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Calculating customer value: a guide to relationship marketing

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17th Jan 2008
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Do you know how much a customer is worth to you? Here, Robert Craven of The Directors' Centre provides an introduction to relationship marketing and the concept of the lifetime value of the customer.

By Robert Craven, The Directors' Centre

Question: do you know how much a customer is worth to you?

Unless you know the true value of a customer (to your business) then how can you decide how much you are prepared to spend to acquire one?

Customers are often worth more to us than we realise. This is particularly true in the case of services. What follows is an introduction to relationship marketing and the key concept of customer lifetime value.

Definition

'Relationship marketing' is about maximising long-term profitability through the intelligent use of information. The information is used to enhance and to create superior relationships with customers.

Relationship marketing involves customising and developing the offer that you make. As a result, you also develop your dialogue with the client to maximise the value to them. It is more sophisticated than the traditional marketing process; it makes customers feel valued because it responds to their individual circumstances - in effect, it is marketing with a memory.

photo of Robert Craven, The Directors' CentreRelationship marketing involves customising and developing the offer that you make. As a result, you also develop your dialogue with the client to maximise the value to them.

Robert Craven, The Directors' Centre

The key phrases associated with relationship marketing are
 

  • Customer lifetime value - looking at income, cost and profit over the full period of the relationship rather than just on annual basis
     
  • Data warehousing - the collection together into one place of information from many places
     
  • Data mining - the process of searching for nuggets of valuable information that can provide ideas for enhancing value or for extraordinarily persuasive communications

When is it applicable?

Relationship marketing is particularly good when there is a single decision-maker or when there is a large volume of customers with varying needs. It also works well when customers are not actively account managed by a salesperson. Another way it can work well is when the high costs of customer acquisition (getting customers) makes loyalty a key goal or where the exchange of information between the buyer and seller is crucial or where it is possible to differentiate your product through the quality of your service.

Testing suitability for customer relationship marketing

Jim McLaughlin, senior associate consultant with The Directors' Centre, uses the attached 10-point questionnaire to assess suitability.

1) What are the drivers in the market? Can you deliver increased competitive advantage by creating higher levels of loyalty?

2) How many customers does the business have? Is it clear what a customer is?

3) What is the retention level? If extremely good, it makes relationships marketing less compelling.

4) Do customers buy from more than one supplier? Do they have to? How good is our 'share of the customer'? How will RM improve it?

5) Do we have the IT/marketing/accounting skills to run a more than competent RM programme?

6) Do we have the money to invest in the programme?

7) Do we have the right data? Where can we get it from?

8) Are we already doing a good job for the customer? Can we also improve on this?

9) Does the company have a customer ethos that will maintain and sustain any improvements?

10) Are our existing campaigns well-executed?

Customer lifetime value

Customer lifetime value is at the heart of relationship marketing. Data warehousing and data mining are the tools used in bigger businesses.

Remember, customers do not stop and start with the financial year. It may take several years for your investment on a relationship to pay-off.

In traditional marketing each client is valued on a year-by-year basis, focussing of profit per annum. This approach created a gap between the measurement system and the real world. In the real world it may take some time to make a customer profitable. Remember, customers do not stop and start with the financial year. It may take several years for your investment ion a relationship to pay-off.

Customer lifetime value is a way of considering the customer across their anticipated life as a customer of the company. It acknowledges that the investment a company makes in acquiring a new customer would probably not be repaid with the first purchase or even the first year of purchases!

Case study

Jay Bradbury Photographic Studios specialises in fulfilling all photographic needs for local businesses and organisation. Jay estimates that each new account will stay with him, for, on average, three years. Each account will give him one assignment per month at an average fee of £500. So the lifetime income from a new client can be anticipated to be £18,000.

With a gross margin of 30 percent, one new account will generate £5,400. Hence Jay has calculated that even if he spent £3,600 trying to acquire a client then it would still be money well spent because this would still give him an average net margin of 10 percent (£1,800).

Lifetime value of a customer calculator
  • On average, a new customer will buy from the business for ____ years.
     
  • And, on average, a new customer will generate ___ orders per year.
     
  • The average order value is £___.
    So, lifetime income from a new customer is:
     
  • ___ years x ___ orders pa x £___ order value = £___.
     
  • Therefore, with an average gross margin of ___%,
     
  • A new customer will generate a lifetime gross margin of £___.

About the author
Robert Craven is MD of The Directors' Centre, and a keynote speaker and author of the best-selling business books Kick-Start Your Business and Customer Is King. His new book is Bright Marketing - why should people bother to buy from you? www.bright-marketing.com

 

Replies (3)

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Dr. Graham Hill
By Dr. Graham Hill
28th Jan 2008 13:59

This article is a poor introduction to Customer Lifetime Value (CLV), for a number of reasons.

1. It hardly considers the multitude of costs that need to be allocated across the customer base. Just factoring costs into the 'sales margin' is inadequate and greatly overinflates CLV.

2. As Michael reminds us, it doesn't consider the time value of money at all; usually applied as a weighted average cost of capital (WACC) or discount rate. Omitting the discount rate hugely overinflates CLV.

3. As Sumit reminds us, it doesn't consider the referral value of a customer. Recent research by Kunar showed that a customer's referral value may be up to four times their purchase value. Omitting the referral value deflates CLV.

It pays to read around when looking for information about CLV. This article is a very poor introduction to the topic.

If you want to know more, see any one of the following books. Their authors really know their topic.

Gupta
Managing Customers as Investments

Blattberg
Customer Equity

Roland Rust
Driving Customer Equity

Peppers & Rogers
Return on Customer

Kumar & Reinartz
Customer Relationship Management

These are all books I use in my daily consulting & interim work. They are all available from Amazon.

And a new one I have just ordered to look at:

Bejou
Customer Lifetime Value

Graham Hill
Independent CRM Consultant

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By michaelicollins
22nd Jan 2008 08:24

The one element omitted from Robert Craven's calculator is the discount factor needed to be applied to each year's calculation, so that customer value reflects the changing value of money over the years. The discount factor is calculated using the formula for discounted cashflow: D=(1+i)^n, where i is the rate of interest used within the business and n the number of years to be discounted.

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By mobike
26th Jan 2008 01:49

An excellent introduction to lifetime value of a customer.

The lifetime value of a customer increases further if you take into consideration the number of referrals a satisfied customer makes.

Businesses that value their customers benefit by tracking the new customers that they help bring in.

The formula I use to forecast this value is estimate the number of people that the prospect or customer could have (Number of potential customers "Christmas Cards" are sent to) and divide that by the "referral objective" (Say 5% of these potential contacts for each year.)

Multiply this by the acquisition costs you save and you will get the additional value as a result of referrals.

I hope this explanation is as lucid as Dr. Craven's. I suspect it's not.

Sumit Roy

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