The customer is the most important aspect of every business around which the whole business revolves. The customer satisfaction is the major aim of the business. Thus, retaining the customer and providing him what he needs is the priority of the business. Thus, a business earns a profit from the customer over the time a customer stays with the business. Therefore, Customer Lifetime Value can be defined as the net profit that can be earned from the customer from the entire future relationship with the customer. Thus, it is a prediction as to the retaining of the customer and how much value can be associated to it. The future cash flows predicted from the customer are calculated on the present value of the customer relations.
Customer Lifetime Value or CLV is widely used these days in the industry so as to know about the customer of the business and they're worth. It is used to assess the financial value of each customer. This way the business can rank its customers because at times the value of a few customers is more than the rest. It is important for the business to know its customers and prioritize them. This helps the business in categorizing their customers and emphasizing on the important ones.
CLV is used widely these days to categorize the customers. It has become important for the business to know their customers. Some customers bring huge revenues to the business and some don’t. Thus, a business cannot treat all the customers equally which is why the business must create segments of the different customers and focus on the one which brings huge revenues for the business. CLV helps in carrying out this process.
CLV is calculated by subtracting the cost incurred on the acquisition of the customer and the cost incurred for serving them by the revenue generated from them. The other expenses incurred by the customers i.e. expenditures on every visit, customer database maintenance etc. are also attributed to the cost incurred by the customers.
The Customer Lifetime Value can be calculated using any of the following two methods:
The historical method is simple and more reliable than the predictive model. The prediction model may be rendered useless in case of any uncertainty.
Average revenue per user: Under this method, the average revenue earned from a customer is calculated. This average revenue can be calculated for every month i.e. Total Revenue earned from the customer divided by the number of months for which the customer has been associated with the business. This average can be used to predict the future revenue that can be earned from the customer. This method is most widely used as it helps to ascertain the average value. Even if the value fluctuates, it will not affect the average and will fall in the same circle.
Cohort analysis: Cohort Analysis is used by the companies to analyze the customer groups in total. This approach is used to study the market groups rather than studying individual groups. The cohorts are formed of the customers with similar traits and characteristics. The customers behave in a uniform manner. Their behavior is studied and it is ascertained as to what affects their tastes and preferences. Factors such as market changes, seasonality and the introduction of new products, competitors or promotions could skew cohort analysis.
Individualized CLV: It is a difficult and complex process to ascertain the CLV of a customer. It is a timely task and the companies choose to either outsource the function or use secondary data to ascertain the value. This lowers the burden on the company and helps in finding reliable data. This could mean comparing CLVs as obtained through social media advertising against those from other digital marketing tactics, for example, with a focus on whether company resources are being efficiently spent.
It is important for the business to ascertain the customer lifetime value so that it can formulate strategies accordingly. The CLV can be used as follows:
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This is a measure of the financial worth to the organization of a retained customer. Measuring the lifetime value of a customer requires an estimation of the likely cash flow to be provided by that customer over their customer lifetime. That is to say, if a typical account lasts for ten years, the net present value of the profits that would flow from that customer over ten years will need to be calculated. There is a direct linkage between the customer retention rate and the average duration of a customer relationship. Increasing the retention rate of customers will have impact on profitability, as well as what the effect of extending the customer lifetime by a given amount will be. This information provides a good basis for marketing investment decision making; in other words, how much is it worth spending, either to improve the customer retention rate or to extend the life of a customer relationship? For this understanding, measuring and managing customer loyalty is very important.
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