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Re-evaluating CRM cliches No 3: Customer Lifetime Value

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26th Aug 2001
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Somewhere in the chorus of every consultant's hymn in praise of Customer Relationship Management is an expression along the lines: "To manage customer relationships properly, we need to understand Customer Lifetime Value."

This week I want to take that phrase, try to examine what it means, and see how we can use it - or similar concepts - in a practical CRM project.

Let's start at the beginning with defining Customer Lifetime Value. A good source of Brownian motion, says the Hitchhiker's Guide to the Galaxy, is a hot cup of tea. A good source of CRM definitions is the Peppers and Rogers web-site.

Their glossary defines Lifetime Value as being the same as Actual Value, which they define as: "the net present value of the future profit stream from a customer". Now let me say immediately that I think this is an excellent definition of Customer Lifetime Value, nearly all consultants would agree with it, so the following is in no way meant to reflect criticism specifically on Peppers and Rogers, at least not more than it does on all CRM consultants who use the expression Customer Lifetime Value.

For the financially illiterate amongst us, let's also try and outline what is meant by "net present value". As I understand this, we expect to make profits from a customer over a period of time (years, months). Let's calculate the profit we'll make in each time period (year, month), and add them all together, to get the total value we're going to earn from the customer. Of course, because a dollar (or pound) in my pocket today is worth more than a dollar tomorrow, we should discount future dollars to reflect that loss of value, and discount more the further away in time the future profit occurs. Typically, you might discount future profits by, say 15% a year. So the net present value is the future profit stream, with each element discounted appropriately.

Now, I'm sure the accountants amongst you are rolling in agony at this definition, and if so, feel free to add a response to the editorial with a better definition (in Plain English) of net present value.

So now we've got a definition of Customer Lifetime Value which says it's the sum of the future profits we get from the customer, where those profits are discounted to take account of how far they occur in the future.

Your CRM consultant will then tell you that you should make your decisions on how you treat your customers based on their Life-Time Value (LTV). Let me give you a practical example of how LTV can be simply used in practical life.

In the UK retail banking industry, university students are treated particularly favourably. Despite the fact that most of them are financially irresponsible, liking nothing better than to spend any money they can get hold of on parties, alcohol, and other entertainments; despite the fact that they have very little money and no idea of how to manage it, the banks fall over themselves to offer students loans, and help them financially through their university educations. Why? Because they perceive that these students will turn into the graduates of tomorrow, and then into the high-earners of the day after, so becoming highly profitable customers of the future. In other words, because of their perceived Customer Lifetime Value, the banks are willing to be nice to them today. Of course the banks are relying on these student customers being loyal (or on customer inertia) to realise these future values.

So this idea of Customer LTV seems to make sense. What possible issues could we have in making it a core part of CRM environment?

Well, let's start with a definitional issue. LTV covers the future profit-stream coming from the customer. Does the past profit stream from the customer have no value? Is the commercial relationship between companies and individuals so cynical that 50 years of past profit to a bank is worth nothing in evaluating how we'll treat a customer now and in the future? I suppose for many companies it really is only about the present and the future, and nothing about the past, but if so, customers' attitudes towards their suppliers should be similarly hard-hearted. We're certainly not dealing with a corner-shop here.

Are there other issues that worry us about customer LTV? Well yes. Let's start with a "reductio ad absurdum" argument. If we don't distinguish between future profits and current profits other than by discounting, we can, in theory, go bust by maximising our net present value. If we identify a set of customers who are unprofitable to begin with, but have such high profits out in time that they outweigh, even after discounting, the immediate losses, the sum of the LTVs could encourage us to go after that set of customers and find that though we're going to make lots of money in the future, we run out of cash (which you do only once) before the predicted profits arrive. Is it to naïve to so suggest that there are a lot of dotcoms who have just suffered the consequences of similar problems?

A far more likely scenario is that before we enjoy the profits from those long-term valuable customers, a competitor, grown fat on the profits from immediately profitable customers (though less attractive in LTV terms), devises a strategy to steal all our customers we've been nursing through their lean times. So tactics can destroy a long-term strategy.

Another key issue is how long is the customer's life? Do we really think that we can predict a customer's behaviour, say, 50 years into the future? This has to be madness. The student of today is going to have perhaps 50, perhaps 70, perhaps 100 years of economic activity in a fast-evolving economic environment. Do we really think we have any idea how we might begin to predict the value of that relationship? The predictive techniques used are also built from historic data, so we are trying to predict the economic value of customers over the next 50 years from customers who have been active in the last 50 years (i.e. from 1950). This is patently nonsense. In practice, companies I've seen trying to implement Customer LTV measures limit themselves to a 3-5 year forecast, but this is hardly lifetime value.

Finally, let's add a reality check. Nearly every company I've worked with has had enormous problems defining historic customer profitability (How do we allocate the fixed costs? etc.), and this has frequently precluded implementing historic measures of customer profitability. If we can't get agreement to how to measure the fixed past, do we really think we're going to get agreement on how to measure the indeterminate future?

Summarising so far, I think we have to say great theory, shame about the reality. But I don't quite want to give up on the idea yet. One other area of difficulty I have with LTV is that it mixes current value/opportunity with future value/opportunity. There is a tactical opportunity to make money now (or better, in a service industry we have an ongoing revenue/profit stream which will continue given that it doesn't change) and a lot of longer-term profit opportunities. LTV adds the discounted values of those together and gives us one variable. Is that sensible? Perhaps we would gain some value if we treated those two figures differently. Perhaps we could call one of those "current value" and the other "future value". Perhaps we could also make a couple of other changes. Given the difficulties with measuring profitability (usually due to the allocation of fixed costs), maybe we could try and measure the contribution which the customer makes (the revenue minus the costs of doing the transaction).

