Why do you need to measure a customer’s value to the firm?

Insights from VK*

By V Kumar, Ph.D.

Businesses need every possible competitive advantage when the economy has taken a nosedive. Utilizing the Customer Lifetime Value (CLV) measurement has provided that advantage to many companies, from giants such as IBM and an upscale global fashion retailer to a many smaller firms across the globe.

CLV is a formula that helps a marketing manager arrives at a dollar value that is associated with the long term relationship with any customer.  In other words, CLV reveals how much a customer relationship is worth over a period of time. It differs from other metrics in that it is a forward-looking measurement of a customer’s performance and takes into consideration all the elements of revenue, cost and purchase behavior that drive profitability. CLV helps marketers adopt the right marketing activities today so that they can increase profitability tomorrow. Those who have been the best customers are not rewarded — those who will be the best customers in the near future are rewarded. None of the other well-known customer performance measurements is as all-encompassing as the CLV metric.

For example, the Share of Wallet (SOW) metric represents the spending that a business obtains from a customer in products and services in relation to the total spending in that category. The past profit metric assumes that the past spending behavior of the customer will continue in the future. This is not always the case. The Recency, Frequency and Monetary Value (RFM) metric, which measures the number of days/weeks/months since the last transaction occurred. It also measures how much the customer has contributed towards revenues in the past and how frequently this customer has been buying from that firm. However, none of the above three metrics reveal any information about whether or not a customer is loyal, when a customer is likely to buy next, or how much profit a customer is likely to give. CLV overcomes these three issues by incorporating the probability of a customer being active in the future and the marketing dollars that need to be spent to retain a customer profitably.

*V. Kumar (VK) is the Richard and Susan Lenny Distinguished Chair Professor in Marketing, Executive Director of the Center for Excellence in Brand & Customer Management, and the Director of the Ph.D. program, J. Mack Robinson College of Business, Georgia State University, Atlanta, Georgia.

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