Dr. V Kumar
ING Chair Professor of Marketing; Executive Director, ING Center for Financial Services; and Chairman and CEO, IMC International

Customer Lifetime Value
What is Customer Lifetime Value?
Customer Lifetime Value (CLV) is a simple but powerful concept. Its simplicity comes from its basic definition: “Measure of expected value of profit to a business derived from customer relationships from the current time to some future point in time” (usually three years in the case of most businesses). Its power comes from the level of sophistication invested to develop the metric before deploying it as a marketing decision support system.

Customer Value Framework - The Future of CRM
For a firm to manage its interactions with its customers on a continuous basis such that it can maintain and improve customer relations and simultaneously maximise profitability, it is important for the firm to ensure that its Customer Relationship Management (CRM) program is woven around the concept of Customer Lifetime Value. Such an approach is known as the Customer Value Framework (CVF).

Adopting the CVF
Based on the company’s level of maturity in CRM, CVF can be adopted at level one and gradually taken to level three as described here.

Micro-understand the Loyalty phenomenon in
the firm
Contrary to conventional wisdom, all loyal customers are not necessarily profitable and all profitable customers are not necessarily loyal (Reinartz & Kumar 2002). It has been demonstrated that the pursuit of Loyalty defined either as ‘Duration of Association’, ‘Share of Wallet’, ‘Recency, Frequency and Monetary Value (RFM) score’, or ‘past profitability’ may not be an optimal marketing goal. Empirical evidence has been gathered to show that customers who purchase steadily from a company over time are not necessarily (1) cheaper to serve, (2) less price- sensitive, or (3) exhibit a tendency to bring in new business (Reinartz & Kumar 2000). Therefore, we should be aware that the perceived benefits associated with cultivating loyal customers do not always materialise. Marketing decisions should therefore be based on the understanding of the link between Loyalty and Profitability rather than on Loyalty as an end in itself. In other words, loyalty and profitability should be managed simultaneously and a segmentation scheme (True Friends, Barnacles, Butterflies and Strangers) based on both these dimensions achieves that purpose (Reinartz & Kumar 2002). As a strategy, managers should then limit their spending with their customers so that it does not exceed the gross margin. Level 2 demonstrates how this can be done.

Determine the Profitable Lifetime Duration for every customer
No firm would want to waste its resources by chasing customers who are not likely to be profitable in the future. Deciding when to let go of an unprofitable customer is therefore critical. Reinartz & Kumar (2003) suggest a procedure that can be followed for obtaining individual Profitable Lifetime Duration estimates. The first step involves determining the contribution margin expected from each customer in future periods based on the average of the contribution margins in the past. The second step is to determine for each future period, the probability that the customer will be active and will transact with the firm. The third step is to combine these two components .The fourth step is to discount the expected contribution margin in each future period to its Net Present Value (NPV) using the cost of capital applicable to the firm. If, in a given month, the cost of additional marketing efforts turns out to be greater than the NPV of the expected contribution margin, we know that the Profitable Lifetime Duration of the customer has ended. Thus, the length of the profitable lifetime duration is determined. Also, the NPV of the Expected Contribution Margin suggests the upper limit for spending on each customer. This information should help managers save time and resources by not contacting the unprofitable customers. If managers are interested in understanding the factors that drive the Profitable Lifetime Duration, Level 3 offers such guidance.

Determine and control the factors that affect the Profitable Lifetime Duration for every customer
Reinartz & Kumar (2003) provide intuitive explanations and empirical evaluation for the expected effects of key variables that could impact Profitable Lifetime Duration (PLD). For instance, a customer who has a tendency to buy across the product line of a firm and therefore exhibits a high ‘Degree of Cross-buying’, can be expected to exhibit a sustained profitability compared to other customers. Customers who demonstrate a moderate but stable time interval between successive purchases are likely to be profitable for a longer duration than customers who have long inter-purchase intervals or those who burn out after a rapid series of purchases. Surprisingly, ‘Number of Product Returns’ can relate positively to profitable lifetime duration, because heavier buyers are also likely to return more merchandise, and a positive experience during the return procedure is likely to boost the buyer-seller relationship. By monitoring and influencing some of these commonly measured variables, managers can enhance the firm’s profitability across its customer base. Although the factors can vary across industries, there are some common factors that affect the PLD.

Applying the Customer Value Framework
Once the firm has developed the CVF, there are several strategic marketing objectives that may be fulfilled through the prudent application of the CVF. A few exciting applications (based on the author’s pioneering research findings) have been discussed here:

Optimal Resource Allocation across Marketing & Communication Channels
The inter-purchase time for a customer is influenced by marketing strategies that a firm adopts. Given the constraints of marketing expenses, a manager can determine the frequency of each of the available marketing and communication strategies so that the Customer Lifetime Value is maximised (Venkatesan and Kumar, 2004).Figure 1: Optimal Resource Allocation
Figue1: Optimizing marketing spend across different customer contact channels to maximize profitability.

By applying an optimisation model, a manager can know the extent to which he or she can decrease face-to-face meetings and increase the frequency of direct mailers, or vice versa, for each customer, or for segments of customers, to achieve an increase in total profitability. To illustrate the application, consider a real world situation.
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