Customer Lifetime Value

Customer lifetime value (CLTV) is the present value of the future cash flow attributed to the customer relationship. It projects the total profit from a customer during her lifetime. The CLTV is often used as an upper limit on spending to acquire the customer. If the expected cash flow from the relationship with the acquired customer has a present value of $100, then the firm should spend no more than $100 to acquire that customer. Let me explain:

As you know, we—the average American—change cars every five years. This means we buy on average a minimum of 10 – 12 cars in our lifetime. What would happen if a car dealer recognized this fact and became friends with us? In our lifetime, we would give him approximately $500,000 worth of business (new car purchases, car services, accessories, etc.). 

Carl Sewell realized this fact and built a nearly $1 billion business while running a chain of car dealerships in the southwest. He shared his secrets with the world in his book, Customers For Life: How To Turn That One-Time Buyer Into a Lifetime Customer. It's a fun and to-the-point read.

Now, if that car dealer makes, on average, a 10 percent profit on a deal, then his total cash inflow is $50,000. How much should he spend in acquiring a new customer: $500, $1,000, $1,500? The answer comes from the fact that he is not going to receive $50,000 in a single installment; this money will come over the period of the lifetime of his customer. As we know, because of inflation, a dollar today will be worth only eighty cents in five years. So his $50,000 in the next 60 years—customer lifetime—is only $365 in today’s dollars. Technically speaking, the net present value (NPV) of $50,000 at a 10 percent discount rate is $365, so a dealer should spend no more than $365 to acquire a new customer. If the dealer wants to acquire 100 new customers, then his marketing budget should be about $36,000.

The risk of course is: what if the customer doesn't stick with us for their full lifetime? You can see why businesses become fanatical about providing exceptional customer service. They want to protect their investment and the best way is through exceptional customer service.

By the way, while we are on the subject of customer value, let me tell you that this customer value also plays a major role in a company’s valuation. It appears as customer equity on a company’s balance sheet. That’s why you will find companies with zero or negative revenue but with very high valuation. For example, last year eBay bought Skype—a zero-dollar revenue company—for over a billion dollars because there was a very high customer lifetime value for existing Skype users. Similarly, Microsoft invested $200 million plus in Facebook for less than 10 percent of a share, valuing it as more than a billion dollar company. Facebook revenues were, at that time, non-existant.

Now that you know what the customer lifetime value is, let’s see how to calculate it for your business.

Related:

• Table of Content
• Red Queen Effect – An Introduction
  
• The Billionaire Code
  • Secret of World Class Companies
    
  • Impact of Using Secrets of World Class Companies
    
• Cracking the Code
  
  • Customer Experience
    
  • Customer Engagement Channels
    
  • From Multiple Channels to Integrated Multichannel Selling
    
  • Benefits of Integrated Multichannel Selling Models
    
  • Customer Relationship Lifecycle
  • Integrated Multichannel Selling Models
    
    • Reduced Costs
      
    • Improved margins
      
    • Broader market coverage
    • Rapid revenue growth
      
  • In Conclusion
    
• Implementation Plan
  • Renovation or Innovation?
    
  • Implementation Process
  • Baseline current go-to-market activities
    
  • Protect & Renew
    
    • You've Got Customers. Now What?
      
    • Net Promoter Score
      
    • Customer Profitability – A look from inside
      
    • Finding Treasures