Customer Lifetime Value

Title Page (a) Title of submission: Customer Lifetime Value (ii) Theme: National Seminar on- "Changing Scenario of Consumerism" in the Department of Commerce, Bharathidasan University on 7.01.2006 and 08.01.2006. (iii) Name of the author: Prof. R Ramakrishnan (iv) Designation with department: Head, Department of Management Studies (v) Mailing address:College:Muthayammal Engineering College, Rasipuram 637408 Residence: Suri Illam, 10A swami Sivananda Salai, Rasipuram 637408

(vi) E-mail address: [email protected] (vii) Phone number(s) College: 04287-220837 and 226837 Residence:04287-225837 Mobile: +919952669656 (viii) Fax number: 04287-220837 and 226837

Presented by me At the National Seminar On "Changing Scenario of Consumerism" organized by Department of Commerce, Bharathidasan University, Tiruchirapalli on 11th and 12th February 2006 with financial assistance from Consumer Welfare Fund (through Ministry of Consumer Affairs, Government of India, and Indian Institute of Public Administration, New Delhi)

1 of 8 Prof R Ramakrishnan, HOD, Dept of Management Studies, Muthayammal College of Engineering, Rasipuram 637408 Cell +919952669656 email: [email protected] Electronic copy available at: http://ssrn.com/abstract=1747726

Customer Lifetime Value Customer Lifetime Value (CLV) a marketing metric that projects the value of a customer over the entire history of that customer's relationship with a company. It is the current value of the likely future income flow generated by an individual purchaser. It is variously referred to as lifetime customer value or just lifetime value, and abbreviated CLV, LCV, or LTV). Customer Lifetime Value (CLV) determines the value of a customer to the firm over the life cycle of the customer. It seeks to maximize profit by analyzing customer behavior and business cycles to identify and target customers with the greatest potential net value over time. A Profitable customer is one that overtime yields a revenue system that exceeds by an acceptable amount of the company's cost stream of attracting, selling and servicing that customer over time. This paper looks at the various concepts connected with Customer Life time value.

2 of 8 Prof R Ramakrishnan, HOD, Dept of Management Studies, Muthayammal College of Engineering, Rasipuram 637408 Cell +919952669656 email: [email protected] Electronic copy available at: http://ssrn.com/abstract=1747726

Customer Lifetime Value People need to consume resources to survive. Consumption was based on necessities. Being frugal and saving was the norm while spending heavily or extravagantly was frowned upon and seen as wasteful by most all over the world. Limited consumption in the past was due to the scarcity of resources due to the limited ability to extract and use them Some of the factors which resulted in Consuimerism are  Technological developments resulting in accessibility of additional resources,  These progress resulted in production of more goods than required. The capitalists responded by convincing people to buy things, by altering basic institutions and even generating a new ideology of pleasure.  Expansion of consumer credit which created the required mass market  Another revolutionary development to influence the creation of the consumer was advertiement. Over the years marketing have changed from transactions to relationship and is now seen as the process of defining, developing and delivering value to the customer. The production costs have been reduced through TQM, JIT, FMS and efficient supply chain management. These have however resulted in tough competition and the high rate of brand switch among consumers. Quality and effective service leads to satisfied customers and helps in developing loyalty. Commitment to innovation and customer oriented business decision-making is the order of the day with the focus on  Customer driven marketing practices,  Profitability and  Strategic marketing practices Relationship marketing is about customer value and value chain. Customers define the business and their relationships are the key strategic assets of the organization. Quality and service act as the customer retention tools. The need to be in constant contact with the customer is a key principle of Relationship marketing. Consumer credit cards, Frequent Flyer programme, discount coupons by shops are all used to reward customers for frequent and loyal purchasing behaviour. Further each transaction is now entered into a database. Customer Lifetime Value is one of the major focus areas for companies because the cost of acquisition of new customers is much higher than the cost of retention of existing customers. 3 of 8 Prof R Ramakrishnan, HOD, Dept of Management Studies, Muthayammal College of Engineering, Rasipuram 637408 Cell +919952669656 email: [email protected]

