Customer Lifetime Value

Lifetime value
 There's a reason why you've been on hold with customer service for an hour says the Wall Street Journal, that company may have decided you're not profitable. It's one of the stories I shared in the most recent Learning Habit issue.

    Algorithms determine Customer Lifetime Value (CLV) by keeping a tally of how much money a customer spends. It's important to remember that CLV is about profit and not just revenue. Companies determine the CLV of a person as a score. The score may include geography — the zip code of where we live — and the number of returns we make.

    What else could be part of the score? Some algorithms may include website and customer service interactions, social media activity, marital status — many of the things marketers asked for years in warranty cards and contests, for example — in addition to transaction records.

    In theory, CLV is a prediction of the net profit attributed to the entire future relationship with a customer. But is it not missing something?

Crippling flaw in CLV

    Michael Schrage says#:

Innovation must be seen as an investment in the human capital and capabilities of customers.

[…] serious customer lifetime value metrics should measure how effectively innovation investment increases customer health and wealth. Successful innovations make customers more valuable. That’s as true for Amazon, Alibaba, and Apple as for Facebook, Google, and Netflix. No one would dare argue that these innovators don’t understand, appreciate, or practice a CLV sensibility.

    In other words, what has the company done lately to keep customers coming back for more? This is the value of a brand to a person or fan. When done well, companies can partner with customers in creating value. Cost reduction, advocacy, product ideas, feedback and data sharing are just some of the upsides.

    Part of the brand reinvention of a business where we grew revenues to position it for an acquisition included partnering with the ultimate users of our products to gain insights on the state of the market. That qualitative information helped us shape our forecasts and quantitative tracking.

    This kind of valuable personal involvement tends to get lost in all the talk about engagement in social. An overlooked yet effective marketing tactic continues to be making the customer better. In fact, investing in customers increases their value to the business.

Other dangers of CLV

    What happens inside the organization should not be discounted from CLV. It's not a number plucked from thin air, it's the result of a calculation we make based on the business we run.

    Bill Gurley addresses other dangers of overly focusing on customer lifetime value for Internet businesses. My observation is that once we find a formula, we typically become enamored with the formula and forget where it came from and that the point is not the formula but the behavior we're trying to predict.

    Data looks back, we're terrible at making predictions, especially when emotion is involved. Gurley# has “reasons to avoid worshiping at the LTV altar.” Some of his points are useful to seeing a broader definition of customer lifetime value:

  • It's a tool, not a strategy — confusion of output and inputs. Things like average revenue per user (ARPU) and customer acquisition costs (CAC) are outside our control.
  • The model to calculate CAC is confused and misused — for example, customers who seek out a business on their own or as referred by others should not be calculated as a cost. Many discount “revenues” rather than marginal cash contribution. All future variable costs of supporting the customer should be part of the equation to estimate future contribution.
  • Business is not physics, the formula is not absolute — complex adaptive systems cannot be modeled with certainty.
  • CLV variable tug at one another — imagine a balloon. When you squeeze in one area, the air moves to another. Raise prices and you increase churn, increase customer service support and cost goes up. The problem keeps moving because it's very challenging to have cheaper, faster, and better all at once.
  • Purchased customers underperform organic customers — this is almost on every metric. Once businesses are done pampering the top customers according to their definition, they'll likely need to buy more customers to replace those that have walked away because they were treated poorly (as in not deemed valuable enough).
  • Marketing dollars could go to the customer — in servicing the customer, giving the customer a better reason to buy more. This is value left on the table when a business follows the premise that CLV is entirely the responsibility of customers. Jeff Bezos says, “More and more money will go into making a great customer experience, and less will go into shouting about the service. Word of mouth is becoming more powerful. If you offer a great service, people find out.”
  • An obsession on formulas is blinding — effective public relations, social media, and word of mouth require more creativity and an open mind. They reward businesses with some of the best reach money can't buy, the spontaneous testimonial and recommendation of customers.
  • Tomorrow never arrives — focusing overly on the past, as in data about purchases, and the future, as in lifetime value, discounts the potential value of a simple single action and decision today.

    The problem includes timing. Which is as much art as science. Few things in life are certain. While CLV can be useful. What's the lifetime cost of getting value wrong?


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