So if we had a measure of customer contribution (immediate value) and customer potential (longer-term value) would we gain anything? Well, we'd probably have customers in a number of different categories:

  • customer not contributing today, and with limited potential (manage up or out)
  • customer not contributing today, but with significant potential (maximise customer value)
  • customer contributing today, but with limited future potential (customer retention)
  • customer contributing today, and with significant potential (favoured customer)

Now this is beginning to look interesting. Not only do we have customers in different categories, but there seems to be an obvious customer strategy for those different categories. If we can measure current contribution, and put in place a measure of customer potential, then we can segment our customers based on those measures, and derive segments that should have different customer strategies applied to them.

Now I can feel a few "yes, buts" coming on. The two most obvious ones are:

If it's so difficult to measure future customer profitability, how come you think you can measure customer potential?
The answer to that is complicated and too difficult to go into in detail in this editorial. In principle it involves identifying the major profit opportunities within a company's business model, building propensity models which measure the probability and value of each customer exercising that profit opportunity, and building a matrix of the resulting indexed scores. The sum of those scores can be seen to be a measure of customer potential. The methodology is outlined in a presentation on this site called: Understanding your customers better. I know a number of people who have gone a long way down the road to implementing such a matrix, and those who have been most successful in using it would much prefer if I didn't keep going on about how useful it is!

If I can't get agreement on how to implement customer profitability measures, how are we going to get agreement on measures of customer contribution and customer potential?
The answer here is to make sure that the algorithm you implement is accurate but imprecise. In other words it's the granularity of the answer that causes the difficulty. If you want to measure customer profitability to the nearest cent (penny) then you need a complex algorithm with plenty of room for debate. If you want to rank customers from high contributors to very poor negative contributors on a 5-point scale you need a much simpler algorithm. If we can rank customers on a 5-point scale for both contribution and potential, then we have a 25-cell matrix from which to derive our segmentation - more than enough to get started with - and derive value, provided we are fairly accurate (significantly better than random) in how we allocate customers to the matrix.

Please don't get me wrong in these editorials. These slightly ironic comments on LTV are meant to encourage a little of that painful activity called thinking. Similarly, I don't think that the implementation of a customer contribution/potential matrix is the be-all and end-all of Customer Relationship Management.

What I do think is that the competition between consultants on the theory of CRM has got so far ahead of where most client companies actually are, that there is real danger that we expend huge amounts of energy (and money) implementing a theoretical infra-structure which doesn't deliver any value for many reasons.

Many companies are trying to 'boot-strap' themselves into CRM. What they need, we believe, are a number of pragmatic methodologies which deliver value and represent a stepping-stone towards the CRM world. A number of people have said in response to my first editorial in this series that Database Marketing is one of those. I believe the customer potential / opportunity matrix is another.

Last week we talked about the need to provide the customer with a 360 degree view of the organisation. We hope to talk about other practical ways of making money out of CRM in future editorials in this series.

As always, the best measure of the success of these editorials is the comments you make, so please add a comment to this editorial, or write to me directly, at: [email protected]

Regards,

Richard Forsyth
The CRM-Forum
The independent resource centre for CRM

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By AnonymousUser
28th Aug 2001 11:11

Rather than get hung up on one approach, I think it helps to figure out a couple of things first of all:
1. Why are we doing it? 2. What can we measure? An example I think will serve to help. Couple of years ago I worked for a very large computer company which invested heavily in sales and relationship resources on its B2B business. We wanted to increase the productivity of these resources , and take a more hard headed and pragmatic approach, based on profit potential. Using a simple matrix based on hi/lo share & hi/lo growth plus total IT spend, we were able to plot all our accounts into one of the four quadrants that resulted. Whilst we had good info on past performance, we did not have great info on the future, so we used as proxies the growth rate of companies based on previous 3 yrs history and also used another proxy for share of wallet, which was based on industry averages of IT spend. Whilst this was not massively scientific, it helped us come up with a better rationale for deploying resources than before.(needless to say all growth projections going forward were too large!) This was however the first step, and if we'd stopped here, it might have been a case of 'rearranging the deck chairs on the Titanic'. So the second step was to figure out high potential buying behaviour The upshot was that marketing needed to give some practical direction to the field to help them expose opportunities that traditionally we were missing. The short term impact was a remarkable change in the levels of respect accorded marketing. The company is profitable, though growth is slow and remarkably there is now a considerable amount of cross product collaboration, as insights have been shared. This pragmatic and imperfect approach yielded actionable results. In my years at the company, I had never witnessed any global approach working so successfully. Everyone is now worried about customers, even if the maths is a bit dodgy!

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By admin
27th Aug 2001 17:51

The CRM Goal is simple: Grow yield per customer.
LTV is the soft metric equivelant for "yield per customer" - but is often mis-used at the expense of marketers' credibility with Finance, IT and Exec. Management.
Many companies over-invest in scrutinizing their customer activity, cost/revenue streams without looking for an 80/20 shortcut. If you can identify your "golden goose" customers LTV - except for your ideal customer profile - may be irrelevent.
The question is "Why LTV?" The LTV formula should highlight operational issues/opportunities as well as marketing and sales. My last excercise with a client to map "the customer experience" detailed 84 interaction points used to derive customer yield. Each intersection has 8-16 nested factors to determine customer value, lift and trigger events/rules. (this level of analysis is why SAP and PeopleSoft will have a leg up in CRM - they have already been run through the ABC cost accounting support process)
LTV makes sense in catalog and continuity marketing but does not make practical sense in many industries or channels.
The referneces to banking are obvious with the large number of "unprofitable" customers financial institutions carry - but those customers bear large amount of the operating cost- pointing to the need for LTV to reference cost allocations - expense balancing and other non-marketing variables.
The evolution of the web as a self-service and collaborative market will continue to drive LTV discusions as more savy customers negotiate preferential pricing/recognition in exchange for dealing "direct" managing their own business. The yield per customer discussion will become more prevalent at the Board level, shareholders, and eventually customers will demand to see their personal statement of condition depicting their value Then business gets interesting.

