Unit 38 LO1 Demonstrate an understanding of the concept of customer lifetime value, how to calculate it, and the different factors that influence it-BTEC-HND-Level 4 & 5

Course: Pearson BTEC Levels 4 and 5 Higher Nationals in Business

In this article, I am going to demonstrate an understanding of the concept of customer lifetime value. Customer lifetime value is determined by how much a customer spends over their lifespan and how many times they spend with your company. It is important to understand that there are different factors that influence CLV such as age, gender, location, product category purchase history among others. These factors should be taken into consideration when marketing products or services in order to increase profitability.

I will be discussing some of these influencing factors and what you can do in terms of marketing to increase CLV for your business.

An important influencing factor is the location of the customer. For example, if you run a bar or nightclub in an urban area, there are more customers in that vicinity as opposed to say buying a business in a rural area where fewer people will purchase your service.

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Also Read: Evaluate the different segments in a customer base and the appropriate opportunities for customer value creation

Traditional concepts of marketing compared with those of value and retention

Customer value, satisfaction, and retention

Customer value:

The concept of customer value is based on the analysis of the needs and wants of a customer. The needs and wants have to be analyzed in order to be able to meet these needs and wants.

The key to creating customer value is to provide a solution that meets the customers’ needs, which will then result in them buying your product or service.

Customer value is the sum of the value that a customer receives from using a product or service. Value can be measured in one of two ways:

  1. Intrinsic Value: This is the value that a customer perceives in using the product or service.  Examples include increased safety, comfort, convenience, entertainment, and freedom from worry while driving.
  2. Instrumental Value: This is a value that customers receive from using the product or service as a means to achieve some other goal. Examples include saving money on gas and maintenance costs, getting to work faster, attending school or work more efficiently, and avoiding traffic jams.

Customer satisfaction:

The concept of customer satisfaction is based on the analysis of how customers feel about a product or service. A customer may be satisfied with a particular product or service if it meets their needs and wants. Customer satisfaction is the degree to which customers are satisfied with the products and services they buy, use, and/or experience.

Customer satisfaction is the extent to which customers are pleased or content with the brand of a company. It has been defined as “the degree to which people are happy with a brand, its reputation, its performance, its operations, and its products.”

Satisfaction can be measured in two ways:

  1. Subjective Satisfaction: This measure is obtained by asking customers to describe how satisfied they are with their purchase, service, or experience.
  2. Objective Satisfaction: This measure is obtained by asking customers to rate a product or service on a number of criteria, such as quality, value, safety, and reliability.

Customer retention:

Customer retention is the measure of how often customers return to a brand. It is closely related to customer satisfaction but measures the extent to which customers continue their relationship with a brand after they have purchased it.

Customer retention is the amount of time that a customer remains a customer of a company or product. It has been defined as “the proportion of people who initially used the service, product or brand and continue using it.”

Retention rates can be measured in two ways:

  1. Purchase Retention: This measure is obtained by asking customers about their intention to purchase similar products or services in the future.
  2. Revenue Retention: This measure is obtained by measuring how much money a company keeps after subtracting out expenses.

Customer retention is a key strategy for organizations seeking to grow their business by increasing customer lifetime value (CLV). Retention is a key marketing strategy that decreases the cost of acquiring a customer and increases the profitability of the customer. The key elements to retention are:

  1. Customer Satisfaction
  2. Customer Loyalty
  3. Customer Engagement
  4. Repeat Purchase (retention)
  5. Product Portability (transferability)
  6. Product Performance & Value (value proposition)
  7. Service Quality & Reliability (delivery)
  8. Ease of Use for Customers (ease of use for businesses and employees, too)

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Customer Lifetime Values (CLVs)

Customer Lifetime Value is typically cited as a percentage of the customer’s revenue. But it can be shown that CLV is actually the (mortgage) value of all future payments in present value terms.

Thus, for example, if you’re thinking about giving a 20 percent discount to a customer today and assuming this will make them more likely to buy from you later on, then for every dollar less they are paying now, customer lifetime value will actually go up by $1 in future when they become clients because instead of receiving $100 now they’ll only have to pay $80. The principle behind this is that money has an interest-equivalent earned each year over time and this amount increases with inflation since interest rates are usually higher than inflation.

Merits of CLVs

Customer Lifetime Value (CLV) is a metric that estimates the lifetime value of a single customer to your business. This number takes into account the cross-selling opportunities with existing customers as well as any potential future revenue from them. Completing an accurate CLV calculation requires some detailed analysis and data capture in order to work out all the variables accurately.

For example, how much will this customer spend over his lifetime? Will he buy more than one product or service? And so on.

The main benefit of completing such a calculation is you can calculate which products/services should be prioritized for investment with your current resources given the potential return on investment they offer. Furthermore, it provides decision-makers and marketing managers with hard data that supports investment in customer retention and acquisition, which is a great way to increase revenue.

