Why is CLV important in customer analysis

Customer Lifetime Value - on the trail of customer value

Dorothea Heymann-Reder September 05, 2017 3993 views
The Customer Lifetime Value (CLV) describes the contribution marginthat a customer provides for a company during the entire business relationship (customer life cycle), discounted to the respective point in time. Put simply, it expresses the value that a customer has for a company on average over their entire customer existence. Discounted means that the pro rata value of future payments by the customer is included. The result is the present value of the customer relationship. Discounting is a somewhat complex calculation that was discussed in an article by Dr. Rainer Hastedt is explained in more detail. For the sake of simplicity, it is neglected in our further explanations. The contribution margin is the difference between the revenues and the attributable variable costs of the customer relationship. It should cover the fixed costs and also generate income for the company.

The sense of customer lifetime value

The CLV considers your investments in customers in relation to the return that these investments generate. It provides information about the ROI (Return on Investment) of your marketing, sales and customer management measures. The point is of course to optimize your measures and focus on the most profitable target groups possible.

Requirements for the customer lifetime value consideration

To get meaningful numbers, you need differentiated data. It is not enough to divide the costs of marketing plus sales plus customer care by the total income from all customer relationships. This number does not give you any insight into your corporate management. You should therefore include at least two dimensions in your consideration:

Customer Lifetime Value according to phases of the customer lifecycle

The following phases of the customer lifecycle and your investments in them should be analyzed:

Initiation

How high are your marketing investments and what is their effect? This phase includes campaigns, advertising measures, lead generation and the qualification of the contacts gained through to handover to sales.

Sales support

How high are your sales investments and what effect do they have? This phase includes more intensive, more individual support for the contacts gained, right through to the offer and the closing costs.

Customer care

What are the costs of service, support and individual customer care after the deal? In this phase, a contribution margin calculation is also possible for the first time. As the customer relationship matures, you can also expand it and realize cross-selling potential.

Customer lifetime value according to target groups

Even if you know your effort in the above phases, it will not help you if you cannot analyze customer groups or, depending on the business model, ideally also individual customers. Therefore the customer groups or segments are the second important dimension of your CLV calculations. The following segmentation criteria could help you:

ABC customer segments

The ABC customer analysis is based on the Pareto principle. According to this, the 20% customers with the highest turnover are A customers, the 20% customers with the weakest turnover are C customers and the remaining B customers. This “rule of thumb” can of course have different percentages in your business environment.

Customer portfolio

The portfolio approach from the financial sector works as follows:
High customer benefitLittle customer benefit
Great value to businessesStarsQuestion mark
Low value to businessFree ridersPoor dogs
 
  • Stars - have a lot of added value from the company's products, are loyal and bring the company a lot of income. It is a win-win situation.
  • Poor dogs - have little added value from the company's products and generate little income for the company. You shouldn't invest a lot in customer loyalty.
  • Question mark - have little added value from the company's products, but generate a lot of income for the company. It pays to develop better products for them so that they don't migrate to the competition.
  • Free riders - have a lot of added value from the company's products, but bring it little profit. This can e.g. B. Large companies that use their purchasing power with the suppliers. Here the company could try to raise prices or lower the level of service.

Scoring models

Here you assign points to the segmentation criteria relevant to you in order to weight them. The more points a customer or target group has overall, the more valuable he or she is to your company. Instead of segmentation criteria, a scoring model can also consider and weight transactions with customers.

Requirement for the calculation of the customer lifetime value

In order to be able to calculate the CLV, you need the following data:
  • Your marketing, sales and customer care costs.
  • A breakdown of these costs into variable and fixed costs.
  • A breakdown of these costs by customer groups, segments, lines of business.
  • Incoming and outgoing flows from the customer relationship, target group, product group, etc.
  • Ways to break down and compare this data by period.
  • Ideally, a contribution margin calculation integrated into your CRM.
Armed in this way, you can not only determine customer value, but also obtain valuable information about the ROI of your marketing, sales and customer loyalty measures.