Customer Lifetime Value (CLV) is a marketing metric that projects the value of a customer over the entire history of that customer's relationship with a company. It is the current value of the likely future income flow generated by an individual purchaser. It is variously referred to as lifetime customer value or just lifetime value, and abbreviated CLV, LCV, or LTV). CLV determines the value of a customer to the firm over the life cycle of the customer. It seeks to maximize profit by analyzing customer behavior and business cycles to identify and target customers with the greatest potential net value over time. It allows companies to know exactly how much each customer is worth in monetary terms, and therefore exactly how much a marketing department should be willing to spend to acquire each customer. It is a concept adopted from direct marketing which looks on the long term customer behaviour as the key for success. The norms for this success are based on  The cost of acquiring a new customer and  The benefits & costs of retaining an existing customer Relationship marketing is the key concept that helps the companies in developing loyal consumer base. It embraces all those steps that companies undertake to know and provide value to its customers It is more profitable to have a set of regular long-term loyal and profitable customers than to have more number of customers. The 20:80 rule of marketing is that 20 % of the customers account for 80% of the company's profits and it is much cheaper to retain a consumer than to attract a new one. To reach these customers and convert them into partners is the real challenge. Loyal customers become more valuable over time. They are different from other customers as they tend to      

Buy more often Buy more items Buy higher priced items Have lesser service cost Have lesser sensitivity to price Have higher retention rates.

A Profitable customer is one that overtime yields a revenue system that exceeds by an acceptable amount of the company's cost stream of attracting, selling and servicing that customer over time. Building a relationship with customers only works when the customer benefits from the relationship. This can happen when you provide to customers something that they will appreciate and value, but at the same time do not cost you too much. One must try therefore building a relationship with 4 of 8 Prof R Ramakrishnan, HOD, Dept of Management Studies, Muthayammal College of Engineering, Rasipuram 637408 Cell +919952669656 email: [email protected]

customers whose behavior can be modified, to convert them over time into long run loyal and profitable customers. The critical factor that influence the Lifetime Value is the likelihood that the customer will voice his /her satisfaction or otherwise to others and its level of influence. A proper understanding and measurement of customer profitability is essential for profitable growth, and is achieved only by using advanced marketing technologies. Customer Lifetime Value (CLV) is the value of the customer over the Lifecycle and is a multiperiod calculation, usually stretching 3 to 7 years into the future. Following steps can be used for calculating the CLV in a simple manner: 1. Calculate the average sale "S" by dividing the total amount of sale by number of sales transaction for the period (usually one year. 2. Calculate the number of times an average customer buys " T" from the company by diving the total number of sales transactions by the total number of customers. 3. Find out the number of years "Y" an average customer buys from the firm. 4. Find out the number of people " R " referred by the an average customer- this is usually between 3 to 12 5. Find out the percentage of such referrals "C" who become customersthis is usually between 20 to 70% 6. Customer Lifetime Value is calculated as Lifetime value = S * T* Y (1 + R* C ) The Lifetime Value of a customer is the net profit the customer generates over their Lifecycle and is used to make decisions about allocating marketing to ideas that generate high potential value customers, and away from ideas generating low potential value customers. Repeat behavior indicates higher Lifetime Value, and predicts future repeat behavior, regardless of what the actual monetary Lifetime Value is. The Customer Lifetime Value numbers are really very powerful measures as it include in a single set of numbers based on the    

The retention rate, The spending rate, The costs of marketing, and The discount rate.

Customer lifetime value calculations are usually calcualted based on certain data inputs like  Acquisition cost - average amount of money that is required to acquire a new customer.

5 of 8 Prof R Ramakrishnan, HOD, Dept of Management Studies, Muthayammal College of Engineering, Rasipuram 637408 Cell +919952669656 email: [email protected]

 Churn rate - the percentage of customers who end their relationship with a company in a given time period.  Discount rate - The cost of capital used to discount future revenue from a customer. The formula for the discount rate is: D = (1 + i)n Where i = the current interest rate plus a risk factor, and n = the number of years that you have to wait to get your hands on the future money. The current interest rate is often substituted for this  Retention cost - The amount of money a company has to spend in a given time period to retain an existing customer.  Time period : The unit of time into which a customer relationship is divided for analysis which is usually one year.