Value of customer data

Customer data is a cost of doing business. A customer will always have some way to spend their money – so the company should take advantage and reinvest in the customer’s data to grow profits and revenue from other sources than just this one customer.

We drive traffic through strategized Marketing initiatives like PPC, SEO, social media, PR… If only 10% of my customers convert via all these efforts then I still need those customers otherwise it would be with great effort with no reward. You could ask why build relationships? The objective is broader than that; the primary goal is a lifetime value relationship-based company that moves our product or service downstream (adds more offerings or sells higher-priced services for instance).

Measurement and analysis of CLVs

A Customer Lifetime Value (CLV) is the value of all profits a customer has generated for your company since they became a customer, minus any costs spent in acquiring them. This is also often defined as the “existing customers’ lifetime worth”. A Company Lifetime Value (CLV) is the total value of all profits made by your company during its existence. It can be thought of as ‘the discounted sum of all future CLVs’.

The easiest case to understand would be a single item that generates $100 in revenue today, and does not require any maintenance or additional input from you: it will make 100 profit for 1 year. If you calculate the present cost to generate this profit– say flipping an item on eBay at a 10% cut, it will require $90 in gross revenue to pull this off; that’s your cost.

How to calculate and increase your customer lifetime value:

Determining your customer acquisition costs, repeat transactions, and customer retention rate

Customer acquisition costs, or CAC, are the expenses associated with acquiring new customers.

A high repeat transactions rate is crucial to determining a sustainable business model. Repeat transactions are how businesses typically calculate customer lifetime value (CLTV) and they give a clearer picture of the long-term profitability and sustainability of your customer base. Every e-commerce store owner should closely monitor their sales conversion rates – which can be tracked in Google Analytics – and set up goals for themselves that they want to hit by the end of the week so they know where these two metrics stand in less than five minutes after logging into their accounts.

Customer retention rate is a major factor in determining business viability and should be closely monitored by e-commerce store owners. It is determined by the proportion of customers who make repeat purchases, the average value of those transactions, and how often they make them.

The formula for calculating customer retention rate is:

Customer Retention Rate = Net New Customers / (Net New Customers + Existing Customers)

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Calculations applied to calculate the customer lifetime value

To calculate your customer lifetime value, you will need to look at the following considerations:

  • Number of repeat purchasers in a given year
  • Value of purchase for each repeat purchaser in a given year
  • Total spends from annual purchases by all purchasers over time.

This calculation is highly dependent on the type of business and also the number of customers coming back every year.

For example, Joe’s Chili Parlor would more closely focus on calculating their average yearly spending instead of solely basing customer lifetime value off one visit. But let’s say that we are measuring Joe’s Chili Parlor against Apple as an example; Apple would still be able to make this assessment from some perspective.

A few key points to remember is that surveys are typically used for data collection, which means they need to have a large sample size. It’s also important to pay attention to the time frame allocated in collecting this data.

Creating balance in the business model

There are many things that will affect the balance equation for any given business. The two most important factors are the revenue comparison between profit and loss, as well as the time in which they happen. The purpose of income is to create an equilibrium, so when five days have elapsed from a single day with a $500 unfavorable variance and no stagnant days in between, then this creates a new operating factor of 7%.

If fifty more days show up with an average loss of $800 each time where there are still no idle periods in-between, then the next month should be even worse because it would be now 65% lower. However, if there were 100 consecutive profitable times amongst those losses for varying amounts ranging from $200 to $400, then this month would be a positive variance of 10% which means that the next one should show even more profit than what was expected when looking at the numbers. This is because now we have an average result of $900 with 50 consecutive times where this happened.

Factors influencing CLVs:

CLVs within both B2C and B2B contexts

It’s fascinating that the CLV of a company (B2C) is interpreted in both a way beneficial to the company and harmful to the customer. However, it’s both unavoidable and advantageous for companies themselves (B2C).

The average CLV can be compared as if every B2C customer were on an airline with loyalty pricing – many business people fly often because they know that price points vary based on how long ago or often you last flew.

This is also why different businesses have different CLVs in terms of time frames such as annually or monthly, etc. It costs more per flight each year to fly using annual pricing than it would if you bought flights one at a time, yet people don’t mind because annual pricing is ultimately cheaper than buying flights one at a time. The same applies to businesses, as each business has different prices depending on what “kind” of business it is and how often that customer buys from the company.

Customer experience and how it can affect CLVs

Customer experience is a term that encompasses all the interactions between customers and companies. Every time a customer shops at a store chats with someone on the phone or sends an email from their computer, they are generating an experience for themselves.

Communication can be difficult to manage in a corporate environment because although every employee (chains down) is providing part of the customer’s experience, it’s not always clear who at each point in the company hierarchy should be responsible for making sure communication works smoothly among departments.

For example, if retail employees decide to cross-train and provide tech support when no technicians are available then there will likely be huge gaps between the expected service level provided by these two teams suddenly left alone together.

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