Customer Life Time Value

Jörg Ladner, 2020, info@subscription-economy.de

When I read in Anne Janzer’s book “Subscription Marketing” (2nd edition, CPC, Mountain View CA, 2017) about strategies in relationship marketing for the subscription economy, it struck me again how much importance mathematics has gained in marketing. In times of marketing automation this is actually a self-evident insight. But for me as a salesperson, marketing has always been more of an art than a planned action. However, the evaluation of our existing customer data is not a phenomenon of digitalization or the subscription economy. Stone and Shaw already describe analytical methods for marketing in their 1988 book “Database Marketing” (Gower Publishing, London, 1988). The Subscription Economy is not based on the sale but on the subscription of goods and services. It is therefore obvious that it uses different key performance indices to evaluate the business facts. In the subscription economy, the assessment of annual or multi-year economic benefits has become more important than the consideration of individual transactions. One of these key performance indices is the (also not new) Customer Life Time Value (CLTV).

The importance of CLTV lies in the evaluation of the contribution of customer management initiatives to increased profitability and the economic well-being of a company. The CLTV is not a statistical value but a prognostic value. It is a prediction of the profitability of a customer, a customer segment or our customer base. Past and future, incoming and outgoing cash flows are included in the calculation:

  • Marketing and sales costs of customer acquisition
  • Customer-specific costs for the provision of products and services
  • Marketing and selling expenses for customer retention and up-selling
  • Revenue

and data on customer behaviour

  • Customer Retention or Churn Rate
  • Time gap between orders
  • etc

CLTV is the concrete monetary valuation of customer relationships. It summarizes the profit & loss statement.

The components of the CLTV help us to understand which strategies and tactics have an impact on our client relationship and on increasing the CLTV:

  • How much can we invest in the acquisition?
  • What effort can we put into customer retention?
  • What is the Return on Marketing Invest?
  • Which marketing measures are successful?
  • Which cost reductions are possible?
  • What influence do competitors and other external influences have?
  • What contribution do individual customers and customer groups make to profit?
  • How are order size and order frequency distributed?
  • What influence do customer retention and churn rate have on customer base, turnover and profit?
  • How do customers perceive the economic value of our offer?
  • How do we compare with our competitors?

The CLTV also answers the question of the viability of the offer. David Skok’s interpretation of the CLTV has become established in the literature (e.g. Warrillow, John: The Automatic Customer, Penguin Random House, UK, 3rd edition 2016). According to Skok, if an offer is economically viable, the CLTV is at least three times higher than the customer acquisition cost (CAC). Particularly successful bids have a CLTV:CAC ratio of 8 or greater.

Investors are also interested in customer life time value. After all, it is a barometer of return for them: “What factor is multiplied by every euro invested in a company?

So is increasing CLTV the strategy for corporate growth? If a company’s growth strategy is based on CLTV, it follows one of two tactics:

  • The maximum exploitation of the upselling potential of the customer base
  • Concentration on the acquisition of new customers while reducing marketing and sales costs per new customer

The disadvantages are obvious: in the first case we “squeeze” every possible Euro out of the customer and in the other we neglect our customer base. Both lead to dissatisfaction and the possible migration of customers. In the subscription economy, however, customer loyalty and the quality of the customer relationship are the most important assets. Customers have a keen sense of whether sellers are only interested in their money or whether a mutually beneficial business relationship is also being sought. The perceived and real economic value of the offer by the customer must be so high that a change of supplier is not considered. Therefore, any CLTV-oriented growth strategy will have to be subordinated to the maintenance of a positive customer relationship.

In the analogue and digital media, there is a multitude of more or less complex formulas for calculating CLTV. Regardless of which formula is used for the calculation, we need information about the payment flows and the behaviour of our customers. The probability that the CLTV will result in a correct forecast therefore depends strongly on the available database. For start-ups or companies from the “classical” economy, which enter the subscription economy with an offer, the calculation of a realistic CLTV is not possible due to the small data basis. In this case I would like to refer to David Skok’s article from 2016 “What’s your TRUE customer lifetime value (LTV)? – DCF provides the answer” (https://www.forentrepreneurs.com/ltv/, December 2019)

As with any other formula, the quality of the data used influences the calculation result. Poor data gives a poor result. Data maintenance is a permanent task. The same applies to data selection. In a segmented customer base, the customer groups should be analyzed individually. Only then can meaningful CLTVs be calculated.

Here is a sample calculation:

Note: In this example I consider one (1!) customer. I use a simple formula that takes into account the three main variables for calculating the CLTV:

  • Turnover: How much turnover does a customer generate in each period (monthly, annually)?
  • Margin: How much remains after deducting the costs for customer care?
  • Churn: What is the probability that a customer will quit?

Depending on the industry, the composition of the direct costs and the amount of revenue naturally varies.

The customer pays 1.200€ in the first year of use.
Through additional bookings, the turnover grows by 15% annually. On average, customers stay with the offer for five years. These sales figures result (in €):

year 12345 total
revenue 1.2001.3801.5871.8252.0988.090

The unit costs for the first year are as follows:

  • New customer acquisition (marketing and sales) 800€
  • External products and services for the initialization of the offer 400€
year1 2 3 4 5 total
revenue1.2001.3801.587 1.825 2.0988.090
aquisition800         800
initialization400         400

Direct costs after the first year

  • External products and services for the operation of the offer 350€
year1 2 3 4 5 total
revenue1.2001.3801.587 1.825 2.0988.090
aquisition800         800
initialization400         400
operations3503503503501.400

Other direct costs in all years for

  • Marketing (up-selling and conservation) 240€
  • Customer service (hotline, etc.) 340€
year1 2 3 4 5 total
revenue1.2001.3801.587 1.825 2.0988.090
aquisition800         800
initialization400         400
operations3503503503501.400
marketing2402402402402401.200
customer service3503503503503501.700

Now we add the line for the profit/loss analysis:

year1 2 3 4 5 total
revenue1.2001.3801.587 1.825 2.0988.090
aquisition800         800
initialization400         400
operations3503503503501.400
marketing2402402402402401.200
customer service3503503503503501.700
profit / loss-5804506578951.1682.590

The first year ends with a loss. The investment in the customer is higher than the subscription turnover achieved. Reasons are the costs for customer acquisition and for the realization of the offer at the customer. A balance sheet situation that is not uncommon for some industries and offers in the first year. If we are unable to reduce costs, the only option would be to increase the subscription price. Is the offer then still competitive or does it correspond to the economic value for the customer? In the years 2 to 5 the offer generates positive numbers and at the end of the 5 year period the CLTV is 2.590€. The CLTV:CAC ratio is 3.23. The offer is above Skok´s limit for a viable offer. Nevertheless, it seems that there is still much room for improvement.

In two sentences: The CLTV is a key figure for evaluating the return on investment of our marketing and sales activities. It helps to answer the question of where we should invest effort and resources.