Customer Lifetime Value (CLV)

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1 Customer Lifetime Value (CLV) The concept of Customer Lifetime Value or CLV was first discussed in 1988 but it was famous coffee brands in America like Starbucks that used it on a large scale to measure the value that different customers hold for the company. CLV is now being used in all types of industries including insurance as the new metric to measure the value of your business or rather your customer. But what is it and how much value can a company derive from it? Let s consider our customers, which customer is the most valuable to the company? The broker and internal sales staff will answer that it must be the customer with the highest premium. The underwriting department may disagree, they need to show an underwriting profit so they will consider the customers with the lowest loss ratios to be the most valuable. The marketing department may also have a different view, they may consider the clients that represent the most brand value or buy the most products. The answer is that all of them are correct but it s a combination of all these measures and more that the CLV aims to capture. CLV = the net profit that the company will earn over the complete future lifetime of the client CLV assists us to rank customers based on the value that they bring to the company and research shows us that the sum of the CLV of all our customers is closely related to the value of the company. 01

2 A simple equation may look as follow: CLV = Future Premiums Future Expenses Future Claims But of course, actuaries can never keep it simple and so the equation can become very complex depending on the needs of the company and what the company wants to use the CLV for. The equation may include: The ability to cross sell to a customer and what the value of the cross sell can be; Assumptions on lapses; Future premium increases; Inflation and discount rate; Stickyness or persistency of the client; Different periods of projection; Commission; Claims expenses; Underwriting expenses; and, Marketing expenses. Start with a basic equation and add complexity over time. Inefficient Marketing Many companies, and this applies to companies in all industries, have no clear customer cohort that they target and if they do they do not follow through in targeting only those clients. Each company has 4 types of customers, they are illustrated below: Costs Profit 02

3 The goal of a CLV exercise is to identify the customers groups that provide the best return on the money spent to obtain and service these customers. Consider the following example, a company approaches 1,000 potential customers that are randomly selected. We assume that the cost to the company of a no strike client is 5 and the cost of a strike client is 50. The outcome may look as follows: The company ended up with 8 customers at a cost of That gives an average cost per client of Let s assume that the company conducts a CLV exercise. The outcome of the CLV exercise tells the company not only who are the most valuable clients but also the clients that are likely to stay with the company for longer, the clients that are likely to buy the products and the clients that the company is likely to up sell or cross sell to. Armed with this information, the company again approaches 1,000 prospective clients. This time the clients are carefully selected based on the output from the CLV exercise. With slightly better strike rates the results may look vastly different: 03

4 The company signs on 44 customers at a cost of This gives an average cost of 371 per customer which is less than a quarter of the cost when approaching clients randomly. But our work is not done yet. Using the output from the CLV exercise we now know what the value of each customer is. If the value of the new customers is more than 370 then we are increasing the value of the business, if not we are destroying value.. Existing Customers Let s assume the CLV exercise showed us that we can divide our existing customers into 2 cohorts only, that is good customers and bad customers. The CLV, that is the net profit over the lifetime of the client, for the good customer is and for the bad customer It tells us that the bad customers are costing us more to service and thereby destroying value. The company either needs to cancel these customers, service these clients more efficiently so as to reduce the cost or increase the premiums over time so as to breakeven at least. Benefits to the Company CLV can be a powerful tool that values the entire relationship with a customer, including the potential to up-sell or cross-sell, as well as the probability of retention. In addition, it can enhance the current customer base by increasing retention of valuable customers and reducing expenditure on less valuable customers. This increased retention, lower marketing spend, and increased chance of up-selling and cross-selling, increases the profit of the customer, and hence the business as a whole. CLV is more than just a value, it is a tool to create value. It is an analytical framework that governs the decisions made at a marketing level. CLV looks at your individual customers, and not just the aggregate value of the business, and helps determine which customers are valuable, how to manage the relationship, and what to spend to garner 04

5 Distribution Channels CLV can determine the effectiveness of a distribution channel, and act on enhancing it, and furthering its reach. Each channel will have its own unique strengths. Knowing these differences can allow companies to utilize them on target groups where CLV has deemed them to be most effective. Moreover, it creates a profitable customer base with which to establish a strong relationship through up-selling and crossselling. CLV analysis can deliver improved customer value, increasing persistency and brand image, leading to growth. Process As mentioned earlier, the CLV exercise can be as simple or as complex as the company wants it to be. Some of the decisions that will have to be made and that will determine the scope are illustrated below: 05

6 Closing Remarks A well planned CLV exercise can add tremendous value to the company and indicate: Which customers must be retained; Which prospective customers are most likely to buy products from the company; Which policyholder will provide the highest return over the short term and long term; Which distribution strategy is the most effective; and, What is the cross-sell value for different cohorts of customers. If you would like to discuss this article further, please chat to your usual QED contact or the author, Anton Reinke. You can also visit our website to find out more about QED s services and to access other articles of interest. CONTACT US Anton Reinke office anton.reinke@qedactuarial.co.za Disclaimer: The information contained in this article is based on our analysis and interpretations of publicly available information obtained from sources believed to be reliable. QED does not guarantee the accuracy of this information and does not accept any liability, loss or damage arising directly or indirectly from reliance upon the information in this article. 06