This is the third of a four-part series on the North Star goals that set category leaders apart from their peers. You can find Part 1 (one-to-one, omnichannel personalization) here and Part 2 (first-party customer view) here.
Sales and marketing professionals understand the continual pressure to reach and convert new customers to a product or service and how easier it is to keep a happy customer than win new ones.
It seems that brands are starting to take this to heart in a big way, so much so that according to Reuters, “lifetime value” is Silicon Valley’s next buzzword. Today, the marketing technology industry focuses on providing solutions for leading brands to measure and capture greater customer value over the long term.
In this third article in a four-part series, I will discuss why brands must adopt a customer lifetime value model as one of their primary organizational KPIs and the importance of creating long-term, loyal customers over continual customer churn from dissatisfied customers.
What is a customer lifetime value model and how is it calculated?
Let’s begin by making sure we have a good understanding of what exactly a customer lifetime value (CLV) model is.
While the name is descriptive, what we are doing is understanding the total potential value that an individual customer can bring to our organization once we acquire them.
This goes well beyond an initial sale and many organizations invest quite a bit in acquiring a customer — in some cases losing money on an initial acquisition — to generate a lot of value over the long term.
There are quite a few different methods to calculate CLV, but a (relatively) straightforward method is the formula below:
For each of those terms in the equation above, here’s a definition:
- Purchase frequency (PF): How often the average customer buys your product or service. Choose a measurement for frequency that makes sense for your business. For instance, a car manufacturer and a quick service restaurant will have different time frequencies that make sense. The former might be in years and the latter in weeks.
- Average order value (AOV): The average amount a customer spends with your brand when they make a purchase based on the total value of purchases by new and existing customers.
- Gross margin (GM): This helps you calculate your profit on each order and gets to a much more accurate number than simply using the average order value (AOV) to measure how much you make from the average customer. Gross margin is calculated as the total sales revenue minus the cost of goods sold (COGS) divided by total sales revenue.
- Customer lifespan (CL): This is the average amount of time a customer continues buying your products and services. Again, make this in the same unit of measurement as your purchase frequency (weeks, months, years).
- Number of new customers: This is the number of new customers you gain within the same unit of frequency chosen for purchase frequency and customer lifespan.
Beyond the mere calculation of CLV, an organization must embrace the total value a customer can bring as a factor in strategic planning, culture and key performance indicators (KPIs) that drive decisions.
Dig deeper: The one martech metric that really matters: Customer lifetime value
How does a CLV model change a company’s goals?
You’d be hard-pressed to find a successful organization that doesn’t value a long-term customer. But there is a big difference between simply wanting to create a great customer experience and actually delivering on it so that your customers buy more often and refer others to the brand.
To embrace a customer lifetime value model is to shift the strategy and direction in several key areas. Let’s discuss three of these, though I’ll admit there can be many other benefits in addition to the ones below.
Organizational KPIs become aligned with customer success
The first thing that adopting a customer lifetime value model as a strategic KPI changes about your company’s goals is that it makes it very clear that customer success equals business success.
While short-term sales and revenue goals will always be important, when CLV is recognized and adopted as a primary goal, teams and initiatives prioritizing long-term customer success gain more latitude to treat customers well to build loyalty and grow their value over time.
Acquisition and retention goals gain greater alignment
If there is any friction between sales, marketing and customer service or support within your organization, you are likely experiencing a conflict between the need to acquire new customers and the need to retain them.
When a customer lifetime value model is embraced as a primary KPI, it becomes necessary that the quality of leads be such that new customers become lifetime ones.
While this may already be a goal of all teams, it is easy to compromise to get some net new customers simply “in the door” to hit a sales quota or marketing target.
When customers who are not good fits for your products and services are no longer prioritized, you can focus more on high-quality potential lifetime customers.
Attribution models become more holistic and multi-touch
The last example I’ll provide here has to do with how you measure the effectiveness of your marketing.
If you’re accounting attribution for only new customer acquisition, you will only look at a subset of the channels that both new and existing customers are exposed to.
When looking at a customer lifetime value model, you aren’t just looking at attribution models for which channels contribute to an initial sale. You will now look at:
- What contributes to building a good foundation initially.
- What channels contribute to keeping that customer engaged and loyal.
In the best scenario, this also means that you would be switching from a first- or last-touch attribution model — giving the “win” for a conversion to either the first or last channel that an audience member saw or interacted with — to a multi-touch attribution model, that can give “credit” to all of the channels that a customer interacted with throughout their journey.
Doing this is no small feat, particularly for large and complex marketing programs, but can be extremely beneficial in helping to maximize ad spending and understanding what points of interaction your customers find most valuable so they can be prioritized.
And, of course, not all of your customers are exactly the same either. Some will find specific channels more valuable and prefer them over others so this is not a one size fits all approach, either.
Focusing on the long-term value that you provide to your customers and what your customers provide to your business can reap many benefits, though it does require a commitment from many parts of the organization to hold true to this as a principle.
Dig deeper: Marketing attribution: What it is, and how it identifies vital customer touchpoints
Making CLV happen
So, while all of this sounds great, you might be thinking to yourself that this would be next to impossible in your own organization for one of many reasons. These could include:
- Silos that prevent data from being tracked and followed.
- Teams that don’t share acquisition or sales data with one another.
A lack of a common taxonomy to reconcile activities across departments, product lines, or divisions.
- Or any myriad of other issues.
To this, I say that doing this all at once may be difficult, but that doesn’t make it a worthwhile endeavor. As with most important initiatives, you need to start somewhere, so figure out what you have and build from there. An iterative approach with a minimum viable product (MVP) approach in mind can go a long way.
In the case of a customer lifetime value model, an MVP may be a lifetime view of the customer but with slightly less accuracy or fidelity, which can grow over time. Alternatively, it could be that you build out CLV across a subset of overlapping products and services.
If you are truly starting at square one, you may need to ensure that the individual building blocks of the CLV calculation can be built and measured one by one. The important thing is to start somewhere!
In the next article, I will discuss the fourth and last North Star goal, which sets the foundation for all the work done in an organization. This is the culture of the organization, wherein the goal is to be agile and customer-centric in all things. We’ll see why this is important and why this is good for both customers and employees.
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