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By admin
27th Aug 2001 15:45

Richard,

Thanks a lot for your editorials. I really enjoy reading them.

Here are my thoughts about LTV:

The assumption under which the Peppers definition of LTV „the net present value of the future profit stream from a customer” is true, is of course that you start looking at t=0 (that is at the beginning of the customer lifetime) and end at t=x (the presumed end of your relationship with this customer). If you look at a customer who purchases your products since 5 years, you would have to go back to time zero of course, when his lifetime at your company started. So LTV does not neglect past experiences. It is focused on the whole customer lifecycle and not only on a piece of it (which would put the whole philosophy of LTV ad absurdum). No cynism there.

The reason why people started to look at the LTV was not only to better serve customers but to forecast profit for each customer and in sum to better predict profit (or loss) for the whole company. A company that is focused on all those LTV’s of its customers and oversees that the sum is a huge minus for the next year (or years) faces a severe controlling problem and should think about changing management but shouldn’t blame the LTV. (There are indeed some dotcoms who have just suffered the consequences of this problem).
I also think that this is also true when it comes to the evaluation of how long a new found customer might stay being your customer. It’s the mix of good statistical/data mining tools and marketing/controlling expertise that should manage to carefully plan customer behavior – and profit. You are right – a prediction for the next 90 years is mad, discounting future profits for this period, too.
LTV is still a perfect instrument to help me evaluate which of my customers I should treat like diamonds because I don’t want my competition to steal them (Not to worst tactic to reach my long term strategy).

:-)

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By admin
27th Aug 2001 14:34

Most definitions of LTV use NPV but I often suspect that this is too prescriptive, too narrow, too simplistic. How do we measure intangibles like the "referral value" of each customer, for example?

Even if you accept that a purely financial measure like NPV is appropriate, as Richard points out, its accuracy is debatable. In fact, there are a number of valuation techniques in use. The main attraction of NPV is its (relative) simplicity. Would it be cynical to suggest that, when it comes to valuing companies etc., the technique used is the one that gives the "right" answer?

Company accounts are sometimes criticised as presenting too narrow a view of performance, of being "unbalanced". If NPV, along with other purely financial measures are too narrow, too prescriptive, do we need a "balanced customer scorecard" to measure LTV?

:-))

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By jimnovo
28th Aug 2001 15:56

Outstanding series; vetting these issues at a high-level is I'm sure helpful to readers.

I'd like to add my LTV "proxy" ideas to those of Richard, Jeremy, and others. My suggestion is to focus on changes in LifeTime Value, rather than any absolute number. In many cases, it is more important to determine the *direction* of future customer value - is it increasing or decreasing relative to other customers? This allows the proper allocation of resources for customer retention and growing customer value without the mathematical gymnastics of determining an *absolute* LifeTime Value.

With this approach, the LTV metric has more weight in what is happening now and in the future, rather than what has happened in the past - usually a good thing, since you don't want to rest of the successes or failures of the past.

But how do you track and evaluate future value and direction of this value? By using customer behavior metrics known to affect the likelihood of ongoing customer involvement and interaction with the company. Customers frequently telegraph their intentions through their behavior (or lack thereof) when compared with other customers; this sets up the ability to compare and rank customers for future potential and value, and determine if it is rising or falling. For example, increasing Frequency of contact just before a contract renewal may be a positive indicator; declining balances in an account after consistent increases can be a negative indicator. These indicators are developed by comparing defecting customers with best customers and looking for differences in behavior.

Rather than try to explain more about these techniques in this format, I suggest you read an article of mine posted to the CRM-Forum library this week titled:

Tracking the Potential Profitability of B2C CRM Implementations.

It's linked on the home page of CRM-Forum or you can use this URL:

http://www.crm-forum.com/library/art/art-121/

Jim Novo
Drilling Down Project

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By admin
28th Aug 2001 11:21

Your editorial neatly sums up many of the issues concerning life time value. I believe that the confusion/misuse/misunderstanding over LTV comes from the multitude of definitions out there.

Whatever way you phrase it, or whatever buzzword you use to describe it, there is no doubt that by understanding what a customer has brought to the bottom line up to today and what they will bring to the bottom line in the future is incredibly useful for business planning.

By referring to the contribution to the bottom line implies understanding all those elements that have a bearing, including referrals, 2nd lifetime etc that have been mentioned above.

As to how you calculate/predict the value I believe that the approach followed by Qube (www.qube.co.uk) is incredibly simple in concept and yet can incorporate as much as complexity as the business requires.

In a nutshell the concept is identifying all customer "events" that have a bearing on the bottom line and then either calculating them or predicting them time period by time period. If you believe in allocating fixed costs then you can do this by assigning a fixed cost "event". If you believe in referral value then you can build in a referral "event". By building up the events you can create a picture of value as complete as you need it.

...and no I do not work for Qube!

David Pardoe
The Data Laboratory
[email protected]

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By r.forsyth
27th Aug 2001 13:51

Richard,

I like the thrust of your article--many CRM consultants and policy wonks talk about customer profitability but not many companies are really measuring it.

But you don't need to be a rocket sciencist to calculate it. Our "Customer Based Accounting" method can be employed if you can come up with a spreadsheet listing customers and their revenue for a period of time--plus get some costs data from the annual report or from the bean counters.

Jay Curry, Chairman
The Customer Marketing Institute
www.customermarketing.com

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By r.forsyth
28th Aug 2001 09:41

Excellent editorial on the realities, myths, and mysticism of customer lifetime value. It's an extremely important subject that often gets mangled and misunderstood by CRM practitioners and consulting professionals alike.

