Customer Lifetime Value

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The company needs to determine the level at which it should acquire new customers. A good business plan focuses on having multiple jobs from one customer. When a company loses a customer, it not only loses its existing revenue but also has to find a new customer.

The total amount of money received from a customer over a period of time is known as the lifetime value of the customer.

In order to understand which customers produce the most profit, we need to understand the 80-20 rule, also known as the Pareto goal. Rule 80-20 states that 80% of profits are generated by 20% of customers. Therefore, it is important to identify these customers and keep them, as losing them can lead to huge losses for the company.

Data from such customers is invaluable to the company, as illustrated by the Sports Authority, which was funded and later acquired by Dick's Sporting Goods in 2016. At this discovery, the Sports Authority customer list is estimated at $ 15 million. . The value of this list was based on the lifetime value of the customer who will convert to Dick's Sporting Goods upon receipt.

Such purchases are common in business, where the larger company gets smaller to move customers to their destination.

Customer lifetime value is a function of these elements:

1. Annual customer sales (or annual customer revenue)

• Refers to the expected revenue from a customer
• ACS = Expected number of transactions x Average transaction size

2. Customer Retention Rate (RR)

• Refers to the probability of retaining customers each year

3. Sales Margins (M)

• Refers to the total profit out of the yearly revenue
• Margin = Revenue - Costs

4. Discount Rate (DR)

• Refers to the rate at which the present value of the future revenue is calculated
• Value of money received in the future is less than the value of money received now
• Since the customer lifetime value is the present value of expected future revenues, we multiply the entire term with the discount rate to obtain the present value of the money that will be received at a certain date in the future.

5. The sigma (Σ) symbol in this formula represents the addition of the value of a customer across multiple years.

• Theoretically, the number of years can go until infinity.
• Practically, we calculate the customer lifetime value for three to five years.
• The net present value of the customer relationship decreases every year.

These values, when used in the formula for CLTV, give us the customer lifetime value for all the customers whose sales are being considered under ACS.

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