What is Customer Lifetime Value (CLV)?
In this clip from our eLearning series, Allison Hartsoe, CEO of Ambition Data, takes a deep dive into Customer Lifetime Value (CLV).
Customer Lifetime Value vs. Recency Frequency Modelling
Customer Lifetime Value can be defined as the present value of future cash flows attributed to a customer during their entire relationship with the company. Let's take a close look at what that means because there's always confusion between CLV and recency frequency modelling. Recency frequency modelling takes into account how recently a customer made a purchase and how often they make a purchase. Company's can use this data to guess how that customer will behave in the future. But this approach is often chunky and doesn't bucket or segment customers very accurately. An analogy that you can use for recency frequency modelling is driving your car while looking in the rearview mirror. On the other hand, Customer Lifetime Value is like driving a car while looking out the windshield. By looking at what's in front of you rather than behind you, brands can make more accurate predictions about what customers are going to do in the future.
The CLV formula
CLV formula
While there is no one "right way" to measure CLV, the formula below can be customized to fit the unique relationship that a customer has with your company. The net cash flow per period is represented by margin, or m. Some companies choose to subtract customer acquisition cost to get a true net. If you want to use CLV to estimate something like the upper bounds of spending, then customer acquisition cost definitely needs to be excluded. But generally you should treat m as a constant. Retention over time is represented by r. Most companies might have a 60 - 90% retention rate. If you had a retention rate of about 20% and your time horizon is one year, then you would lose 100% of the customers that you acquired after 5 years on a rolling basis. r to the t simply means the time at which revenue is booked. If revenue is booked at the beginning of the period then t would be 0. Your discount rate is represented by d. This is the time-value of money. It wouldn't be accurate to project CLV without discounting cash because dollars received today are worth more than those received tomorrow. You should align with your CFO for the proper discount rate you should be using. Your time horizon is represented by T. For most companies, at year 15 there's very little difference between that and infinity. So the maximum value that's pulled from all your customers is generally reached by year 15 at the latest. If you're using the CLV formula to make marketing decisions it's a good idea to take a shorter time horizon to make more immediate decisions. If you're using CLV to determine company valuation then you should use the longest time horizon possible. Learn how Rubano can help you maximize CLV to drive more revenue for your brand.