Allow me to further complicate the picture. With apologies to Peppers and Rogers, there is a good deal more to customer lifetime value than looking at present, and even potential, direct economic estimates. There are intangible - yet quantifiable - elements that can, and should, also be factored into a lifetime value equation. These include information value, the proportionate amount that can be determined from anecdotal and dimensional insight provided by customers, and that is layered onto present and future economic value estimates. In addition, there is referral value, the monetary amount derived from customers who recommend a supplier's products/services to friends, colleagues, and relatives. A bit more esoteric, perhaps, but achievable with some effort.

As discussed in Customer WinBack, the new book I've co-authored, there is also 'second lifetime value'. That's the extended amount, gross and net, from incremental, or second lifetime, purchases of a lost customer who has been won back. If you regard the customer's actual lifetime, or life cycle, as we do - as acquisition, retention, and win-back - and see them as interdependent in optimizing CRM, this makes eminently good sense. Within our book, we've devoted two whole chapters to the estimation of lifetime and second lifetime value; and we've identified some excellent examples of companies that do this very well.

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By admin
28th Aug 2001 06:13

The CLTV article makes interesting reading.Before calculating the CLTV it would be nice to list down the business objectives of measuring the CLTV.These objecives can be as differentiated as doing a due dilligence of the company (ex. telco) to service differentiation strategies.
The benefits of CLTV perse is only one goal.The analysis process itself brings in lot of value to company.Customer segmentation is an essential part of CLTV.The granularity of segmentation should be limited by business objectives .Attributing the cost to customer level using ABC is another challenge.Predicting/forecasting the future loyalty /revenues based on external /internal events and on assumption of business continuty is an important factor.And finally what is so sacrosanct about the CLTV calculated once.This is a dynamic value based on many factors/events.Take for example telco.How accurate would the cltv calculated an year back would be accurate after 2 years when 3G networks would cater to a lifestle of telecom subscriber than that of just his/her communication needs.
A good CLTV framework would involve lot of dynamic inputs from the end user and to an extent support what if kind of analysis.This is a Business strategy framework serving short term and long term goals and understanding the business better.The company executives start to thing in time frames that is a side benefit.

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By r.forsyth
10th Sep 2001 14:53

Third, calculating the future value of a customer portfolio is not an
intellectual challenge, but an accurate calculation of costs requires a
lot of '3-T work' (Tedious, Taxing and Tiresome). Activity based costing
is the only way to derive total customer costs. Information from the
existing operational accounting system within an organization can be used
to produce a fairly accurate valuation of the total customer portfolio.
But when you move into specific value tiers and develop strategies for
segments within these tiers, close enough is not good enough. Finer
representations of costs, including the cost of capital are required to
take action (i.e., manage customer value). In addition, ABC converts many
fixed costs into variable costs. This gives managers much greater control
over their cost structures and allows them to make adjustments based on
what their customer value systems are telling them.

Finally, we define customer value, from the corporation's perspective, as
'the present value of lifetime sales to all customers net of the costs of
attracting, serving, and retaining them, including the cost of capital
employed in doing so.' The definition used by Peppers and Rogers is
directionally sound, but using 'future profit stream' rather than
future 'economic' profit stream, ignores the cost of capital. This
oversight will generally cause the valuation of a customer portfolio
(tier or segment) to be overstated. This is no small matter when an
organization wants its valuation of the customer "asset" to be taken
seriously by the investment community.

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By r.forsyth
10th Sep 2001 14:57

Second, any organization exclusively focused on customer lifetime
value (CLV) to the neglect of customer annual value (CAV), could,
theoretically, 'go bust by maximizing net present value.' This seems so
obvious, it¹s difficult to imagine it needs to be stated. After all, you
can't maximize long-term shareholder value on a platform of short-term
bankruptcy. Using your retail banking example, university students might
be highly profitable customers in the future, but shareholders should not
be asked to subsidize them in the interim. If an organization has decided
to attract these types of customers, it should know the minimum it needs
to offer them. It¹s not unusual to find companies providing unprofitable
customers with more than they need to and certainly more than these
customers are willing to pay for. I'd want to see empirical evidence that
these young customers will stay with the bank, how long it takes for the
relationship to turn profitable and exactly what the organization is
doing
to minimize economic losses in the meantime. Information acquired through
customer listening systems, transactional behavior and stock-and-flow
analysis
would produce such evidence.

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By r.forsyth
09th Sep 2001 17:16

There's a lot of good stuff in the responses to this editorial. With many of them, I only wish there was more detail. Many of the ideas would be worthy of an article / presentation in the CRM-Forum library.

I was particularly interested in the idea raised by a couple of people that the change of direction in LTV was significant. I can't quite my head round this but it sounds significant. I wonder if it relates to an idea I've used in the past where we use customer potential as the measure, where customer potential is defined as the difference between what we've got from the customer now, and what we could get from him now. The point being that it may well target you on unprofitable customers with large potential, rather than profitable customers with little potential??

Anyone care to elaborate??

Regards,

Richard Forsyth

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By r.forsyth
04th Sep 2001 15:32

Richard

I pretty much agree with your comments on LTV. However, it is the
MOST useful metric you can have on a customer... if you get it
halfways right! The way that I have LTV scored in the base is three
metrics broken out. Current value which is how much that customer has
contributed (net) to date, NPV which is future net earnings. I also
have a calculated measure which is a ratio between the two. The ratio
keeps you honest and stops you throwing away too much money or indeed
not enough to manage the customer. For my business, which as you
know, is Telecoms the next most important piece of data is a good
churn score. I find that if you combine the value metrics along with
the churn score into a High/Med/Low matrix you get some excellent
insight into where to spend your marketing and retention dollars,
excuse me, pounds. I am not suggesting just using this tool alone,
but I do find myself going back and pulling it from my toolkit more
often than others.

Definately a good series of editorials, very informative and
provoking.

As a suggestion for your next series you might want to consider, CRM:
Consultant Relationship Management, "the role of the consultant and
how to maximize your returns".

