Abstract The significance of Customer Lifetime Value (CLTV) is now being increasingly acknowledged among the decision makers around the world. However, only a few actually take the plunge and implement it in their organization. This white paper recommends a framework for practitioners to measure & implement CLTV within an organization.
1. Synopsis 2. Introducing CLTV. a) Segmentation framework b) Vintage based framework.. c) Survival Analysis. 3. Why does CLTV matter?.. 4. Issues faced while implementing CLTV.. 5. Fractal s MDEM (Measure, Demonstrate, Execute and Monitor) framework.. A. Measure.. i. Segmentation of framework 1 2 2 2 2 4 4 4 5 5 ii. Vintage based forecast framework. 5 iii. Survival analysis. B. Demonstrate C. Execute D. Monitor. 6. Summary. 7. About Fractal Analytics. 6 6 6 8 8 9
Synopsis A primary factor instrumental in the success of any firm is its ability to provide better services to the customers and offer superior value propositions. The fulfillment of expectations of customer nurtures their relationship with the organization and its products. The right marketing strategies, backed by the right marketing metrics helps to grow business and profitability. One such marketing metric is Customer Lifetime Value (CLTV). In spite of the obvious edge it offers, only a few organizations make an enthusiastic attempt to implement this process. The possible reasons attributing to this could be, difficulty in tracking idiosyncratic customer purchase behavior for many purchase situations or that there could be variations on highest value people over time etc. This white paper explains CLTV model designed by Fractal Analytics and implementation of the processes required by an organization to get CLTV-aligned. It also helps to understand the advantages of being a CLTV aligned organization. The CLTV is the economic value of the customer relation during the complete period of the relation of the customer and the company. The evaluation of CLTV helps to optimize the investment of the limited resources on their different customers and prepare the customer acquisition strategy accordingly. The significance of Customer Lifetime Value (CLTV) is now being increasingly acknowledged by the decision makers around the world. Organizations are consistently collecting more and more information about their clients to study the customer behavior and characteristics which has been playing a crucial role in devising out their customer - centric business strategies. 1
Profitability [unit] How to become a CLTV aligned Introducing CLTV Businesses flourishes when there is a healthy customer development and retention process at work. The Customer Life Time Value (CLTV) is a framework that helps businesses, develop strategies to extract incremental value from their customers. It is measured as the profitability of a customer during the customer s lifetime. In other words, the process aims to understand the true value of customer longevity so that an organization can ensure that it is spending the right amount of money and resources. CLTV is the sum of both historic Customer Value and future Customer Value. Measuring CLTV CLTV can be estimated using multiple techniques. In this section we will explore 3 ways in which CLTV can be measured. a) Segmentation Framework Segmentation Framework provides a simple but elegant approach for the calculation of customer s lifetime value. Total customer base is segregated into segments based on their transaction behavior. For each segment a formula is derived, as a function of customers vintage and recency, for the calculation of customer s lifetime. Customer s profitability is calculated based on measured historical values and predicted values. Segment (based on Spend and Usage) Segment (spend, usage) Customer Lifetime F (vintage, recency) Customer Lifetime Value CLTV = CLTV History + P(t)*T*[Monthly Potential] b) Vintage based forecast framework The Vintage framework is a more powerful segment based approach for predicting the customer s lifetime. Customers are segmented on their transaction behavior and for each segment customer s lifetime value curve is obtained. Customer Lifetime Value is the area under the curve. 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 CLV for time T ( t 0 to t 1 ) CLV (t 0 t 1 ) = f(x) c) Survival Analysis Survival model is developed based on customer s past behavior and trends, to calculate the probability of a customer s survival for next n years. CLTV is calculated based on historic and predictive Customer Lifetime Value for each customer. CLV = CLV History + CLV Future f(x) t 0 t 1 Months on Book CLV Future = Survival (t) * T * [Monthly Potential] 2
