Customer Lifetime Value, Part II: LTV as a Business-Building Tool

In my last post I discussed the basic concept of customer lifetime values and why they’re so important to businesses, in terms of helping them visualize the value-creating role that customers play.

Quarterly sales show the value already generated by a customer’s current-period transactions. LTV predicts future value likely to be created by a customer.

But now, assuming that your analytics people actually have gone to all the trouble of modeling your customers’ LTVs, what should you do with this information? What actions can you take to build your business?

As a first step, even if your LTV calculations are only based on a rudimentary analysis, they should allow you to better prioritize your marketing activities:

• Look-alike acquisition: If we know what a high-LTV customer looks like, then we ought to be focusing our customer acquisition efforts on those prospects who most closely resemble our high-LTV customers. Target selection is particularly critical to high-end goods, such as automobiles, for instance.
• Selective anti-churn activities: When a customer with a $200 LTV leaves, the economic cost is four times greater than when a $50 LTV leaves, so to get the most bang for your buck your anti-churn efforts should be concentrated first and foremost on high-LTV risks. Telecom companies are masters of this.
• Adjusting service levels: Since better customer service almost always costs more money to provide, higher-LTV customers are the first ones who should receive better, more costly services. That’s why airlines tier their customers into Platinum, Gold, and other levels, for instance.

But aside from this simple prioritization tactic, there is another, even more important business-building strategy made possible when you think of your customers in terms of their lifetime values (rather than just their current spending):

Track changes in your customers’ LTVs, over time.

Whenever you implement some action or tactic that increases a customer’s LTV, you are adding real economic value to your business by the amount of that increase. You may not realize that value immediately, and you may not be as certain of the exact amount as you would be of an actual sale already concluded in the current quarter, but an LTV increase still represents genuine value for your company. It just hasn’t been collected from the customer yet.

Or think of it this way: If you had bought a stock last year and you now want to evaluate how you’re doing on that investment, you wouldn’t be satisfied just in knowing how much you already collected in dividends, right? No, you’d want to know what the stock is worth now, even though you might not plan to sell it and collect that value yet.

And businesses should think of their customers in a similar way. Customers are financial assets to a business, like stocks or bonds, but these particular assets have brains and memories, so their values will go up and down based on how they have been treated. Obviously, the most direct way to increase any customer’s LTV is to provide a better customer experience, first by reducing the friction that often leads customers to defect, and then by improving the level of engagement with a customer, so as to create more emotional loyalty and commitment.

However, since it almost always costs money to improve the CX, it’s only logical to ask how much value can be created, in exchange for what cost? And this is why it’s important to be able to track LTV changes. Tracking changes in LTV requires a business to evaluate customer LTVs at regular intervals, with models that can be compared on a time-sequence basis.

As we were writing our 2005 book Return on Customer: Creating Maximum Value from Your Scarcest Resource, Martha Rogers and I searched the academic literature in vain for any mention at all of using changes in customer lifetime values as a business-building tool, and we found not a single mention. Lots about prioritization, but not a peep about growing these values, over time.

Since then, however, forward-thinking companies with advanced predictive analytics initiatives have begun to focus on the issue. Royal Bank of Canada, for instance, was an early adopter of change-in-LTV as a KPI. And an analysis a few years ago from Aberdeen found that top-performing companies using customer analytics outperform their peers in areas such as “year-to-year changes in customer lifetime value.”

So my advice is, start thinking of customer lifetime value as a tool for building your business over the long term. What you want, fundamentally, is to improve the customer experience in ways that increase the lifetime values of your customers, growing them into ever more valuable assets.

LTV change is the primary value-creating vehicle behind improvements in the customer experience. 

Think long term. It’s no longer rocket science. 

In my next post, the third and final part of this series on customer lifetime values, I discuss how you can actually track LTV changes in real time, in order to evaluate your current-period strategies and tactics based on the improvements they are likely to make in customer lifetime values.