Keith

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By AnonymousUser
03rd Sep 2001 14:00

Dear Richard,
I love your editorials .They are not too long as your friend says but they really encourage the little painful thing called thinking.
First of all: PRG are talking about an actual and a strategic value and call the two of them together CLV.So the current value and the oppotunity as mentioned by you are respected.
But let's stick for a moment with retail banking that you mention:
A student is opening an account and is taking a loan i.e. the bank is financing the student,hoping that he remains a client.If the CLV discount rate (Let's assume the 10 year US Gov.Bond rate)equal the IRR of the bank the present value of this account is zero.(I have assumed that the actual value is the pres.value future profits of the existing calendar year and the strtegic value is limited to 5 future years and both together represent the CLV).The CLV can even be negative in case the discount rate is higherr than the IRR.Not only accountants should be rolling in agony ,also CFOs.This is what you mentioned by running out of cash flow.However:The CLV in future years can still be negative but the CHANGE is positive.This means that the customer is producing value instead of destroying it.After 3 years he finalised his studies and ,say,the change in CLV is taking a big leap into a positive number.
From my perspective the CLV is the crucial but difficult point in CRM.Without measuring and monitoring it following a certain formula you will never be able to come to a final value judgement of your customer.

Axel Heinemann

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By r.forsyth
09th Sep 2001 17:05

Scott,

I agree strongly that we need to make benefit for the customer. It has to be be a win-win situation. We've been thinking about this issue and this week's editorial (Back to the Future) is a start towards focusing more on the customer, as is a response to Bob Thompson's comment on my editorial on 1-1 at http://www.crm-forum.com/cgi-bin/item.cgi?id=55192&d=345.

By the way, is your very interesting surname Scottish, or is there some other culture that uses Mac as a prefix to surname??

Regards,

Richard Forsyth

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By admin
04th Sep 2001 18:55

One of the most serious flaws in much of the discussion of customer lifetime value is the absence of regognition and discussion of the lifetime value that customers can GAIN from a relationship with a service provider. All the emphasis seems to be on what the provider/seller can gain from the customer, none on what the customer can gain in a lifetime relationship.

Clearly, many services deliver little or no lasting value, but some definitely do: financial planning/investment counseling; education/training; health care; assorted repair and remodeling services; for example. And in some of these cases, the value that customers can deliver goes well beyond the conventional repeat/cross/up-buying and referral/WoM to include political support, volunteer services, donations, etc. Universities, for example, may keep alumni on their CRM rolls for decades even with no ROI, hoping for a bequest in their wills.

When lasting value is delivered, and when customers recognition of, gratitude and attribution for such value can make a difference to customers' lifetime contribution value as well as length of lifetime, it often helps to remind, or indirectly heighten customers' awareness, appreciation and attribution of such value, and thereby gain added value from them. Possible methods for tracking value delivered, and heightening customers' recognition thereof seem to be omitted from most CRM discusssions, even though the Internet is becoming an excellent way to do both.

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By r.forsyth
10th Sep 2001 14:59

A few thoughts came to mind after I read your piece.

First, companies may not be ³so cynical² as to neglect past profit
performance, but markets are. Shareholders take a decidedly prospective
view
when valuing a company¹s stock. The stock price of any given public
company today represents the market¹s view of how the assets (tangible
and intangible) of that company will be employed to produce future cash
flows--which cover all costs, including the cost of capital. Economic
cash flows correlate most highly with long-term corporate (i.e.,
shareholder) value. Customers produce these cash flows, which is why
the yet-unrealized value of a customer portfolio is often an intangible
asset of enormous value. Profit performance in the past (enterprise-wide,
segment, or individual customer) has little bearing on the market¹s
valuation except as it relates to the ³credibility effect² of pro-forma
disclosures. The market¹s prospective view heavily influences corporate
governance.

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By r.forsyth
09th Sep 2001 17:05

Scott,

I agree strongly that we need to make benefit for the customer. It has to be be a win-win situation. We've been thinking about this issue and this week's editorial (Back to the Future) is a start towards focusing more on the customer, as is a response to Bob Thompson's comment on my editorial on 1-1 at http://www.crm-forum.com/cgi-bin/item.cgi?id=55192&d=345.

By the way, is your very interesting surname Scottish, or is there some other culture that uses Mac as a prefix to surname??

Regards,

Richard Forsyth

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By r.forsyth
09th Sep 2001 17:13

Keith,

Thanks for the valuable contribution.

Glad to see you separate current value and future value, which is one of the key ideas I've been keen for people to take up.

I hadn't thought of the ratio of the two values being important, but it certainly makes sense.

This would make a very good case study with a bit more detail which we'd love to publish if it's not too sensitive????

Regards,

Richard Forsyth

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By r.forsyth
09th Sep 2001 17:16

There's a lot of good stuff in the responses to this editorial. With many of them, I only wish there was more detail. Many of the ideas would be worthy of an article / presentation in the CRM-Forum library.

I was particularly interested in the idea raised by a couple of people that the change of direction in LTV was significant. I can't quite my head round this but it sounds significant. I wonder if it relates to an idea I've used in the past where we use customer potential as the measure, where customer potential is defined as the difference between what we've got from the customer now, and what we could get from him now. The point being that it may well target you on unprofitable customers with large potential, rather than profitable customers with little potential??

Anyone care to elaborate??

Regards,

Richard Forsyth

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By r.forsyth
10th Sep 2001 14:59

A few thoughts came to mind after I read your piece.

First, companies may not be ³so cynical² as to neglect past profit
performance, but markets are. Shareholders take a decidedly prospective
view
when valuing a company¹s stock. The stock price of any given public
company today represents the market¹s view of how the assets (tangible
and intangible) of that company will be employed to produce future cash
flows--which cover all costs, including the cost of capital. Economic
cash flows correlate most highly with long-term corporate (i.e.,
shareholder) value. Customers produce these cash flows, which is why
the yet-unrealized value of a customer portfolio is often an intangible
asset of enormous value. Profit performance in the past (enterprise-wide,
segment, or individual customer) has little bearing on the market¹s
valuation except as it relates to the ³credibility effect² of pro-forma
disclosures. The market¹s prospective view heavily influences corporate
governance.

