Customer Lifetime Value (CLV) is a powerful metric used to maximize shareholder value. It allows organisations to make smarter decisions, notably on customer acquisition and retention, and pricing. More and more organisations are using the metric, notably e-commerce and SaaS businesses. However, there are many misconceptions about it. Today, we will investigate the three main pitfalls when dealing with CLV. These are:
- Pitfall #1: Not factoring in variable costs
- Pitfall #2: Not accounting for the time value of money
- Pitfall #3: Using a finite horizon instead of an infinite one
Pitfall #1: Not factoring in variable costs
The first pitfall is not factoring in variable costs when…
Why is that? After all, when calculating CLV for the average customer, it seems only natural to sum the cash flows to the average tenure, quite literally the tenure for the average customer. This is correct, but only if the cash flows in question are both the true cash flows for the average customer and undiscounted.
The “double-averaging” mistake
In an “undiscounted” world, summing the true cash flows for the average customer (that is, not reduced by the effect of churn) to the average tenure and summing the cash flows reduced over time by churn to infinity is equivalent.
Using a simple example…
Alexis Charolais
Analytics-focused consultant at Bain & Company with a strong interest in Customer Lifetime Value. Angel investor & start-up advisor.
