How to Calculate Customer Lifetime Value in Data Driven Marketing
It’s quite helpful to understand the contribution your customer base will produce over the lifetime of your relationship and data driven marketing can assist in seeing this trend. A common calculation in this vein is known as customer lifetime value or CLV. It involves some degree of advanced knowledge of finance. But the basic idea is worth understanding.
Essentially, CLV takes into account two factors related to time:
The change in the value of money over time: This is done via the finance equivalent of a bird in the hand is worth two in the bush. Because money earns interest if you save it, a dollar in hand today is worth more than the promise of a dollar in the future.
In that case, you’d discount every dollar of revenue you expect to get next year to 96 cents to make it equivalent to today’s dollar. Understanding the nuts and bolts of this calculation requires some advanced knowledge of finance. In particular, determining the interest rate to use in applying this principle depends heavily on what sort of revenue stream is being analyzed.
The churn rate: This is a measure of how many customers you expect to lose over the course of the year. If your churn rate is 5 percent annually, for example, you would only include 95 percent of next year’s expected revenue in your CLV calculation.
You (or your finance partner) perform these discount and churn calculations for each year going forward. You’ll have to choose a reasonable time period that represents the expected lifetime of your customer relationship. Once you do, you add up all the yearly contributions to get the customer lifetime value.
You can do this calculation at the individual customer level. But it doesn’t really represent what you can expect from an individual customer. The churn rate is what you expect to see across a particular profitability segment. It doesn’t tell you which customers are actually going to leave. CLV calculations should only help draw conclusions about customer segments.
One useful application of CLV is in budgeting. By knowing what you can expect to earn from a given segment over the entire lifetime of the relationship, you can make an informed decision about how much you want to invest in acquiring or servicing that segment.