Which customer is worth it?

Customer lifetime value (CLTV or frequently CLV) is the anticipation of the net benefit ascribed to the entire future association with a customer. It is an essential thought that urges firms to move their emphasis from quarterly benefits to the long-term strength of their customer connections.

In mathematical terms, Customer Lifetime Value is a lead indicator for the amount that can be spent for acquisition of nascent customers as CLTV signifies how much each customer is worth in monetary terms – given it would cost ₹X to reach that customer through various marketing mix elements and service him across his tenure with the firm.

One of the principles that help in understanding customers and the revenue they bring along is the Pareto Principle which states that for many events, roughly 80 per cent of the effects originate from 20 per cent of the causes.

Applied to business, this signifies that 80 per cent of your revenue can be attributed to 20 per cent of your customers. While the accurate percentages may not be 80/20, it is still the case that a few customers are worth a whole lot more than others, and distinguishing your ‘top pick’ customers can be immensely valuable to your business.

Most often, firms measure customer value by way of their past spends and cost to serve the customer and overlook the future spends and forward-looking costs.

Most firms use the customer profitability approach to differentiate and segment customers which may not take into consideration future effects whereas CLTV is probably more directly connected to the customer’s value to the company during his entire interaction period.

Here is how CLTV can be viewed from a wider angle.

Customer segmentation By segmenting customers according to CLTV, marketers can apply more relevant campaigns for outcomes with improved precision. Identifying customers who exist in both high CLTV segment and low customer-share segment suggests the best undiscovered potential and huge upside income opportunity.

Customer segmentation additionally acts as a catalyst for more personalised, timely and appropriate campaigns to increase customer share and improve CLTV.

CLTV is customer segmentation that commences with the construct that not all customers are equally important. CLTV-predicted segmentation model enables a company to focus on the most valuable cluster of customers, understand their behavioural characteristics, and invest more in them rather than in less valuable customers.

Acquisition channel route CLTV model is one of the most beneficial methods used for identifying customers and taking decisions regarding customer-specific channel strategies.

It has been observed that customers coming through different channels have differing values of CLTV and hence the best way to utilise it is to segment customers by acquisition channel. When you segment your customers in this way, it gives you two very actionable pieces of information. First it shows which channel is generating the most lucrative customers, and second it shows you how much a customer from each channel is worth. Thus, knowing the CLTV of different channels allows you to allocate resources to channels that generate the most value for your business.

Focus areas for growth When CLTV is understood, any organisation can analyse it thoroughly to determine areas that will provide maximum business impact and efforts that are needed to change or transform to generate maximum revenue. Essentially CLTV is the product of three factors:

When CLTV is optimally used as a product of three distinct segments, the area that needs the most amendment could be found and the resources can be put into that territory all the more intensely.

For example, if a company discovers that its average order value (AOV) is the lowest component of its CLTV, it can optimally address it by improving it with tactics such as cross-selling, product bundling, and more.

Similarly, if they are having a tough time with the purchase frequency, they can experiment or innovate with some strategic programmes such as gamification and points to get customers to return more often.

Managing the sales force CLTV could be utilised to determine which sales regions to concentrate on, how to allocate sales resources, how to reward sales teams; say, a higher reward for offering to clients with a high potential CLTV or getting new clients with a high CLTV, and how to run differentiated yet structured sales incentive programmes; say, incentivising a business channel partner with the largest number of higher CLTV customers rather than just by sales value or volume.

Reactivating the inactive Since marketing budget is a constraint faced by every organisation, it makes imminent sense to use the CLTV metric to identify inactive customers with a higher CLTV and win them back for the firm.

Since it costs five times more to acquire a new customer rather than win back a lost customer, this proves to be a significant revenue-saving strategy. It is also known that second-time customers have a higher CLTV versus their initial term with the company.

As a metric for M&As If an organisation calculates the CLTV for its entire client segments or values itself through CLTV using current active customers as a reference, it will have a precise picture of its most significant assets, i.e., its market position and its current valuable customers.

Futuristically, those CLTV values can be used as a component for valuation that would be needed for mergers and acquisition.

For instance, to establish the worth for a company, an essential component of the business value estimation is the calculation of the customer capital predicated upon numbers of customers multiplied by an average value. However, this value will often be an estimate more than the real future customer value.

A concrete calculation of CLTV of the customer base is a better predictor of how much a company is worth, concretely, if the calculation includes the threat of a higher defection rate because of the prospective sale of the company.

In this way CLTV can be applied to business scenarios for merger between two companies. The merger will influence both the acquisition rate and the retention rate and hence the change needs to be addressed for concise valuation.

Subhiney Chhabra is Senior Sales and Marketing Consultant with Hansa Cequity

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