The entire customer lifecycle in one software

You won't find much of this data in a traditional CRM. No incoming and outgoing flows are recorded here. And the contribution margin accounting is also an impossibility without access to cost and performance accounting. Many companies therefore make do with Excel evaluations. However, these have the disadvantage that they are fed from an incomplete and inconsistent database. Some values ​​are not available at all, others in three different versions. So the evaluation stands on clayey feet right from the start. The solution to this dilemma is an integrated company software that aggregates and evaluates data from different company areas over the entire customer lifecycle. If marketing, sales, customer care, projects and finances are integrated in a uniform, consistent database, meaningful analyzes can also be created across departmental boundaries. Software like Scopevisio is also so flexible that processes from almost all industries can be mapped in it.

CLV model in the B2C area

Suppose an average customer buys a new coffee machine worth 100 euros every four years. The contribution margin is 40 euros. Over the course of 20 years, the manufacturer earns a customer value of 200 euros.

Problem

This model calculation raises many questions at first glance.
  1. Customer loyalty in the consumer goods sector has been declining for a long time. Today, no consumer goods manufacturer can simply rely on a customer to buy their coffee machines only from them for twenty years.
  2. Second point on the topic of buying behavior: The demands are increasing, the product life cycle is decreasing. If a customer bought a new model every four years in the past, they may buy one every three or two years in the future.
  3. In addition, he will hopefully opt for a more expensive model, as purchasing power increases with age. Or he switches to tea and in the future buys a kettle or leaves the customer altogether.
  4. The cross-selling potential is not included. If the customer is satisfied with the coffee machine, they may also purchase other household appliances from the same manufacturer. His customer value increases dramatically.
  5. With so much satisfaction, he might make recommendations and attract more customers. This is also an increase in value that is difficult to quantify with the CLV.
  6. The model calculation does not take into account any changes in the revenue and cost structure or in the market. Perhaps in a few years production will be much cheaper and the contribution margin will increase accordingly.
  7. Or the trend is turning - greed is cool - and only cheap products with a low profit margin are in demand.
  8. Economic or demographic developments as well as Internet offers influence purchasing behavior, and, and, and ...
This shows that calculating the CLV over a long period of time is all too theoretical. In the B2C area, long-term forecasts of future customer value are fraught with extreme uncertainty.

Customer Lifetime Value in B2B

In the B2B sector, long-term customer relationships are more the rule. The more complex and individual the product or service, the greater the chance that the customer once won will remain loyal. But even here it happens that customers change providers. The reason is not always the price. Better service, higher quality products, greater physical proximity, personal sympathy or antipathy, changes in staff, business policy or strategy can be the decisive factor in ending a long-term customer relationship. The competition never sleeps. However, providers have ways of reducing churn: Long-term service contracts and active customer support have proven their worth as measures for customer loyalty. However, these cost money. So the provider should always keep the contribution margin of the customer relationship in mind in order to decide whether the investment in the customer is worthwhile.

Model calculation for rental models

The easiest way to quantify the CLV is to offer services with a rental model. Suppose you offer software-as-a-service. An average customer brings in sales of 1,000 euros per month. The contribution margin after deducting the attributable variable costs is 500 euros and the business relationships extend over at least five years. Then the customer value (without discounting) would be on average 30,000 euros over the entire period.

Conclusion

The customer lifetime value is a very theoretical value. Depending on the industry, it is difficult to predict the long-term value of a customer relationship. In B2B business this is more possible than in B2C, although here too the predictions are very uncertain. Nevertheless, the consideration of customer value is extremely important for companies. Analytical CRM systems are now able to neatly segment customer groups and to focus marketing and sales measures. The better the database, the greater the analytical potential. Incoming and outgoing flows, for example, are not recorded by a traditional CRM. Contribution margin accounting is not possible without access to cost and performance accounting. The solution is an integrated company software that aggregates and evaluates data from different company areas over the entire customer lifecycle.

Dorothea Heymann-Reder

Dorothea Heymann-Reder writes blog posts, advice articles and white papers. Her specialist articles deal with commercial and business issues as well as the entire spectrum of digitization.

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