October 2015 | 

CLV: The Numbers You Need to Know

CLV: The Numbers You Need to Know

“Customer Lifetime Value isn’t even in the vocabulary of most companies,” says Wharton marketing professor Peter Fader. That means Fader, who is a global CLV thought leader, has his work cut out for him. But he’s up for the challenge.

“Those who are talking about it are mostly marketers, and some of them view it as a bit faddish,” he says. “That’s what I thought in the beginning too. But now we’re seeing that CLV can be a genuine game-changer. Its use cases are growing, and it has the ability to bridge silos, offering a ‘gold standard metric’ that everyone from marketers, R&D people, HR, and senior executives can share.”

Fader, who teaches the two-day executive education program Bringing Customer Lifetime Value to Life: Practical Methods and Applications, says those coming to Wharton to learn how to do the calculations, and how to apply them, represent a cross-section of companies that understand how powerful CLV can be. “Many of the participants want to know how to get the numbers, and then they’re tasked with getting everyone else to trust them. Getting the numbers is the easy part. The models we use are well established — some have been around for decades — but they have either been ignored or used only in marketing. Getting buy-in across the organization is the hard part, but we provide a very compelling sales pitch.”

One of the most interesting developments for CLV has been in the finance suite, where it is being used to value the organization. Traditionally, corporate valuation is a top-down calculation. But when you project the value of every customer, and add them up, you get a value for your organization (barring investments and non-operational assets). “Beyond an accurate valuation tool, CLV also offers many diagnostics for pain points and opportunities,” explains Fader. “Recognizing the value of your customer assets is an objective method for valuation. Some companies are using it as the basis for private equity activities and hedge fund investments. Every day, finance professionals are gaining a greater appreciation for it.”

He adds that R&D should be paying attention as well. “This part of the organization rarely has direct contact with customers, but they make decisions about which new products or services to add, and which to discontinue. The problem is you can’t judge the value of a product by itself. You have to judge it based on which customers are buying it. It might be a loss leader that makes your best customers happy. A product shouldn’t be judged by its sales, per se, but by how much its presence or absence impacts the CLV of the customers who buy it.”

It follows that rewards and incentives for R&D teams should be based on CLV. Typically, those in R&D are rewarded on the basis of how many units of a new product have sold. But, says Fader, “are those sales really creating incremental revenue for the company, or are they just cannibalizing sales of existing products? CLV is a great way to get a holistic vision of your customer, and it tells you how much genuine value you are creating with new products.”

Sales is another area in which CLV is being put to use. “As in R&D, a sale in and of itself doesn’t tell the whole picture. It is much more effective to reward salespeople for how much expected future lifetime value they create. The sales force incentive programs used by most companies value ‘order takers,’ not necessarily ‘relationship builders.’ This is where CLV comes in. When you periodically calculate CLV for each customer, you can reward sales people for how much of future expected value they increased. Reward them for the fact that the customer took the sales call, showed up at an event, tried a sample. Those actions don’t necessarily show up as dollars today, but with a forward-looking metric like CLV, they can be captured and rewarded.

While Fader is encouraged to see finance, R&D, and sales using CLV, ultimately he wants senior executives to understand its value. “The first forays into customer-centric strategies didn’t go very well,” he notes. “Talk of the ‘customer experience’ can have a hollow ring — it’s hard to quantify, and CEOs have been dismissive. But CLV is different. When you add all of your CLVs, you get a real number that represents customer equity. This might be seen as an intangible asset from a pure accounting standpoint, but it is a very tangible asset when it comes to critical operational decisions.”

“I want CEOs to know their customer equity,” he continues, “and how it changes over time. I look at other marketing metrics that get talked about in the C-suite (such as Net Promoter Score), and I believe CLV should be there too. As CEOs become more quantitative, they’re looking for new angles to impress Wall Street and differentiate themselves. CLV can do that.”