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By admin
04th Sep 2001 18:55

One of the most serious flaws in much of the discussion of customer lifetime value is the absence of regognition and discussion of the lifetime value that customers can GAIN from a relationship with a service provider. All the emphasis seems to be on what the provider/seller can gain from the customer, none on what the customer can gain in a lifetime relationship.

Clearly, many services deliver little or no lasting value, but some definitely do: financial planning/investment counseling; education/training; health care; assorted repair and remodeling services; for example. And in some of these cases, the value that customers can deliver goes well beyond the conventional repeat/cross/up-buying and referral/WoM to include political support, volunteer services, donations, etc. Universities, for example, may keep alumni on their CRM rolls for decades even with no ROI, hoping for a bequest in their wills.

When lasting value is delivered, and when customers recognition of, gratitude and attribution for such value can make a difference to customers' lifetime contribution value as well as length of lifetime, it often helps to remind, or indirectly heighten customers' awareness, appreciation and attribution of such value, and thereby gain added value from them. Possible methods for tracking value delivered, and heightening customers' recognition thereof seem to be omitted from most CRM discusssions, even though the Internet is becoming an excellent way to do both.

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By r.forsyth
10th Sep 2001 14:53

Third, calculating the future value of a customer portfolio is not an
intellectual challenge, but an accurate calculation of costs requires a
lot of '3-T work' (Tedious, Taxing and Tiresome). Activity based costing
is the only way to derive total customer costs. Information from the
existing operational accounting system within an organization can be used
to produce a fairly accurate valuation of the total customer portfolio.
But when you move into specific value tiers and develop strategies for
segments within these tiers, close enough is not good enough. Finer
representations of costs, including the cost of capital are required to
take action (i.e., manage customer value). In addition, ABC converts many
fixed costs into variable costs. This gives managers much greater control
over their cost structures and allows them to make adjustments based on
what their customer value systems are telling them.

Finally, we define customer value, from the corporation's perspective, as
'the present value of lifetime sales to all customers net of the costs of
attracting, serving, and retaining them, including the cost of capital
employed in doing so.' The definition used by Peppers and Rogers is
directionally sound, but using 'future profit stream' rather than
future 'economic' profit stream, ignores the cost of capital. This
oversight will generally cause the valuation of a customer portfolio
(tier or segment) to be overstated. This is no small matter when an
organization wants its valuation of the customer "asset" to be taken
seriously by the investment community.

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By r.forsyth
10th Sep 2001 14:57

Second, any organization exclusively focused on customer lifetime
value (CLV) to the neglect of customer annual value (CAV), could,
theoretically, 'go bust by maximizing net present value.' This seems so
obvious, it¹s difficult to imagine it needs to be stated. After all, you
can't maximize long-term shareholder value on a platform of short-term
bankruptcy. Using your retail banking example, university students might
be highly profitable customers in the future, but shareholders should not
be asked to subsidize them in the interim. If an organization has decided
to attract these types of customers, it should know the minimum it needs
to offer them. It¹s not unusual to find companies providing unprofitable
customers with more than they need to and certainly more than these
customers are willing to pay for. I'd want to see empirical evidence that
these young customers will stay with the bank, how long it takes for the
relationship to turn profitable and exactly what the organization is
doing
to minimize economic losses in the meantime. Information acquired through
customer listening systems, transactional behavior and stock-and-flow
analysis
would produce such evidence.

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By r.forsyth
04th Sep 2001 15:32

Richard

I pretty much agree with your comments on LTV. However, it is the
MOST useful metric you can have on a customer... if you get it
halfways right! The way that I have LTV scored in the base is three
metrics broken out. Current value which is how much that customer has
contributed (net) to date, NPV which is future net earnings. I also
have a calculated measure which is a ratio between the two. The ratio
keeps you honest and stops you throwing away too much money or indeed
not enough to manage the customer. For my business, which as you
know, is Telecoms the next most important piece of data is a good
churn score. I find that if you combine the value metrics along with
the churn score into a High/Med/Low matrix you get some excellent
insight into where to spend your marketing and retention dollars,
excuse me, pounds. I am not suggesting just using this tool alone,
but I do find myself going back and pulling it from my toolkit more
often than others.

Definately a good series of editorials, very informative and
provoking.

As a suggestion for your next series you might want to consider, CRM:
Consultant Relationship Management, "the role of the consultant and
how to maximize your returns".

Keith

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By AnonymousUser
03rd Sep 2001 14:00

Dear Richard,
I love your editorials .They are not too long as your friend says but they really encourage the little painful thing called thinking.
First of all: PRG are talking about an actual and a strategic value and call the two of them together CLV.So the current value and the oppotunity as mentioned by you are respected.
But let's stick for a moment with retail banking that you mention:
A student is opening an account and is taking a loan i.e. the bank is financing the student,hoping that he remains a client.If the CLV discount rate (Let's assume the 10 year US Gov.Bond rate)equal the IRR of the bank the present value of this account is zero.(I have assumed that the actual value is the pres.value future profits of the existing calendar year and the strtegic value is limited to 5 future years and both together represent the CLV).The CLV can even be negative in case the discount rate is higherr than the IRR.Not only accountants should be rolling in agony ,also CFOs.This is what you mentioned by running out of cash flow.However:The CLV in future years can still be negative but the CHANGE is positive.This means that the customer is producing value instead of destroying it.After 3 years he finalised his studies and ,say,the change in CLV is taking a big leap into a positive number.
From my perspective the CLV is the crucial but difficult point in CRM.Without measuring and monitoring it following a certain formula you will never be able to come to a final value judgement of your customer.

