Understanding the Lifetime Value of a Customer

Jul 17, 2012

You may have run across the term Life Time Value of a customer or LTV. It is a common marketing buzzword, and you often hear about it in the context of Customer Relationship Management (CRM). The basics of LTV and CRM mostly come down to tracking and retaining your customers to keep them coming back. Increasing the number of happy return customers can have a huge impact on your business.

The principles behind LTV are actually quite simple. Suppose you have a customer named Fred. In 1999, he bought a $29 widget. Six months later in 2000, he saw an ad, came in and purchased a mega-widget for $59. Then he got a postcard from you in 2001, and he bought a micro-widget for $109. Sometime in 2002, he moved out of state, and you haven’t heard from him since.

With current data collection methods, it’s easy to calculate what Fred’s activities mean to your bottom line. To estimate your lifetime value of an average customer, you look at your customer sales database and do some calculations. The estimated average lifetime value of a customer equals the average sale multiplied by the estimated number of times customers reorder. In Fred’s case, he bought a total of $197 of merchandise from you over the course of three years. The average sale was about $65 ($197 divided by 3). If you looked at all of your customers and found that they had similar purchasing habits, your LTV of your average customer would be $195 ($65 times 3). Similarly, a non-profit organization can do a similar exercise with their donor base to see the long term value of the donor.

Think about what might happen if you could increase the number of times Fred came in and bought something (or donated something). What if you could increase the number of items Fred purchased? LTV and CRM are so interesting to marketers and business owners because it is far more expensive to find a new customer than it is to retain existing ones.

According to studies by the Danna Group, it’s not uncommon for companies to lose from 20 to 50 percent of their revenue each year from customer defections. When a customer leaves and never returns, the effect is measurable. For example, think about what would have happened if Fred had come in, bought the first $29 item, and then never returned. You would have lost $168 in sales.

Many businesses have tried to ignore the problem by working harder to acquire new customers. Unfortunately, this approach is expensive. With an understanding of the basic tenets of CRM and LTV, you can create and implement strategic programs that are aimed at enhancing customer relationships and decreasing customer defections.

You can use many techniques to retain customers. Some businesses reward customers with “loyalty” programs that give them a discount if they buy a certain number of items or spend a certain amount of money. Others keep in touch with regular communication, such as direct mail, newsletters or postcards. In either case, it comes down to reminding your customers that you exist. If your customer had a good experience buying from you, and you take the time to remind him of that fact, he might just return.

Return customers (and donors) are what LTV is all about. If you run a sale and sell your widget for $27 instead of $29, think about the LTV of the buyer. The loss from that initial purchase could be worth it in the long run if it nets you a new customer. Then by implementing customer retention programs, you might get that $2 back many times over.

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© Action Graphics, 2012. 

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