As the saying goes “One man’s trash is another man’s treasure” – not that I’m calling anyone’s customers trash but not every customer is valuable to every business. The trick is to understand why and do what you can to get the most out of all your customers.
So how do you know if a customer is valuable? There are 2 things you first need to define:
1. What is value?
Value is, by definition, the degree of importance that you give something. This can be in a monetary form or the result of some philosophical reasoning. It may be aspects of both. A customer may lose you money but be your biggest brand ambassador, so how much is good PR worth?
2. When is it measured?
Are you interested in how valuable your customer has been to date, or how valuable they will be over the next year? 5 years? 10 years? This is where you can begin to think about a customer’s lifetime value (LTV).
What is LTV?
LTV is built around 2 figures; historical and future value. Historical value, the value of a customer to date, is largely dependent on tenure. Future value, the predicted value of a customer for a future time period, relies on the forecasting of both value and churn.
Calculating historical value is pretty straight forward (I am not going to describe this as easy and if you’ve been involved in cost to serve calculations you’ll know why). It doesn’t however involve any complicated data modelling like that required predicting a customer’s future value.
Future value calculations require a set lifetime – even if you want to look at the “true” lifetime of your customer, some customers are so loyal that retention models predict they will never leave. This highly distorts their LTV; in the real world we know they are never going to live to 500 years old, let alone still be a customer! I suggest a maximum of 5 – 10 years, anything more than this and you’re trying to predict a business and customer that may not resemble that of today.
There are many calculations out there for LTV – as long as you follow the basic structure outlined above, you can build in any business rules you like.
LTV calculation example:
A customer has been with the company for the past 3 years and is worth $180 to date. They have a 12 month retention rate of 75%. Their predicted margin for the next 12 months is $100. I want to determine the maximum future value of this customer over the next 5 years.
This example shows that the maximum predicted value is somewhere between 3 and 4 years. The exact value is $128 over a period of 3.48 years. Taking into account their historical value, this gives the customer a LTV of $308.
So get mining and modelling and calculating! That customer that makes you nothing now could be the tortoise that beats the hare.