Axel Heinemann

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By admin
27th Aug 2001 17:51

The CRM Goal is simple: Grow yield per customer.
LTV is the soft metric equivelant for "yield per customer" - but is often mis-used at the expense of marketers' credibility with Finance, IT and Exec. Management.
Many companies over-invest in scrutinizing their customer activity, cost/revenue streams without looking for an 80/20 shortcut. If you can identify your "golden goose" customers LTV - except for your ideal customer profile - may be irrelevent.
The question is "Why LTV?" The LTV formula should highlight operational issues/opportunities as well as marketing and sales. My last excercise with a client to map "the customer experience" detailed 84 interaction points used to derive customer yield. Each intersection has 8-16 nested factors to determine customer value, lift and trigger events/rules. (this level of analysis is why SAP and PeopleSoft will have a leg up in CRM - they have already been run through the ABC cost accounting support process)
LTV makes sense in catalog and continuity marketing but does not make practical sense in many industries or channels.
The referneces to banking are obvious with the large number of "unprofitable" customers financial institutions carry - but those customers bear large amount of the operating cost- pointing to the need for LTV to reference cost allocations - expense balancing and other non-marketing variables.
The evolution of the web as a self-service and collaborative market will continue to drive LTV discusions as more savy customers negotiate preferential pricing/recognition in exchange for dealing "direct" managing their own business. The yield per customer discussion will become more prevalent at the Board level, shareholders, and eventually customers will demand to see their personal statement of condition depicting their value Then business gets interesting.

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By admin
28th Aug 2001 06:13

The CLTV article makes interesting reading.Before calculating the CLTV it would be nice to list down the business objectives of measuring the CLTV.These objecives can be as differentiated as doing a due dilligence of the company (ex. telco) to service differentiation strategies.
The benefits of CLTV perse is only one goal.The analysis process itself brings in lot of value to company.Customer segmentation is an essential part of CLTV.The granularity of segmentation should be limited by business objectives .Attributing the cost to customer level using ABC is another challenge.Predicting/forecasting the future loyalty /revenues based on external /internal events and on assumption of business continuty is an important factor.And finally what is so sacrosanct about the CLTV calculated once.This is a dynamic value based on many factors/events.Take for example telco.How accurate would the cltv calculated an year back would be accurate after 2 years when 3G networks would cater to a lifestle of telecom subscriber than that of just his/her communication needs.
A good CLTV framework would involve lot of dynamic inputs from the end user and to an extent support what if kind of analysis.This is a Business strategy framework serving short term and long term goals and understanding the business better.The company executives start to thing in time frames that is a side benefit.

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By r.forsyth
28th Aug 2001 09:41

Excellent editorial on the realities, myths, and mysticism of customer lifetime value. It's an extremely important subject that often gets mangled and misunderstood by CRM practitioners and consulting professionals alike.

Allow me to further complicate the picture. With apologies to Peppers and Rogers, there is a good deal more to customer lifetime value than looking at present, and even potential, direct economic estimates. There are intangible - yet quantifiable - elements that can, and should, also be factored into a lifetime value equation. These include information value, the proportionate amount that can be determined from anecdotal and dimensional insight provided by customers, and that is layered onto present and future economic value estimates. In addition, there is referral value, the monetary amount derived from customers who recommend a supplier's products/services to friends, colleagues, and relatives. A bit more esoteric, perhaps, but achievable with some effort.

As discussed in Customer WinBack, the new book I've co-authored, there is also 'second lifetime value'. That's the extended amount, gross and net, from incremental, or second lifetime, purchases of a lost customer who has been won back. If you regard the customer's actual lifetime, or life cycle, as we do - as acquisition, retention, and win-back - and see them as interdependent in optimizing CRM, this makes eminently good sense. Within our book, we've devoted two whole chapters to the estimation of lifetime and second lifetime value; and we've identified some excellent examples of companies that do this very well.

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By r.forsyth
27th Aug 2001 13:51

Richard,

I like the thrust of your article--many CRM consultants and policy wonks talk about customer profitability but not many companies are really measuring it.

But you don't need to be a rocket sciencist to calculate it. Our "Customer Based Accounting" method can be employed if you can come up with a spreadsheet listing customers and their revenue for a period of time--plus get some costs data from the annual report or from the bean counters.

Jay Curry, Chairman
The Customer Marketing Institute
www.customermarketing.com

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By r.forsyth
28th Aug 2001 17:32

In my editorial, I forgot to point out that there's other material in the CRM-Forum on the issue of measuring customer value which I should point you at.

Can I highlight three. Firstly Dr Jim Barnes is publishing his views on measuring customer value in his newsletter. One which has just been published is:
The Relationship Equity Index: Part II – Creating a Customer Relationship Index .

Michael Meltzer also has his inimitable views on Customer Profitability. You should check them out at:
Are Your Customers Profitable? and
Customer Profitability: Information Just Isn't Enough

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By admin
27th Aug 2001 15:45

Richard,

Thanks a lot for your editorials. I really enjoy reading them.

Here are my thoughts about LTV:

The assumption under which the Peppers definition of LTV „the net present value of the future profit stream from a customer” is true, is of course that you start looking at t=0 (that is at the beginning of the customer lifetime) and end at t=x (the presumed end of your relationship with this customer). If you look at a customer who purchases your products since 5 years, you would have to go back to time zero of course, when his lifetime at your company started. So LTV does not neglect past experiences. It is focused on the whole customer lifecycle and not only on a piece of it (which would put the whole philosophy of LTV ad absurdum). No cynism there.

The reason why people started to look at the LTV was not only to better serve customers but to forecast profit for each customer and in sum to better predict profit (or loss) for the whole company. A company that is focused on all those LTV’s of its customers and oversees that the sum is a huge minus for the next year (or years) faces a severe controlling problem and should think about changing management but shouldn’t blame the LTV. (There are indeed some dotcoms who have just suffered the consequences of this problem).
I also think that this is also true when it comes to the evaluation of how long a new found customer might stay being your customer. It’s the mix of good statistical/data mining tools and marketing/controlling expertise that should manage to carefully plan customer behavior – and profit. You are right – a prediction for the next 90 years is mad, discounting future profits for this period, too.
LTV is still a perfect instrument to help me evaluate which of my customers I should treat like diamonds because I don’t want my competition to steal them (Not to worst tactic to reach my long term strategy).

