The Value of Determining Customer Lifetime Value

You’ve no doubt heard again and again that your customers are valuable. But do you know just how valuable they are? Can you define how profitable each customer, or each customer segment, is? Value, after all, cannot be measured simply by the revenue a customer generates for your company. It must also include an evaluation of the costs of acquiring, supporting and selling to that customer, says Tom Sweeny, director of research for the Service & Support Professionals Association (SSPA). It takes some effort, but once you understand these factors you’ll be well on your way to determining the value of a customer relationship, which in turn will help you better form strategies to maximize those relationships.

The concept of customer lifetime value (LTV) is the backbone of Sweeny’s latest study, “Customer Retention: Maximizing the Lifetime Value of the Customer Relationship.” LTV is important to understand, says Sweeny, because “it allows companies to look beyond the big sales and understand the financial value of the relationship.” To begin determining LTV companies must look at both the revenues a customer generates each year and the cost variables, such as acquisition costs, support and maintenance costs and account management costs. For example, in one customer relationship Sweeny analyzed the customer generated $12,940 in revenue during five years. Generating that revenue cost the company $7,795. The resulting margin of 39.8%, says Sweeny, indicates a profitable relationship.

Performing these calculations is important for a number of reasons. For starters, you might begin to see trends among certain customer segments that will help you to allocate resources to those groups accordingly. You might find, for example, that there’s a small and relatively ignored segment of customers that generates steady revenue year after year with great margins. They might not be your million dollar accounts, but ultimately they could be more valuable than your million dollar accounts and should be handled accordingly. Or you might discover a segment of customers that is highly profitable, but has very short relationships with your company – a discovery that opens the door to figuring out how you can lengthen those relationships. Once you begin to track all the historical data needed to calculate LTV, you’ll be better able to predict the behavior of similar customers in the future.

“The point is that once you begin the analysis,” says Sweeny, “you then can begin to formulate action plans to maximize the lifetime value of the customer relationships.”

For more information, visit SSPA’s Website at www.thesspa.com.