CLV predicts the potential value of a customer and informs marketing efforts to maximize that value. Its value, says Martha Rogers, lies also in its tendency to grab the attention of top executives better than customer loyalty stats or the popular net promoter score.
"Actual current value is useful, but actual value coupled with potential value could make me a genius," said Rogers. "If I could only be there at the right moment and anticipate a customer's needs, I could deploy my sales force to where the money should be tomorrow. Further, you then could determine which of two customers, both equal in sales, has the greater potential. To treat them as having the same value is insanity."
How to apply customer lifetime value to the marketing function becomes clearer when companies realize there is an upper limit on how much they should spend to acquire a new customer, as well as a limit on the money spent to retain a current one.
"Companies that look at the costs of serving customers, and not just the revenue they bring in, have found that a lot of customers can be unprofitable," said Phillip E. Pfeifer, professor of business administration at the University of Virginia's Darden School. Pfeifer wrote the CLV section of the book, "Marketing Metrics: 50+ Metrics Every Executive Should Master," published last year by Wharton School Publishing.
"Marketers are being asked to be more quantitative about things, and whether the money they're spending makes a difference or not," Pfeifer said. As an example, he cited direct mail: If the assumption is that all prospects have the same likelihood of responding to the mailer, one can simply run an average of the cost of the entire campaign against its ultimate response rate.
"But since you know through your scoring model that the top percentage of prospects will respond best, obviously you start at the top," he said. "Where you stop mailing is in determining the value you'll ultimately get from customers lower on the list."
A standard formula for determining customer lifetime value multiplies a customer's current margin (assuming it won't change over time) by the "present value" of the future relationship, factoring in a standard discount (since money paid later is worth less than money paid now). It sounds heady, but it doesn't have to be that complex.
"If it costs $1,000 to generate a customer, and we get $999 from him, it's not a good deal for us," said Peter Justen, CEO of Mybizhomepage, a Web portal for small businesses that displays a user's QuickBooks information in dashboard form. Mybizhomepage, free to users, typically offers its service to other businesses, such as banks, eager to attract its own customers to a customized Mybizhomepage portal.
To determine the CLV of its users, the company looks at how many are using it as their home page. If a channel partner's portal has powerful CLV, Justen said, he may pump in more marketing dollars in support.
"I don't use difficult formulas," Justen said. "Business is hard enough. The tough part of business is keeping it simple."
A much larger company is Rhom and Haas, a manufacturer of specialty chemicals, which is using a variant of CLV called share of requirements to fine-tune its allocation of marketing resources in favor of those customers with greater potential for incremental sales.
"We found that we were wasting resources putting them against customers that didn't deserve it," said Gerry Lopez, director of marketing excellence. "When you come to a significantly different conclusion on how to deploy marketing and service resources, it can show you tremendous opportunity."
If there are downsides to determining customer lifetime value, they may lie in two areas. First, it's a fairly complex metric that requires faith in predictions (or a consultant to parse it for you); second, it can be tough to get appropriate data. To get accurate CLV values, many b-to-b companies have to reach through a phalanx of resellers to assess their ultimate customers.
Moreover, lifetime analysis tends to stumble over the historical disconnect between marketing and sales, said Tony Jaros, VP-research at Sirius Decisions. Sales often is reluctant to share information, he noted.
"The question is, who owns the data and the customer?" Jaros said. "We often find that intelligence about a customer doesn't get captured anywhere except in the salesperson's brain. I love the theory of CLV; it can be very powerful, but only when used correctly. It's not a savior of a company's shortcomings."