How to determine Lifetime Customer Value

I’ve mentioned Lifetime Customer Value (LCV) in several previous posts. Subsequent discussions around the topic of LCV indicated that while many people talk about it, few actually know the information for their business. Seems that there are perceptions about lack of data, complexity, calculation formula, etc. that get in the way of determining LCV. There’s tremendous value in going through the process and determining LCV for your business. Keep it simple to start, then refine and improve data and calculations over time.

You can find many LCV calculation models on the Internet. For the purposes of this discussion, we’ll use this simplified model I developed:This post will focus on the model and mechanics for calculating LCV using this simplified example. I’ll review analysis and usage in next couple of posts. The following bullet numbers refer to the subscript numbers in the first column of the spreadsheet image above:

1. Unless you only sell one type of product/service/solution to one market segment, you should do LCV calculations by customer or market segment – this will provide much better information and insights to make good strategic decisions. LCV information averaged over all customers in a multi-segment business tends to obscure the nuggets that can make a huge difference.
2. The number of new customers in that customer or market segment acquired in a recent year.
3. What percentage remain active customers in each subsequent year (year over year %).
4. Calculated from the initial number of new customers and subsequent retention rates.
5. Total product/service/solution revenues from these customers each year. Year 1 is when they initially buy, subsequent years are additional purchases.
6. If applicable, the annual license/maintenance/service/support/hosting/etc. fees the retained customers pay.
7. Divide total annual revenue by number of retained customers for each year.
8. Cumulative total revenue divided by initial number of customers. This reflects the LCV in Revenue terms for each customer. In this example each of the initial 1,000 customers that produce $12,000 in revenue in year 1 from the initial sale, produce $18,253 in revenue over 3 years and $22,603 over 5 years.
9. Your total sales costs for acquiring the customers in year 1 and additional purchases in subsequent years.
10. Your total marketing costs for acquiring the customers in year 1 and additional purchases in subsequent years.
11. Your cost of goods sold (COGS) – this example uses a 25% of revenue flat rate.
12. The costs for retaining customers and generating continuity sales(6) – such as support, product updates, services, etc.
13. Total revenue minus total costs.
14. Cumulative gross profit divided by initial number of customers. This reflects the LCV in Profitability terms for each customer. In this example each of the initial 1,000 customers that produce $2,500 in gross profit in year 1 from the initial sale, produce $5,505 in gross profit over 3 years and $7,587 over 5 years.

For added financial accuracy, the Revenue and Profit LCV over the extended period should be calculated in Net Present Value (NPV) using the discount rate (based on prevailing interest rates and risk) to calculate future revenue and profits in today’s value of money. For simplicity, NPV is not included in this example. The time span for calculating LCV should be based on your typical customer life cycle longevity.

What analyses and insights can you glean from this Lifetime Customer Value example that would be beneficial to know in you business?

The next post in this series reviews some of the insights that can be determined from LCV calculations.

Your comments are always welcome.
Copyright © 2009 The Marketing Mélange and Ingistics LLC. http://marketing.infocat.com