Customer lifetime value is often wondered. What is the customer lifetime value and how to calculate it?

It is no secret that firms treat customers differentially. At the same time that one customer spends 10 minutes to connect to customer service, a “Gold” customer calls the phone is picked up immediately by a friendly voice.

How do firms specify the customers to whom they should give preferential and often personal treatment that obviously costs more money and energy, which customer they should connect with through cheaper channels such as the Internet, and which customer to let go?

Firms use many techniques and methods to make these critical decisions. Customer lifetime value (also called CLV or CLTV ) is one of the technique which is rapidly gaining acceptance as a metric to acquire, grow, and retain the “right” customers in customer relationship management (CRM)[1,2].

Customer lifetime value for a firm is the net profit or loss to the firm from a customer over the entire life of transactions of that customer with the firm

The lifetime value of a customer for a firm is the net of the revenues obtained from that customer over the lifetime of transactions with that customer minus the cost of attracting, selling, and servicing that customer, taking into account the time value of money [3].

As a summary, CLV is a measurement of how valuable a customer is to your company. It is an important metric because it it gives insights whether or not you can expect certain customers to become repeat customers.

How to Calculate Customer Lifetime Value ?

Customer lifetime value itself can be measured in different ways. Its basic components include the frequency of purchases, the amount of money the customer spends, the marketing resources, and the likelihood that the customer will continue in the relationship. There are four key performance indicators (KPIs) that determine CLV [4,5,6,7]:

• Average Order Value (AOV),
• Purchase Frequency (F),
• Profit Margin (PM)
• Churn Rate (CR).

Average Order Value (AOV) = Total Revenue / Total Number of Orders

Purchase Frequency (F) = Total Number of Orders / Total Number of Customers

Profit Margin (PM) = (Total Revenue-Cost of Goods Sold(all expenses))/ Total Revenue

Churn Rate (CR) = 1 — Repeat Rate

After calculating 4 KPIs, customer value is calculated by using average order value and purchase frequency.

Customer Value (CV) = Average Order Value × Purchase Frequency

Customer value is calculated by using customer value, churn rate and profit margin.

Customer Lifetime Value = (Customer Value / Churn Rate) × Profit Margin

I have prepared a visual summary for those who have visual memory and enjoy summaries:

Calculation of customer lifetime value step by step:

REFERENCES:

[1] Kumar, V., Ramani, G., & Bohling, T. (2004). Customer lifetime value approaches and best practice applications. Journal Of Interactive Marketing, 18(3), 60–72. doi: 10.1002/dir.20014

[2] Malthouse, E., & Blattberg, R. (2005). Can we predict customer lifetime value?. Journal Of Interactive Marketing, 19(1), 2–16. doi: 10.1002/dir.20027

[3] Jain, D., & Singh, S. (2002). Customer lifetime value research in marketing: A review and future directions. Journal Of Interactive Marketing, 16(2), 34–46. doi: 10.1002/dir.10032

[4] Turow, J. (2008). Niche envy: Marketing discrimination in the digital age. MIT Press.

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