CLTV is measured by transforming customer s past profitability into a forward-looking prediction of customer s profitability over his future tenure. It is the sum of both the historic Customer Value and the future Customer Value. CLTV assigns a single, financial score to each customer allowing for the evaluation of the relative importance of each customer as they contribute to an organization s profits. In another way, CLTV represents the net present value from profits, from a single customer. It can be represented as, Where: r = discount rate N = customer s future tenure i = period (e.g., month i or year i) Survival rate = survival probability of the customer CLTV calculations involve econometric forecasting methodologies. The calculation of a customer s lifetime, or the prediction window is limited by the amount of historic data available. 3
Why does CLTV matter? Issues faced while implementing CLTV CLTV aims at helping organization identify, understand and cater to their most valued customers. The aim of the CLTV, a forward-looking metric, is to enable organizations to differentiate between their best and worst customers at a very early stage. This will help them design strategies to retain and acquire the best customers and drive revenue growth. CLTV calculation can be achieved simply by totaling the annual expenditure and multiplying it by the likely tenure of the customer. But, the calculation assumes a steady business environment without fluctuations in the economy, change in the customer preference, or competitors in the market. At Fractal, the CLTV, a forward looking metric facilitates the projections of the below mentioned business parameters Current and Future Revenues Current and Future Costs Life Expectancy Future Cross-selling Potential The cognizance of the Lifetime Value (LV) of a prospective customer can help in determining required time, effort and money to be spent in acquiring that customer. A customer s LV can enable us to evaluate the campaign benefits versus the costs or investment. The life expectancy of a customer can help us to take actions proactively in lengthening the relation and provoke the customer spend more in order to realize expected CLTV. 4
Profitability [unit] Typical Timeline Objective How to become a CLTV aligned Fractal s MDEM (Measure, Demonstrate, Execute and Monitor) framework Segment (based on Spend and Usage) Segment (spend, usage) Customer Lifetime F (vintage, recency) Customer Lifetime Value CLTV = CLTV History + P(t)*T*[Monthly Potential] Fractal s MDEM framework helps in monitoring & improving initiatives based on Lifetime Value of the customer. function of customers vintage and recency, for the calculation of customer s lifetime. Customer s profitability is calculated based on measured historical values. 1. Build 2. Demonstrate 3. Execute 4. Monitor ii. Vintage based forecast framework Create a model to Analyze existing customer Identify Key business unit Continue to monitor The Vintage framework is a more powerful predict the revenue each Customer generates over their lifetime through CLTV framework and leverage results to get management level buy in for CLTV driven to partner on LTV and plan and execute CLTV based Strategy. Think Big, Act Small initiative using a Test & Learn Framework segment based approach for predicting the customer s lifetime. Customers are segmented on their transaction behavior and for each segment customer s lifetime value strategy. curve is obtained. Customer Lifetime Value is 6 months 6-9 months 9-12 months 12+ months the area under the curve. A. Measure 40.0 f(x) CLTV can be estimated using multiple techniques. In this section we will explore 3 ways in which CLTV 35.0 30.0 25.0 can be measured. 20.0 15.0 i. Segmentation Framework Segmentation Framework provides a simple but elegant approach for the calculation of customer s lifetime value. Total customer base is segregated 10.0 5.0 0.0 t 0 t 1 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 CLV for time T ( t 0 to t 1 ) Months on Book into segments based on their transaction behavior. For each segment a formula is derived, as a function of customers vintage and recency, for the calculation of customer s lifetime. Customer s profitability is calculated based on measured historical values. 5
iii. Survival Analysis Survival model is developed based on customer s past behavior and trends, to calculate the probability of a customer s survival for next n years. CLTV is calculated based on historic and predictive Customer Lifetime Value for each customer. CLV = CLV History + CLV Future CLV Future = Survival (t) * T * [Monthly Potential] B. Demonstrate CLTV based strategy has major implications across various business units; for the strategy to be successful it is important to generate demand from the business. This can be achieved by demonstrating the value of CLTV. An example of how value can be demonstrated is by showing the spread in revenue and profitability between high & low value customers. Demonstrating value ensures engagement & buy-in from the key stakeholders such as: VP Marketing VP Product VP Sales VP Service C. Execute Once the value has been demonstrated, the next step is to develop and