally the greater their lifetime value is.

 

This metric is targeted by the customer support teams / success teams and their aim is to maximize the CLV because it is often said that cost of acquiring a new customer is 5 to 10 times more than retaining the existing customer and hence the customer loyalty and retention is of so much importance to any company.

 

Why CLV is so important to a Business ?

 

i)                   It directly affects your revenue

ii)                  It boosts customer loyalty and retention

iii)                 It helps you target your ideal customers

iv)                 It reduces customer acquisition costs (depicted below)

 

 

How to Increase CLV ?

 

i)                  Improve the customer on boarding process

ii)                 Provide Value Added Services to Customers regularly

iii)                Offer High end Customer Service and 24*7 support (Chat / Social Media / Bots etc.)

iv)                Build Customer relationship

v)                 Listen to Customer Feedback

vi)                Detect pain points early and provide solutions

vii)               Offer Personalized experience to your customer

viii)              Digitize the customer connects / interactions

ix)                Offer easy billing cycle / payment plans

x)                 Do the up selling / cross selling with loyal customers

xi)                Increase the quality / value of your product / service and price in proportion

xii)               Increase your average order value

xiii)              Under promise and Over deliver

xiv)              Focus on delighters as per Kano model (picture below)

 

 

 

Example of Customer Lifetime Value :

 

i)  Travel Booking companies / portals often track and focus on CLV as :

CLV = Number of trips* Avg, Spending per Trip* # of years associated with company

E.g. Make My Trip.com, Yatra.com, GoIbibo.com etc.

ii)  Food Chains companies / portals often track and focus on CLV as :

CLV = Number of customer visits* Avg. Spending per Visit* # of years associated with  

company

E.g. Mcdonald, Starbucks, Pizza Hut, Chaos, Grofers, Bigbasket etc.

iii)   Retail Chains / portals often track and focus on CLV as :

CLV = Number of customer visits at store* Avg. Spending per visit* # of years associated with retail chain

E.g. : Spencers, Future Group, Pantaloons, Lifestyle, Home Center  etc.

 

To conclude, for increasing the CLV, companies provide excellent customer service, promotions, gifts, loyalty schemes / bonus points etc. and try to maximize the CLV as much as possible. Six Sigma Projects on NPS Improvement / CSAT improvement / Reduction of the customer complaints / concerns etc. focus on improvement of CLV by retaining the existing customer and providing them the excellent customer service. Also, if your CLV is low it may result into loss for the business in long run as lost customers / dissatisfied customer will not only hit the revenue by disengaging themselves from your organization but also the dissatisfaction / bad experience felt by them can lead to bad publicity / negative marketing of your organization and loss of new customers / prospects in long run.

Customer lifetime value (CLV) is on the metric to track as part of a CX program ( Customer experience).

CLV is measurement tool to know how valuable a customer is to any organization , not just on a sales basis but across the whole relationship.

CLV is different metric compared to NPS & CSAT because it is connected to tangible benefits linked to revenue rather than a somewhat intangible promise of loyalty & satisfaction.

 

CLV can be measured as shown below

 

Simple calculation with example for customer lifetime value.

Customer X’s revenue/ year = $1000

Customer relationship duration = 10 years

Cost of acquisition = $100

Cost to serve = $100 per year ($1000 over 10 years)

So the math looks something like this:

$1000 x 10 = $10,000

$10,000 – $1000 - $100 = $8900

CLV for Customer A = $8900

 

 

CLV goes hand in hand with important associated metric CAC ( Customer acquisition Cost) , example , if the CLV of an average Tea Shop customer is $1000 but to acquire them ( via advertising , marketing , offers , etc) the Tea chain could be losing money unless it considered its acquisition cost

 

Key importance of CLV.

• It is important metric as it cost less to retain the existing loyalist customer than it does to acquire the new customer.
• Increasing value of the existing customer is more helpful to drive growth.
• CLV helps organization to build strategies to acquire new customers and retain the existing customer while maintain good profit margins.

 

How to Improve CLV

• Invest in customer experience (CX) :-
• Start a loyalty program
• Recognize and reward best customers
• Close loop with unhappy customers   

 

So in short by understanding customer experience and measuring feedback at all touch points organization can understand the key driver to CLV and plan improvement accordingly.

Example, Paid OTT subscription or mobile plan which is basically multi-year relation shift with customer. It is good to spot the early sign of attrition i.e they playing less and less on services over the year.

Customer lifetime value  is the an important quantitative metric which is tracked as a part of the voice of the customer program. This is a measurement to understand how much importance a customer is to the company and this also helps to understand the cost per acquisition. CLV is very different from the net promoter score  while CSAT measures satisfaction. So we can generally talk about it as the sum of the revenue /value from business of a customer and how much time period the customer was with the company.Through this approach we will be able to find that how the current customers are affecting or contributing to the business and is wiser to keep them.  Through this a company can increase value and drive growth.
The first account of CLV was measured in the 1988 book Database Marketing and the early adoptors of this was in  1990 which is by Edge Consulting and BrandScience.

 

We can use the following approach to measure CLV:

Identify the flow and understand where all the value is generated

Map the end to end customer journey

Profit /revenue we are getting at each of this touch

Sum it with the duration of the journey

 

(Take the mean/average of the customer revenue * Profit per customer) ÷ Monthly  Attrition/Retention of the customes

 

For example: $100 avg monthly spend by a customer in an IT development company  * 25% margin ÷ 5% retention rate = $500 LTV

There are 2 best answers - Chetna and Dhirendra Singh for the kind of examples that they have quoted.