Which Customers Are Worth Keeping and Which Ones Aren’t? Managerial Uses of CLV Roy Cardiff runs a mail-order business that tracks sales to each customer. He recently decided to cut costs by curtailing catalogs to those customers who are least likely to buy from him in the future.
His customers break down into three categories: those who made several small purchases throughout the past year; those who made a single purchase but for a much larger amount, and those who have had a long but sporadic relationship with his firm.
Which segment of customers should Smith prune from his mailing list?
According to several Wharton marketing professors who have studied this issue, there is no easy answer, despite new and increasingly sophisticated efforts to measure what is called “Customer Lifetime Value” (CLV) – the present value of the likely future income stream generated by an individual purchaser.
“For many companies, their whole business revolves around trying to understand which customers are worth keeping and which aren’t,” says Wharton marketing professor Peter Fader, who used the mail order example above in a recent co-authored paper entitled, Biases in Managerial Inferences about Customer Value from Purchase Histories: Intuitive Solutions to the Mailing-List Problem. “This has led managers from a broad cross section of industries to seek out more refined measures of CLV, using data-intensive procedures to identify top customers in terms of their likely future purchasing patterns.”
The goal is not only to identify customers, but to reach out to them through cross-selling, up-selling, multi-channel marketing and other tactics – all of which are tied to metrics on attrition, retention, churn and a set of statistics known as RFM – recency, frequency and monetary value.
“CLV is a hot area,” notes Wharton marketing professor Xavier Dreze, co-author of a new paper entitled, A Renewable-Resource Approach to Database Valuation. Although CLV is by no means new – it has long been used in business markets dealing with large key accounts – the concept has been energized by the increasing sophistication of the Internet “which allows companies to contact people directly and inexpensively.” CLV, Dreze says, “sees customers as a resource [from whom] companies are trying to extract as much value as possible.”
Yet many companies are discovering that CLV – which is one component of Customer Relationship Management (CRM) – remains an elusive metric. First, it is hard to calculate with any degree of certainty; second, it is hard to use.
“The only number a manager can have much confidence in is a customer’s current profitability,” says Wharton marketing professor George Day. “And the basic question becomes, now that you have that data, what are you going to do with it? Some companies use this information to create different programs for different value segments. In the financial services industry, for example, customers get different levels of service depending on how big an account they are. But there is always the risk that by doing this you anger other customers.”
In addition, it’s hard to predict how long a customer will stay with the company or how ‘growable’ he or she is. “In the last analysis,” Day says, “companies don’t really know how profitable customers are.”
Rolling the Dice
CLV is an intuitively appealing concept, but one that for a variety of reasons can be very hard to implement, notes Wharton marketing professor David Bell in an article entitled, Seven Barriers to Customer Equity Management.
CLV, say Bell and others, works best in industries where there is a high cost of acquiring or retaining customers, such as in financial services, airlines and hotels. “It’s also useful in situations where you have a skewed distribution of transactions – i.e. where a small number of people drive most of the business, as in hotels – and where firms can offer rewards and inducements to affect customer...
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