execute a CLTV based strategy. Key to the execution strategy is: Select a business unit which has bought in to the concept of customer lifetime value Identify a business problem based on the company s need & economic or competitive landscape Customer How do I get more high LTV customers? What do high LTV look for? What discounts can I offer to high LTV customers? Are they price-sensitivity? Where can I find high LTV customers? What is their consideration at the moment of purchase? What aspect of customer service matters to high LTV customer? There are many application of Customer Lifetime Value. A few of them are highlighted below. I. Customer Acquisition II. Customer Portfolio Management III. Customer Retention IV. CLTV led Advertisement Spend V. CLTV driven Marketing Mix Spend 6
Credit Score How to become a CLTV aligned I. Customer Acquisition CLTV can be effectively used in acquiring new customers with strategies such as: Product design and modifications to serve all customer segments profitably High Achieve customer satisfaction by service instead of running loyalty programs Run proactive retention campaign to retain these profitable customers Derive maximum revenue as long as customer is active Achieve customer satisfaction by service and loyalty programs Maintain good relationships, nurture these customers, defend and retain them Targeting acquisition campaigns at high CLTV customer segments Know when to stop spending on promotional campaigns Channel mix optimization based on CLTV Derive maximum revenue as long as customer is active Find a balance in terms of size and share of wallet Low Risk High Risk LTV Cost = LTV Low Value High Value Acquisition Zone This solution helped clients in acquisition of customers whose LTV is less than the cost of acquisition and servicing. It also helped in saving costs on application processing, acquisition and servicing of loss making customers. Low Low Make no investment in developing relationships III. Retention Decisions CLTV analysis can help in retention decisions by aiding in: Customer Lifetime Knowing the true value of losing a customer Designing retention strategies and offers Use attrition score Use customer lifetime value Low Customers How profitable is the customer? Take appropriate action to develop these customers High High II. Customer Portfolio Management How likely is the customer to close the account? Customers true potential can be realized using Likely Not Likely Likely Not Likely targeted marketing by: Designing campaigns (e.g. fee waivers) Budgeting offers for campaigns Choose to lose do nothing Strengthen Relationship - Increase credit line - Balance Transfer - Incentivise to increase spend Build the Relationship - Increase credit line - Offer add-on card - Offer convenience checks 7
IV. CLTV led Advertisement Spend With a strong CLTV based strategy, the organization can: Perform ad and copy testing with high-cltv customers to improve ad effectiveness Increase brand resonance based on specific CLTV based segments Increase advertisement ROI Summary As elaborated by this white paper, the key to CLTV success lies not only in measuring it but also in successful implementation. Fractal s MDEM framework achieves this in a predictable and systematic manner enabling organizations to make better customer decisions. V. CLTV driven Marketing Mix Spend Identify the most effective marketing channels for high- CLTV customer segments and allocate funds accordingly Reduce cost and increase ROI through better targeting Achieve up to 70% of increase in acquisition ROI D. Monitor We recommend using a Test and Learn Framework that ensures ongoing maintenance and improvement of CLTV implementation. A simple Test & Learn framework can be developed as shown in the diagram below. 8
About Fractal Analytics Fractal Analytics is a global analytics firm that serves Fortune 500 companies gain a competitive advantage by providing them a deep understanding of consumers and tools to improve business efficiency. Producing accelerated analytics that generate data-driven decisions, Fractal Analytics delivers insight, innovation and impact through predictive analytics and visual story-telling. Fractal Analytics was in founded in 2000 and has 700 people in 12 offices around the world serving clients in over 100 countries. Fractal Analytics is backed by TA Associates, a global growth private equity firm, and recently partnered with Aimia, a global loyalty and consumer insights firm. The company has earned recognition by industry analysts and has been named one of the top five Cool Vendors in Analytics by research advisor Gartner. Fractal Analytics has also been recognized for its rapid growth, being ranked on the exclusive Inc. 5000 list for the past three years and also being named among the USPAACC s Fast 50 Asian- American owned businesses for the past two years. For more information, contact us at: +1 650 378 1284 info@fractalanalytics.com 9