The CLV could be calculated from historical data of customers available with the company. This can be extrapolated and used to forecast the customer behaviour. The estimation of CLV could also be used to initiate communication of the information, identification, tracking and organization's response to the customer behaviour and allocation of resources to foster the CLV Lifetime Value is the value of the customer over the Life Cycle The most difficult part of calculating lifetime value is deciding what a “lifetime” is. Lifetime Value doesn't exist without a Life Cycle. Customer LifeCycle is simply the behavior of a customer with your company over time. Customers begin a relationship with you, and over time, either decide to continue this relationship, or end it. At any point in this LifeCycle, the customer is either becoming more or less likely to continue doing business with you, and demonstrates this likelihood through their interactions with you. If you can predict where customers are in the LifeCycle, you can maximize your marketing ROI by targeting customers most likely to buy, trying to “save” customers who have declining interest, and not wasting money on customers unlikely to continue doing business with you. Customers who are the cheapest to acquire may have the shortest LifeCycles, and customers who are expensive to acquire might have very long LifeCycles. Customers who purchased recently were more likely to buy again versus customers who had not purchased in a while Customers who purchased frequently were more likely to buy again versus customers who had made just one or two purchases. Customers who had 6 of 8 Prof R Ramakrishnan, HOD, Dept of Management Studies, Muthayammal College of Engineering, Rasipuram 637408 Cell +919952669656 email: [email protected]

spent the most money in total were more likely to buy again. The most valuable customers tended to continue to become even more valuable. Increasingly consumers can demand more precisely what they want. Use of customer lifetime value as a marketing metric tends to place greater emphasis on customer service and long-term customer satisfaction, rather than on maximizing short-term sales. Lifetime value is the net present value of the profit to be realized on the average new customer during a given number of years. It is a wonderful concept, and can be an excellent guide to profitable strategy. Once you know your Customer Lifetime Value, you'll know how much you can afford to spend -- or lose -- to get that first sale. To retain and increase the value of customers, you have to engage them by communicating on a regular basis. If you don't, customers will be less loyal and either abandon you for a competitor who communicates with them, or will spend less with you over time. Marketing promotions are essential to any kind of customer retention effort; promotions drive the sales activity of customers. By definition a customer who is more likely to respond has a higher future value than a customer less likely to respond. The three key components to maximizing profits in customer marketing are: 1. Structuring offers to get the most profitable mix of response rate and cost of the offer. 2. Creating an "early warning system" to flag customers who are likely to leave so by tracking customer behavior, so they can be targeted for special promotions. 3. Identifying customer acquisition practices that optimize the value of new customers coming to the business for the first time You can organize your business around customer value, if you can compare the future value of customers. LifeTime value is used to make decisions about allocating marketing to ideas that generate high potential value customers, and away from ideas generating low potential value customers. Merchants typically use promotional offers, trial periods, unique content, bundled offerings and more to attract potential consumers. Customer Response, Retention and Valuation Concepts (RFM Model)using Recency and Frequency can be used to rank the LifeTime Value and likelihood to respond of customers relative to each other. Customers are ranked based on their R, F, and M characteristics, and assigned a "score" representing this rank. Assuming the behavior being ranked (purchase, visit) using RFM has economic value, the higher the RFM 7 of 8 Prof R Ramakrishnan, HOD, Dept of Management Studies, Muthayammal College of Engineering, Rasipuram 637408 Cell +919952669656 email: [email protected]

score, the more profitable the customer is to the business now and in the future. After scoring customers using RFM, you will be able to: 1. Decide who to promote to and predict the response rate 2. Optimize promotional discounting by maximizing response rate while reducing overall discount costs Determine which parts of the site or activities attract high value customers and focus on them to increase customer loyalty and profitability *****************

8 of 8 Prof R Ramakrishnan, HOD, Dept of Management Studies, Muthayammal College of Engineering, Rasipuram 637408 Cell +919952669656 email: [email protected]