Aug 18, 2008

Customer Lifetime Value Analysis

Introduction
Among SnA's many analytical projects, Customer Lifetime Value (CLV) analysis is a crucial deliverable for many clients. A general definition for CLV is the "present value of the future cash flows attributed to the customer relationship". Organizations that utilize CLV as a key business metric tend to place greater emphasis on the long-term customer relationship, rather than maximizing short-term sales.

Typical Customer Lifetime Value Calculations
Harvard Business School has published two great examples on how the calculation may be performed. The first example is an Ms Excel spreadsheet (published in 2000) with two scenarios (Basic and Complex) and calculations for each. The second example is a -fancier- Adobe Flash tool (published in 2007) and -similar to the spreadsheet- has input fields for the calculation. A snapshot is below:


It's important to note:
  • Both tools approach the CLV calculation at an aggregate level. This is the common approach in many database marketing resources including Jim Novo's Drilling Down.
  • In this approach, a typical CLV formula will try to integrate all -or some- of the metrics below:
    • Analysis Period: The unit of time into which a customer relationship is divided for analysis. A year is the most commonly used period. Customer lifetime value is a multi-period calculation, usually stretching 2 to 5 years into the future.
    • Churn Rate: The percentage of customers who end their relationship with the company in a given period. [Churn Rate = 1 - Retention Rate]
    • Discount Rate: The cost of capital used to discount future revenue from a customer. This calculation is typically more complex than the standard interest rate.
    • Retention Cost: The amount of money a company has to spend in a given period to retain an existing customer. Retention costs usually include customer support, billing, promotional incentives, etc.
    • Periodic Revenue: The amount of revenue collected from a customer in the period.
    • Profit Margin: Profit as a percentage of revenue.

  • See table below for a typical CLV calcuation (source):

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