:-)

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By AnonymousUser
27th Aug 2001 15:18

Richard,

Your essays on cliches are making a valuable contribution to the CRM conversation. Thanks.

RE: The essay on Lifetime Customer Value, I refer you to the website of Booth Morgan Consulting (www.boothmorgam.com)who has developed a truly innovative approach to the customer value issue. BMC proposes that a company's management will best serve shareholders by making the creation of customer value its primary governance imperative. This proposition is the essence of an authentic customer centric business model. Working with CPAs, BMC has developed a methodology for auditing customer portfolios in a fashion that can be relied on by investors as representing present net value of audited portfolios.

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By admin
27th Aug 2001 14:34

Most definitions of LTV use NPV but I often suspect that this is too prescriptive, too narrow, too simplistic. How do we measure intangibles like the "referral value" of each customer, for example?

Even if you accept that a purely financial measure like NPV is appropriate, as Richard points out, its accuracy is debatable. In fact, there are a number of valuation techniques in use. The main attraction of NPV is its (relative) simplicity. Would it be cynical to suggest that, when it comes to valuing companies etc., the technique used is the one that gives the "right" answer?

Company accounts are sometimes criticised as presenting too narrow a view of performance, of being "unbalanced". If NPV, along with other purely financial measures are too narrow, too prescriptive, do we need a "balanced customer scorecard" to measure LTV?

:-))

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By AnonymousUser
28th Aug 2001 11:11

Rather than get hung up on one approach, I think it helps to figure out a couple of things first of all:
1. Why are we doing it? 2. What can we measure? An example I think will serve to help. Couple of years ago I worked for a very large computer company which invested heavily in sales and relationship resources on its B2B business. We wanted to increase the productivity of these resources , and take a more hard headed and pragmatic approach, based on profit potential. Using a simple matrix based on hi/lo share & hi/lo growth plus total IT spend, we were able to plot all our accounts into one of the four quadrants that resulted. Whilst we had good info on past performance, we did not have great info on the future, so we used as proxies the growth rate of companies based on previous 3 yrs history and also used another proxy for share of wallet, which was based on industry averages of IT spend. Whilst this was not massively scientific, it helped us come up with a better rationale for deploying resources than before.(needless to say all growth projections going forward were too large!) This was however the first step, and if we'd stopped here, it might have been a case of 'rearranging the deck chairs on the Titanic'. So the second step was to figure out high potential buying behaviour The upshot was that marketing needed to give some practical direction to the field to help them expose opportunities that traditionally we were missing. The short term impact was a remarkable change in the levels of respect accorded marketing. The company is profitable, though growth is slow and remarkably there is now a considerable amount of cross product collaboration, as insights have been shared. This pragmatic and imperfect approach yielded actionable results. In my years at the company, I had never witnessed any global approach working so successfully. Everyone is now worried about customers, even if the maths is a bit dodgy!

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By admin
28th Aug 2001 11:21

Your editorial neatly sums up many of the issues concerning life time value. I believe that the confusion/misuse/misunderstanding over LTV comes from the multitude of definitions out there.

Whatever way you phrase it, or whatever buzzword you use to describe it, there is no doubt that by understanding what a customer has brought to the bottom line up to today and what they will bring to the bottom line in the future is incredibly useful for business planning.

By referring to the contribution to the bottom line implies understanding all those elements that have a bearing, including referrals, 2nd lifetime etc that have been mentioned above.

As to how you calculate/predict the value I believe that the approach followed by Qube (www.qube.co.uk) is incredibly simple in concept and yet can incorporate as much as complexity as the business requires.

In a nutshell the concept is identifying all customer "events" that have a bearing on the bottom line and then either calculating them or predicting them time period by time period. If you believe in allocating fixed costs then you can do this by assigning a fixed cost "event". If you believe in referral value then you can build in a referral "event". By building up the events you can create a picture of value as complete as you need it.

...and no I do not work for Qube!

David Pardoe
The Data Laboratory
[email protected]

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By jimnovo
28th Aug 2001 15:56

Outstanding series; vetting these issues at a high-level is I'm sure helpful to readers.

I'd like to add my LTV "proxy" ideas to those of Richard, Jeremy, and others. My suggestion is to focus on changes in LifeTime Value, rather than any absolute number. In many cases, it is more important to determine the *direction* of future customer value - is it increasing or decreasing relative to other customers? This allows the proper allocation of resources for customer retention and growing customer value without the mathematical gymnastics of determining an *absolute* LifeTime Value.

With this approach, the LTV metric has more weight in what is happening now and in the future, rather than what has happened in the past - usually a good thing, since you don't want to rest of the successes or failures of the past.

But how do you track and evaluate future value and direction of this value? By using customer behavior metrics known to affect the likelihood of ongoing customer involvement and interaction with the company. Customers frequently telegraph their intentions through their behavior (or lack thereof) when compared with other customers; this sets up the ability to compare and rank customers for future potential and value, and determine if it is rising or falling. For example, increasing Frequency of contact just before a contract renewal may be a positive indicator; declining balances in an account after consistent increases can be a negative indicator. These indicators are developed by comparing defecting customers with best customers and looking for differences in behavior.

Rather than try to explain more about these techniques in this format, I suggest you read an article of mine posted to the CRM-Forum library this week titled:

Tracking the Potential Profitability of B2C CRM Implementations.

It's linked on the home page of CRM-Forum or you can use this URL:

http://www.crm-forum.com/library/art/art-121/

Jim Novo
Drilling Down Project

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