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Making Cents of Customer Lifetime Value

Making Cents of Customer Lifetime Value

If you manage a call center or are responsible for delivering customer services, you undoubtedly have noticed a shift away from simply providing good customer service and a new-found focus for creating great customer experiences.  Well, its not so much of a shift as it is a realization that customer service is a major component of, and driver for, customer experience.

The fundamental reason for this shift is that market power has shifted away from business (sellers) and now rests with customers (buyers).  The Internet has made it incredibly convenient to purchase almost anything from anyone, at any time.  Furthermore, social media has given customers power to inform and influence prospective customers and e-commerce has commoditized many products and leveled traditional advantages brick-and-mortar retailers once enjoyed. 

But what does this have to do with customer service and experience, you ask? Literally everything. Today, its not enough to have the best product.  Today, you must focus everything you do so you can win, create, and retain loyal customers. Focusing on customer experience represents a fundamental shift in business strategy.  The new way to succeed now rests on customer retention and long-term revenue maximization. 

As a result, there is a new metric that business leaders are beginning to employ.  Its called Customer Lifetime Value (CLV).

What is Customer Lifetime Value?

Customer Lifetime Value seeks to quantify the long-term economic value of a customer.  Understanding the CLV for your business is one of the first steps to improving customer service and retention.  It’s also a valuable metric because it complements the many performance and efficiency KPIs to create a more complete view on both the savings and now the revenue a contact center can influence.  More on this a little later.

How to calculate CLV for your business

Calculating CLV can be as easy or difficult as you need it to be.  You can start with a very basic CLV calculation and then improve upon it as needed. The basic approach is to take the average money a customer spends with you during a given period and then multiplying that by the number of years a customer remains a customer.

Here are two examples.

  • Example one: consumer software company.  If we assume our software company offers its software as a subscription-based service, then calculating CLV is easy.  If the annual subscription is $125 a year and a customer will remain a subscriber for 3 years, then the CLV for our software company is $375.
  • Example two: commercial real-estate company.  If the average rent for class-A office space is $18,750 a month, this is 225,000 annually. If most tenants remain a tenant for 5 years, then the CLV for this company is over $1M.

Now these are easy examples just to familiarize you with CLV and how to calculate it.  What if your business model is different?  Not to worry. Here is a simple way to break it down. First, we need to know the average transaction amount (ATA).  To find this out, take your revenue for a fixed period (week, month, year) and divide that by the number of transactions during the same period.  For example, a hospitality business has monthly revenues of $460,000 and 740 guest registrations.  The ATA then is $622.  Here is the calculation.

ATA = 460,000 / 740 = $622

Next, I need to calculate Average Purchase Frequency (APF).  A simple way to calculate this is to take annual revenues and divide by the number of active customers and then divide again by the ATA.  So, if annualized revenue is $5.52M and there are 4,500 active customers and an average stay costs $662 then each customer stayed roughly two times a year.

APF = $5.52M / 4,500 / 622 = 1.97

If a customer patronizes this hotel for ten years, then the CLV for this hospitality business is $12,253

CLV = 1.97 * 622 * 10 = $12,253

Now that I know my CLV, I have a benchmark I can improve against.  I can also quantify the benefit of improving retention, or the opportunity cost of losing customers -- and by extension, know how much I should invest in customer service, experience, and retention measures.

Going beyond basic CLV

The lifetime value received from a customer is important.  But there are other dimensions to CLV that you can also consider.  For example, what is the value to your business of a customer who is a “net promoter”? A net promoter is a customer who will say positive things about your business to someone else.  This word-of-mouth endorsement is very effective at attracting and winning new customers.  While it is beyond the scope of this paper, you can estimate the value of a customer who is a net promoter (and the costs for a customer who is a net detractor).

There is also a “cost avoidance” side to CLV.  For example, retaining customers longer reduces customer churn and lowers sales and marketing costs.  On average, a business will lose roughly 10% of its customer base each year.

 Furthermore, on average, it costs $162 to acquire a new consumer customer (costs can much higher for commercial customers). Going back to our first example, if a business had a CLV of $125 and a customer base of 5,000 customers, then a 10% churn would cost over $62,000 in lost CLV and over $80,000 to replace those lost customers. Customers who report high customer satisfaction (CSAT) scores cost less to service and support. Finally, happier customers are less likely to harm your brand though negative social media posts.  So as you can see, each of these considerations have tangible economic impact.

How customer experience can improve CLV

As illustrated, customer retention is a significant factor for improving CLV.  In fact, customer retention and customer experience are two sides of the same coin.  Any investment in customer experience is an investment in customer retention, and vice versa.   Which brings us full circle back to customer experience.

Here are three things you can do to improve customer service, and by extension, customer experience.

Understand what your customers want and need. 

Surprisingly, most companies believe they do a very good job providing good customer service to their customers.  The problem is most of their customers disagree.   In fact, most customers are so hungry for good customer service that they are willing to pay a premium for it.

So, a good place to start is to understand what your customers need by asking them.  Use customer feedback tools to understand what they value and then build your services around those customer requirements.

Make it easy

Make it easy for customer to engage you and to get the services they want.  Customers’ expectations are growing. Many strongly prefer means other than a phone call to engage.  Gen Z and Millennial generations overwhelmingly prefer SMS chat or social media engagement over voice access.  Many want more after hours and self-help options. One study reported that nearly 70% of those surveyed prefer self-help over live assist.  Finally, most everyone wants immediate and personalized responses, and to have their issues resolved with minimum effort and on the first attempt.

Empower your people

In the end it all comes back to execution.  Do your people have the training, tools, and resources they need to deliver?  Agents need a single workspace to manage voice and digital interactions, access to customer CRM data and access to line of business systems.  Anything short of this adds complexity which diminishes performance.  Managers need tools to help them forecast and manage schedules, identify and deliver needed training, and deliver of clear operational reporting.  Anything short of this requires managers to make decisions based off insufficient data which can lead to costly inefficiencies.

Clearly each of these initiatives require funding.  But here is where the power of knowing your CLV can help.  A business now has an important tool to help determine how much should be spent and how long it will take to achieve payback.

Again, using our software company, here is a simple example.  If this company reduced its customer churn by 2% this represents an annual savings of over $28,000.  If you assume a three-year payback period, this will allow the company to invest nearly $100K in customer experience and retention tools and programs.

Summary

CLV is a valuable metric that measures customer spend and retention.  Any steps taken to improve customer retention and customer spend will improve a business’s financial health.  High CLV can help a business weather an economic downturn as well as accelerate growth during economic expansion.  Understanding CLV can help a business justify programs and resources needed to retain customers and show where savings and increased revenues can pay for improvements.

In short, CLV is the missing link between why (and how much) to invest in customer service, and by extension, customer retention. 

This post is part of a series of posts discussing the imperative small business have for delivering proactive customer service. You can review the entire series beginning with this post - The Small Businesses Imperative for Proactive Customer Service.