BrainTrust Query: Is Customer Lifetime Value a Waste of Time?
Commentary by Mark Price, Managing Partner of M Squared Group
Through a special
arrangement, presented here for discussion is a summary of a current article
from Cultivating Your Customers, the M Squared
Should retailers measure performance based on customer lifetime
value (CLV)? CLV can be useful in certain situations, but I have found that
in many organizations CLV becomes so complex that it is rarely successful.
is a marketing measurement that combines (1) anticipated length of relationship
with (2) anticipated customer financial value (discounted to reflect the net
present value of future cash flows) to create a predicted measure of how profitable
a customer will be.
If a customer were forecast to be retained for five years
with an average spending of $1,000 per year, for example, then their total
value would be $5,000 (in a simple example, where future cash flows are not
discounted). If you add up the calculation for all customers, you would then
be able to value the business as a whole, since the value of a business is
really just the anticipated future profit from its customer base.
far-reaching the impact of CLV could be, it is not surprising to discover the
calculation frequently debated.
- Should an average length of relationship be used, or should the company
spend the time (and money) to do predictive modeling for each individual
- Should you use a customer’s past performance, or use predictive modeling
to forecast future revenue and margin instead?
- Do you use gross profit or net profit and, if it’s net profit, what
are the allocations of corporate expenses? And so on …
You can imagine how political the discussion gets, especially about the allocation
of fixed costs to different business units, customers and marketing programs. Rarely
does a company arrive at a solution that makes everybody happy. As a result,
when CLV is positioned as a corporate performance metric, it is, in fact, rarely
implemented at all. There are just too many vested interests involved. Not
only that, but evaluating performance based on predicted future revenue can
be a tough nut for non-quantitative people to swallow. “How do you know
that the prediction is going to work out that way, anyway,” they might
In fact, using CLV in marketing is the only place I have seen the metric
work. Even then, it requires training of marketing management before it is
CLV is an example of a theme that I have been focusing on recently. The value
of a metric must be driven by how understandable that metric is and what you
can do with the results of the analysis. If it’s not understood and you can’t
figure out what the action is, I recommend that you not do it. For all organizations,
except the most sophisticated, I am afraid that CLV falls in that category
— for now. That may change in the future as predictive modeling and other
statistical techniques become more widely accepted, but for now basic metrics
achieve over 80 percent of the value with less than 20 percent of the work.
Discussion Questions: Is there a feasible way to evaluate the value of
customers — either generically or individually? Do you think customer
value calculations are worth the trouble?