Measuring Customer Lifetime Value

In business, we have a common rule of thumb that acknowledges the value of customers over their lifetime.  It’s called the Pareto Principle, more commonly known as the 80:20 Rule.  The Pareto Principle says that 80% of your sales come from 20% of your clients.   Unfortunately for these highly profitable customers, many organizations are not designed to nurture them.

 

Measuring lifetime value draws attention to customer retention

 

What gets measured gets done. 

 

In many companies, the sales and marketing team’s performance is measured against how much new business they bring in.   At year end banquets, these are the people who get the awards and accolades for the “Best Campaign” and “Most New Business”.  It is difficult to find and develop new business and the winners of these awards do deserve recognition.  By measuring, then recognizing new business leaders and their accomplishments, companies reinforce the importance of the hunter’s instinct within these teams.  Success, as defined by these metrics and rewards, shifts the management focus toward developing predatory skills.

 

Great hunters have highly specialized skills.  They have the intelligence to outwit their adversary and competition.  They can avoid detection.   They savor the challenge of the chase.  They pounce on opportunity and thrill in the kill.  The organization that focuses on developing hunting skills can become great a making new customers.  New business development is an enormous part of success but like all things without balance, the single-minded focus on it can be detrimental.

 

As Peter Drucker pointed out, the purpose of business is twofold.  The first purpose is to make a customer.  This is the environment that favours strong hunting skills.  The second purpose of a business is to keep a customer. This is where hunters are limited.  They can’t bring their prey back to life.  Without measuring the performance to keep a customer, hunters haven’t the need to develop new skills to heal a wounded relationship or nurture an existing partnership.   The organization that focuses exclusively on developing hunting instincts and views customers as prey limits their potential growth.  In other words, hunters have few reasons to spend time with the 20% of customers who generate 80% of their business.

 

There’s a hole in my bucket

 

I’d like you to consider the twofold purpose of business, to make and keep a customer, like filling a bucket with water.

 

With only new business metrics in place, an organization focuses on filling the bucket.  In my own experience, most of my attention was directed to filling the bucket and discovering new water sources.  Over time, my behaviour became so automated that I neglected to look at the bucket.  Suddenly I realized that the bucket had holes.  No matter how much time I spent finding new water, I would never be able to keep the bucket full.  While I was being praised and rewarded for finding new customers, I had few incentives or resources to keep them.  It’s been my experience that a single-minded focus on new business metrics creates short term thinking.

 

With customer lifetime value metrics (CLTV) in place, an organization focuses on keeping the bucket full.  Viewing a customer value through the lens of their lifetime value changes the way you value and interact with customers.  CLTV metrics direct attention to empathizing with a customer.  Putting attention towards keeping the bucket full is to focus on the 20% of your customers who generate 80% of your business.  CLTV metrics rewire behaviour to look for the holes in the bucket before filling it with water.  You may begin to ask for suggestions and ideas on how to maintain the bucket in good order.   You may find and direct resources to maintain the bucket.  You will find that the bucket will always have leaks, but takes much less work to keep it full.

 

Applying customer lifetime value to your business

 

1. Identify the 20% of your clients who generate 80% of your business.  Talk with your employees about what you can do to super serve these clients.

2. In addition to New Business awards, add a new award called Highest Renewal Rate

3. Review your marketing budget.  What percent of your budget goes toward new business acquisition?  What percent do you allocate to customer retention? How might you best balance the budget between the two? Research of top performers, suggests 2% of revenue is used to create the marketing budget and 30% of which is directed to customer retention.

4. Start a referral program.  Monitoring your referral ratio [(total # of referrals) / (total # of customers)] can be a measure how well you are serving your existing clients.

5. Instead of calculating new sales this week, calculate the lifetime value of each new customer by segment.

 

Do you measure lifetime value of a customer? How do you do it?

 

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