Calculating Customer Lifetime Value How-To Guide

1. How-To Guide Calculating Customer Lifetime Value By Kristen Maida, Research Analyst October 2013 EXECUTIVE SUMMARY Is your organization pouring out a large budget for sales & marketing activities and not seeing the returns? Is your organization focused solely on short term cash flows rather than long term profits? Is your organization unaware of how to calculate the potential profit of each client you bring in the door? If you answered yes to any of these questions, learning what customer lifetime value (CLV) is and how to calculate it may benefit your organization. Common sense tells us that the longer a customer is in relationship with a company, the more profitable that customer relationship is. However, many companies put the emphasis on new customer acquisition and not enough effort is made to retain existing customers. This is a mistake, because the financial impact of retaining customers is substantial: companies can increase profits by as much as 100% by retaining just 5% more of their customers. For these reasons¹, CLV is a crucial metric that most organizations overlook mainly because its definition and purpose are not entirely known. ¹ “Zero Defections: Quality Comes to Services”, Frederick F. Reichheld and W. Earl Sasser, Jr., Harvard Business Review, September, 1990. © 2013 Demand Metric Research Corporation. All Rights Reserved.

2. How-To Guide Understanding the monetary value each customer represents to your organization can help you budget correctly for your business needs, strategically plan your marketing initiatives and improve long-term relationships with your customer base. This How-To Guide details the definition of CLV, the advantages of calculating CLV and the standard formula for calculating CLV. WHAT IS CUSTOMER LIFETIME VALUE? Customer lifetime value goes by many names and abbreviations including CLV, lifetime value, user lifetime value, LTV and CLTV. Although its designations are far-reaching, they all share one general definition: “The net present value of the cash flow relationship with a customer.” - http://www.zurb.com More specifically: “Customer lifetime value (CLV) […]is a prediction of the net profit […] attributed to the entire future relationship with a customer. The prediction model can have varying levels of sophistication and accuracy, ranging from a crude heuristic to the use of complex predictive analytics techniques. Customer lifetime value (CLV) can also be defined as the dollar value of a customer relationship, based on the present value of the projected future cash flows from the customer relationship.” - www.wikipedia.com Customer lifetime value (or CLV as we will refer to it for the remainder of this guide) attempts to assess the true, long-term value and/or profitability of each client/customer. The purpose of this metric is to help businesses identify how much to invest in the development of each account. © 2013 Demand Metric Research Corporation. All Rights Reserved.

3. How-To Guide ADVANTAGES OF MEASURING CLV Calculating CLV provides a multitude of benefits. In our opinion, the most important advantages of identifying CLV are: Valuation of a Customer Relationship– Knowing the dollar value of customers over the duration of the relationship allows you to better assess current and future profitability. The insights gained from this valuation enable more effective investment decisions about customer acquisition costs. Evaluates Proper Investment for Each Customer– Measuring CLV allows you to develop a more accurate sales & marketing budget. When you know the CLV, it makes it easier to justify more expensive account development activities early in the relationship with the customer. Forecasts Potential Future Value of Customer Relationships– The CLV formula not only estimates current value of a client, but also takes into account the potential value of a client. With a numeric value for potential revenues, your organization can more accurately forecast potential total cash flow for future months and/or years. Emphasizes the Importance of Cultivating Long-Term Relationships– an understanding of CLV helps put the focus on client retention within your organization. Inherently, CLV encourages businesses to move past the short-term expense and instead view customer relationships through the lens of long-term profitability. Thus, nurturing customer relationships to eventually obtain these potential profits becomes an integral theme in client retention long-term. © 2013 Demand Metric Research Corporation. All Rights Reserved.

4. How-To Guide STANDARD FORMULA FOR CALCULATING CLV Although organizations tend to differ in the way they calculate CLV, many of them use a variation of the formula below: ?? ??? = ? × ( ? + ?? − ??) M = gross profit margin per customer lifespan ($) RR = the percentage of customers that repurchase/renew for your product/service over a certain period of time (%) DR = the interest rate used to calculate the current value of future cash flows (%) This is the traditional model used to calculate CLV. As mentioned above, most organizations customize this model to suit their needs and some organizations use more advanced models that require in-depth calculations and the assistance of a specified tool. ACTION PLAN 1.Identify the constants for your CLV formula– Find the values of M, RR & DR (defined above) for your organization. 2.Calculate CLV for your customer(s)– Download our Customer Lifetime Value Calculator to easily input your variables and to arrive at a CLV metric. You can repeat the calculation of this formula for each type of buyer persona to gain valuable customer insights. 3.Highlight the customer patterns - Use our Buyer Persona Template and Buying Process Stage Template to highlight the customer patterns you assessed from your calculations. Including this information in these templates will build collateral for your sales & account management teams in order to cultivate the most beneficial customer relationship and derive the most profit from each customer. © 2013 Demand Metric Research Corporation. All Rights Reserved.

5. How-To Guide 4.Consider CLV when planning - Utilize our Marketing Strategy Plan Methodology and Sales Enablement Plan Methodology along with your newly discovered qualitative CLV data to strategize and plan for the proper marketing & sales strategies for your organization BOTTOM LINE Customer lifetime value is an indispensable metric that can serve the long term monetary and strategic goals of your company. Since many organizations are unaware of the importance of this metric, understanding the purpose and advantages to CLV will put your company ahead of the curve when it comes to retaining and nurturing your customer relationships for the benefit of your bottom line. © 2013 Demand Metric Research Corporation. All Rights Reserved.