CRM: Customer Lifetime Value, a critical Customer Equity input

This section is taken almost verbatim from my Marketing PhD work in progress. I have simply edited it by taking out the academic journal references and references to sections for ease of readability. 

These concepts were subsequently very effectively applied by me and my team at Standard Bank, South Africa in 2007, where we generated nearly R700 million in incremental value (approx US$100 million) within 6 months. The case was successfully presented at technology conferences and academic peer review conferences in the US, Canada, the UK and South Africa between 2008 and 2010.


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A consideration of Customer Lifetime Value (CLV) is contextually important for two reasons.

• Firstly, the primary objective of Customer Relationship Management (CRM) is to optimise Customer Lifetime Value  The ability to accurately predict potential product and services utilisation has a potentially significant role to play in the optimisation of Customer Lifetime Value. In so doing, the primary goal of Customer Relationship Management is increasingly likely to be met, itself often a strategic objective of many organisations, although these are not necessarily expressed in terms of Customer Relationship Management.
• Secondly, this section will show that the full calculation of Customer Lifetime Value has some dependence on having knowledge of the expected span of the customer life cycle.            

Even on its own, Customer Lifetime Value is topical from the point of view of both practitioners and the academic community. The concept can be traced back to the 1940’s, with about 30% of respondents to a survey conducted at the time being able to state the average value of their customers. The concept was already quite well developed because the study highlighted the business implications of ranking customers by their assessed Customer Lifetime Value. The purpose of the ranking was to identify which customers were worth focusing on. By the late 1970’s, the Customer Lifetime Value concept was commonplace amongst direct marketers. Indeed, some propose that the Customer Lifetime Value concept originated in the fields of direct and database marketing, with others suggesting that the development of Customer Lifetime Value in this space was driven by the fact that direct marketing provided access to data and information about individual customers, thereby making it easier to investigate many relevant customer issues.

These days, predicting and managing Customer Lifetime Value is considered central to marketing. Customer Lifetime Value is so central, that an insufficient understanding of Customer Lifetime Value could even result in an unsatisfactory outcome of a customer relationship management initiative. Considered differently, companies who understand Customer Lifetime Value could be up to 60% more profitable than those that do not.

Large retailers, financial services companies and telecommunication companies are examples of business who have large volumes of data on their customers. In particular, financial services companies have been and continue to be “increasingly orientated to the life-time value of the customer”. This may, in part, be a result of an increasing shift from a product-centric to a customer-centric paradigm in this industry, which would result in the need for new or supplementary marketing metrics, such as Customer Lifetime Value, to be defined.

The value of a customer to a supplier can be defined as the customer’s economic value to the company, where some authors talk about value measured across the total customer lifecycle, while others talk of future value. As an example of the former, some define Customer Lifetime Value as measuring the return or profit streams of a customer across the entire customer life cycle, and some are explicit about a discount factor - being the Weighted Average Cost of Capital (WACC) – as part of the calculation. 

Figure 4: CLV shown measured over the lifecycle of the customer, in this case, over the total life of the customer (based on Amber 2003:58). Amendments to the diagram show the concept of future CLV

On the other hand, most research gets a little more specific, talking of Customer Lifetime Value measuring future profitability. 

According to some, Customer Lifetime Value is measured from the time of the first purchase until the end of the life cycle, “by definition”. So then why do some authors speak of future value as in the above paragraph? An answer could be found from some researchers who admit that a total life cycle view does not make the most sense – suggesting instead that it makes more sense to design future marketing strategies based on an assessment of future potential, rather than on past performance. Furthermore, they speak of the spirit of Customer Lifetime Value as being forward-looking. Indeed, some qualify it further by stating that forward-looking Customer Lifetime Value measures are more consistent with the principles of shareholder value creation.

For clarity, lets define, quite simply, customer profitability as the difference between revenues and (variable) costs attributable to a customer during a specific period, which they point out, is consistent with the accounting definition of profit. This measure is also known as the contribution in economics and finance. In providing a link from profitability to Customer Lifetime Value, some researchers point out that Customer Lifetime Value is the most efficient metric in managing customer profitability. In its basic form, the future Customer Lifetime Value, at an individual customer level, can therefore be expressed as:

Equation 1: Simple CLV equation derived from the text, where the numerator can be interpreted as the profitability (revenue r_t – cost c_t) of the customer at some future time t discounted at rate i.

Equation 1 shows that future Customer Lifetime Value is the present value of the future profitability of a customer considered over n time periods into the future. The customer retention rate (and many variants of it such as churn and attrition rates), not shown in Equation 1, is considered as a key variable in more sophisticated Customer Lifetime Value models.

Some propose that Customer Lifetime Value consists of four components, not all of which are purely monetarily-based, but all of which have revenue and cost elements. These components are the base potential, the growth potential, the networking potential and the learning potential:

• The base potential consists of the cash flow from products and services that form the core of the relationship

• The growth potential consists of cash flow from cross-selling and up-selling

• The networking potential consists of cash flows acquired by relationships introduced by the customer via word of mouth, referrals etc.

• The learning potential consists of cash flows originating from the exploitation of market-based knowledge created by means of interactions in the relationship

While networking potential has been explored and is a current and highly topical issue in Banking internationally, it is probably the only one of the four components outlined above that has not yet been well explored within the bank being studied. In addition, of the four components, the base potential component is potentially the simplest component to evaluate.

Customer Lifetime Value analysis, in particular an analysis of the terms making up Equation 1, suggests that there are essentially three levers available in the management of customer value, assuming that the discount rate is an exogenous factor in the equation:

• Increasing retention

In general, the longer a customer can be retained, the higher the value realised from that customer. However, note that this is a necessary but not sufficient lever for increasing Customer Lifetime Value. Furthermore, retention is of little value strategically if sales opportunities cannot proactively be identified across this maintained section of the customer’s life cycle. A consideration of the life cycle of the customer can help identify these future sales opportunities.  

• Decreasing costs

Costs are one of two parts of the profitability equation. If costs can be reduced, profitability will increase, ceteris paribus. Greater value can be produced if these cost reductions are sustainable. Knowledge of the customer’s life cycle has little impact here because costs are internal to the organisation and are determined independently of the customer.

• Increasing revenue

Revenue is the other part of the profitability equation. If revenue can be increased, profitability will increase, ceteris paribus. Revenue increases are determined largely by sales growth, which can be achieved by realising more sales opportunities across the life cycle of the customer, or even gaining a greater share of the customer’s wallet, i.e. share of transactions/lending/savings products in the case where the customer conducts banking at more than one institution. Pricing also has an impact on revenue, but a change in price could adversely affect revenue so that the net effect on revenue may be less than it was before the change

Building on Figure 4, to help reach a common understanding of Customer Lifetime Value in the context of business life cycles, note that a full lifetime may be considered to be equivalent to one life cycle of a customer, whether the customer is an individual or a business. However, not all customers are necessarily customers for life. Note that since we are talking about a lifetime, we imply a longitudinal (temporal) aspect to the discussion. Customer Lifetime Value can then be defined as the value a customer generates for the supplier of goods and services over time, which, at its fullest extent, would be over the remaining “economic life” of the customer. 


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If anything, this article shows that while Customer Lifetime Value is not a simple construct, it can be calculated. 


To demonstrate the importance of properly calculating Customer Lifetime Value, it is important to note that it is the most critical input to another important marketing construct, Customer Equity, which I will get to in the next article. 


Again, there is enough detail here to give you enough to calculate Customer Lifetime Value at a per customer level. If you need help, you know where to find me.