Customer Lifetime Value Analysis

Why should you perform Customer Lifetime Value Analysis?

Do you know who your best customers are? Are you able to retain those customers and make them loyal? Do you know the customers that are most likely to deflect and turn to competition? How much money can you spend on retaining your customers and still remain profitable? These are some of the questions that all the digital marketers must have an answer to.

Most complex websites today have millions of visitors, user accounts and daily transactions that make analytics highly challenging. You might think that the easiest way to identify your best customers would be to segment the top spenders, but that will not give you the complete picture. The top spenders might not be giving you the maximum profitability; they might be costly to serve as well. This is where customer lifetime value analysis comes in.

What is customer lifetime value (CLV or CLTV)?

In marketing lingo, “customer lifetime value is a prediction of the net profit attributed to the entire future relationship with a customer.” There are various methods of calculating customer lifetime value. Nabler uses a mix of different techniques like:

  • Cohort Analysis: A time-based segmentation methodology to chart the relationship of customers with your company over time.
  • Regression Analysis: Linear regression to study past behavior and predict the future value of a cohort.
  • Markov Models: Probabilistic models and latest statistical sciences to arrive at accurate lifetime value calculations or value after a certain period of time.

These models take into account the expected benefits that the customer might bring and also the burden on the company in acquiring, retaining, and serving that customer. These would include costs related to managing product returns, marketing activities, loyalty programs, discounts for that customer, and so on. Additionally, indirect benefits like the effect of word-of-mouth, social media referrals, reviews, etc., must also be considered.

Once you arrive at CLV for each customer, the next step is to utilize that metric effectively for optimizing your marketing and sales activities.

Top three benefits of customer lifetime value analysis

  • Know where each customer stands and market appropriately

The first step is to group customers based on their profitability and retention proclivity. This will give you a fair idea of where your customers stand. Although the whole idea of CLV measurement is to identify the star customers, it would be a huge mistake to ignore the customers on the lower rung of the ladder. The aim is to identify why the top customers are loyal and use those insights to capture and retain the mid-level and low-level customers. CLV can help marketers define customer-specific communication strategy with better segmentation of customers. Just by identifying the low and mid-level customers, targeted marketing strategies can be defined to turn them into long-term loyal ones. And similarly, the top cream of customers can be rewarded for their loyalty and enticed with the right offers. Another way to utilize CLV findings is to identify the past top customers that are now inactive so that you can build strategies to reactivate or remarket to those valuable customers.

  • Know the upper limit of spending on acquiring new customers

The advantage of CLV is that it gives a dollar figure for each customer. You can predict how much each customer will cost you and how much profit they might generate. This will also provide you a clear picture of how much money you can spend on acquiring, retaining and serving those customers. CLV calculations can help you allocate the right budgets for different types of customers in the value chain. The idea is not to close the eyes to the low-level customers, but to allot the right amount of money for marketing activities aimed at those customers. Another way companies use CLV numbers is for reducing customer deflection. For instance, it might not make sense for companies to invest in low-value customers that are about to deflect, but it might make sense to offer some incentive to high-value customers who are about to deflect.

Moreover, CLV calculations will also help you identify which channels of marketing are bringing in the best value customers. This will enable you to invest more on channels that work and reduce your spending on the channels that are bringing low-value customers.

  • Forecast future revenues

Customer lifetime value calculations can help you focus on the long-term profits instead of acquiring cheap customers today. The “lifetime” of a customer varies for different businesses. For instance, a financial services company may have a lifetime of decades, but on the other hand, a fashion retailer might consider customer lifetime to be 3-5 years. By using advanced statistical models, analysts can calculate the proportion of purchase, the probability of purchase and repurchase, purchase frequency and sequence for individual customers and this might give you a clearer picture of the probable revenue that you can expect from your current customer base.

To conclude

Beware, CLV is not the final answer to all your customer relationship management concerns. As Warren Buffet puts it, “The CLV formulas can be very helpful. They can help you make the right decisions to drive your business, but if you fall into the trap of believing that the formulas are the be-all and end-all to your business, that’s when it’s not going to work out so well.”

CLV calculations are coming up in a big way and online marketers are realizing that Cost Per Acquisition (CPA) or Cost Per Conversion (CPC) numbers are not giving them the holistic picture. Calculating CLV is a complex activity and requires seriousness, but it is worth it, as it helps marketers to realize the true value of customers while keeping a long-term relationship in mind. It helps them identify the best customer acquisition channels and enables them to intelligently split their marketing dollars in the best possible way. There is an age old saying that, “I know that half of my advertising costs are wasted. I just wish I knew which half.” This saying still holds true in most cases and analyzing CLV can help marketers invest in the advertising channels that yield the best value customers.

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