I have been curious about customer lifetime value (CLTV) for a while now.
I (somewhat*) understand the math and appreciate the attempt to quantify a customer’s value in order to determine how to expend effort accordingly; it is the fact that I have never seen it used in practice to affect business is what intrigues me.
If it is that critical for business, why have I seen no one using it?
Customer Lifetime Value
Customer lifetime value is a marketing construct created to predict “the net profit of the entire future relationship with a customer”.
The notion being that CLTV encourages companies to think about the long-term health of their customer relationships, not just on quarterly profits, and that this information provides guidance on how much a company should spend on these relationships.
The problem I see with CLTV (assuming the models used are the ones easy enough for companies to calculate) is that it either averages out the lifetime value across the customer base or it tries to predict a value for each type of customer using an aggregated retention rate.
That is, either all customers have the same lifetime value or the varying, individual values, calculated with an average retention rate, are not truly exact for that customer.
If CLTV was meant to provide specific insights per customer, then it misses the mark.
If the objective is to know, on average, what should be spent on customers then fine, however this information does not help provide guidance on the ends of the customer spectrum potentially misleading companies into under or over servicing some of its segments.
What is a customer worth then?
And should this be the way to focus operations’ efforts?
Ultimately a customer is worth what they pay you in aggregate minus what you spend to acquire, retain and expand them (and this is only ever truly known at the end of the relationship).
The problem is that companies focus more on the pay than the spend part, yet the latter is the only component the company has complete control over.
Rather than calculate a CLTV and holding (or spending) to that average threshold hoping it does not go over the customer’s predicted value, I prefer companies to determine what its customer’s need to be successful and how to deliver that as efficiently as possible (continually for a cost less than what they are paying).
In other words, drive effort so the customer is successful and the company is profitable over the course of the customer journey.
Bottom Line: How to be Profitable
Customer lifetime value is an informative metric that can be used to categorize customers and provide guidance on effort expenditure.
But it has limitations which if not considered may falsely direct the business into over or under servicing its customers based on revenue prediction.
A customer is worth more when they adopt faster and use regularly, and when they get the assistance they need quickly and before they experience problems.
Understanding what customers need to be successful and then aligning operations to deliver that in an efficient manner making adoption, usage and expansion seamless is the surest way to the highest value, longest lifetime customers.