Customer Lifetime Value
Manage your business based on customer lifetime value concepts.
A company's customer base can be thought of as a collection of stochastic future cash flows, not unlike a portfolio of securities. Managers then evaluate the effects of business decisions against expected changes in the present value of customers' cash flows. This is customer lifetime value analysis.
A newspaper constructed a customer lifetime value model. The figure below shows the event histories of a random sample of customers. Yellow marks a period of rebate subscription, while green marks a full price subscription. Red denotes a period of no subscriptions: The customer churned.
Through the analysis, it was found that a specific demographic group was worth significantly more than initially thought, while the rebate-full price subscription cycle for another group was hardly worth the effort.
Analysis based on the customer lifetime value concept must typically account for two main aspects of customer behavior: The lifetime of a customer and the monetary value generated while active.
Given a set of customer attributes, such as demographic data and past transactions, a model of customer lifetime value is engineered. The model seeks to relate customer attributes to lifetime and value.
An example of a basic quantitative approach is to model value through a linear regression model, while lifetime is estimated based on, say, an exponential distribution.
A customer lifetime value model has several exciting applications.
- Resource Prioritization. Sensible lifetime value estimates can serve as a basis for organizational resource prioritization in areas such as customer service level design, marketing spending, sales force pay and so on.
- Novelty Detection. Detect and react to changes in the marketplace by monitoring the formation of new patterns in customer lifetime value. Are former valuable clients all of a sudden churning at higher rates? Are new groups of high value clients forming?
Businesses can differentiate valuable customers at an early point in customers' life cycle, monitor the customer base evolution and act on their data on a systematic basis. Such businesses gain an edge on the competition.
Want to know more about customer lifetime value? Innohead does workshops, consulting and quantitative model development based on customer lifetime value concepts.