Customer Lifetime Value, What's it all About?
By Rhonda Drake

The following article, written by Rhonda Drake, appeared in Deeper, March 2002.
It provides direct marketers with a better means of understanding what customer lifetime value is,
how it is calculated and how it can be used as a strategic marketing tool.

So what is Customer Lifetime Value? We all speak of it yet few seem to have a consistent definition or clear usage for this measure. And, unfortunately, when most companies do calculate this measure it often serves as merely a kind of "report card" for the cumulative marketing effort.

The fact is, Customer Lifetime Value is a lot more than what most folks think it is. If calculated and used properly, it is a strategic tool for which there are many applications. Such calculations will not only provide valuable statistics highlighting the value of a customer over the course of his lifetime but also assist in assessing the long-term impact of various marketing decisions to the corporation.

In particular, Customer Lifetime Value can be used to:
Highlight changes in customer purchase levels. When LTV statistics are computed at routine intervals following the conversion of a new customer, comparisons can be made to assess customer quality over time. It provides a means by which we can monitor the vitality of the customer base in a consistent manner over time. With such measures, problematic issues such as a decline in customer consumption or an increase in bad debt can be spotted more quickly and addressed proactively.
Assess the results of various name sources, treatments or strategies. When testing a new source of names, implementing a new "customer service" policy, or changing to a new offer, you will calculate LTV statistics. You will compare the value of, for example, names impacted by the new "customer service" policy over a one or two year period to a sampling of names held under the old policy. It is this comparison that will allow you to make the appropriate decision regarding the long-term health of your company.
Segment the customer file for targeted communications. The usage of LTV statistics is particularly useful for CRM communication. Based on profitability within cohort groups, customers can be targeted for special communication. In addition, techniques can be utilized shortly after a customers conversion allowing you to identify which are most likely to become the best customers.

How can you introduce LTV measurements to your organization?

Begin by conducting a historical lifetime value analysis by cohort group to determine which have the highest average value. To accurately assess groups you will need to include active and inactive customers and "peel away" data so you can get 3 or six-month incremental values. A historical analysis will provide good directional trends on customer value even if you cannot accurately assign all costs.

When capturing cost and revenue figures for use in the calculations, keep in mind that this will not be an easy task. Determining costs will be the most difficult task and should include all communication costs including renewal notices, returns, customer service calls, promotions, billing, etc. Due to complexity, you may opt to use average cost figures by calendar year. Tracking revenue will be relatively easy in comparison as most direct marketers already accumulate customer dollars spent. For newly converted customers, you will have the most complete information, which will allow for very accurate LTV analysis.

With time, patience and dedication, any direct marketer -- regardless of the complexity of the business model - can implement this type of strategic reporting. It is essential and necessary to ensure you establish the most appropriate CRM strategies, accurately assess new marketing programs, and are in a position to monitor the vitality of the customer base over time. It provides a means to "normalize" the cost and return on channel, message, product line and offer. It will give you the most complete picture of your business.

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