How to Measure Customer Lifetime Value in This New Normal?

Retailers around the world are facing the ultimate test for survival. The global lockdown led to the closure of physical stores for weeks for the very first-time post world war II. Few retailers had the advantage of being omni-channel and were at least able to stay in business through digital channels. For others, it was, wait, watch and search for alternative ways of selling like - quickly spinning up an e-commerce website, becoming a seller on an already existing market place etc.

***Accenture Report

With lockdown being lifted in a phased manner globally and customers slowly but surely accepting the 'New Normal', businesses have opened with the hope of getting back to business as usual.

‘Hope has never been nor will be a strategy’, and this reality has hit the retail industry hard. Low footfalls, customers wary of overspending and new safety norms that, of course, comes with a cost have seen both sales and margins take a huge hit.

Every retailer wants his customers to come back and more so in the immediate post-covid period so that they can get back to business. The fact that acquiring new customers is ways more expensive than retaining existing customers has never been truer and retailers who understand their customers well will have a huge advantage in retaining their most valuable customers in times where brand loyalty has been dwindling fast.

As per a Mckinsey report “The crisis has prompted a surge of new activities, with an astonishing 75 percent of US consumers trying a new shopping behaviour in response to economic pressures, store closings, and changing priorities”

The Pareto Principle that ‘80% of profits come from 20% of customers’ will enable retailers who understand their ‘Customers Lifetime Value’ to focus on the needs and wants of their most valuable customers.

Retailers who can identify their most profitable customers can build their marketing acquisition and retention strategies around profitability. In-fact retailers can plan and optimise their inventory and supply chain based on what their top customer needs and focus on them instead of mass spray and pray acquisition and retention strategies.

‘Most businesses are data-rich, but information poor –Avinash Kaushik’

Top retail companies globally are now top analytics companies too. With improved computing power and use of advanced machine learning and predictive analytics, these retailers have been able to harness the power of data and understand who their most valuable customers are and how to cater to the needs and wants of these customers continuously and thus plan their entire strategy around them.

‘Customer lifetime value or CLTV is the key metric that will help retailers to assign a value to each customer and thus identify their most valuable customer’.

Table of Contents

Customer Lifetime Value or CLTV represent a customer’s value to the company over some time.

Different companies have been using different methodologies to calculate CLTV.

Before we get into the calculation of CLTV, let us understand the key KPIs used for CLTV calculation.

1. ATV: Average Transaction/Order Value

2. Frequency: Total number of transactions/purchases in a given period

3. Gross Margin: (Sales-COGS)/Sales.Cogs: cost of goods sold

4. Churn Rate: (Customers Lost -Customer Acquired)/Customers at the start of the period

Read more on churn here.

LTV= ATV * Frequency * Gross Margin * (1/Churn Rate)

For example, say for a Retailer x:

1. ATV: $50                                    

2. Frequency: 2.5

3. Gross Margin on his purchase: 55%                

4. Churn Rate: 50%

Then,

LTV= 50*2.5*.55*(1/.5)= $137.5

***It is important for the business that their customer acquisition cost (CAC) is less than LTV

Broadly there are two ways to calculate CLTV for each customer.

Historical Approach

In this approach, based on the past behaviour of the customer, we derive the 4-key metrics.

ATV: Based on ATV of all purchases in the last x time period (x is generally 1 year)

Frequency: Total number of transactions in the last x time period

Gross Margin: Margins based on the customers' past purchase in the last x time period

Churn Rate: Instead of the rate, we assign an active life term to a customer based on business assumptions or customer segmentation like RFM

CLTV(each customer) = ATV * Frequency * Gross Margin *Active Lifeterm

Predictive ML Approach

In this approach, we try to predict the key metrics that define CLTV for x period duration generally a year.

ATV Predicted: Future ATV of the customer is estimated using regression or segmentation approach by calculation the potential headroom of the customer.

Frequency Predicted: The frequency of the customer in the next x period is predicted using some probabilistic models like BG/NBD.

Predicted Gross Margin: The predicted margin is calculated as an index of customers past margin and retailers predicted margin for the new financial year.

Predicted Churn Probability: Churn probability of every customer is estimated using a churn prediction model like survival models, classification models etc.

Predictive yearly CLTV (each customer) = Predicted ATV *Predicted Frequency * Predicted Gross Margin *(1-churn probability)

As CLTV is a function of the 4-key metrics, let us look at how we can improve each of the key metrics and hence improve CLTV.

Increase ATV

· Segment customers based on RFM and identify customers with low ATV

· Run cross-sell and upsell campaigns based on purchase history

· Estimate the head room of each customer to understand potential spend capacity and wallet elasticity

· Personalized product recommendations

· Price optimal product bundling

Increase Frequency

· Dynamic receipt marketing based on the current purchase

· Personalized communication with the right product at the right time using the right channel

· Product purchase frequency-based campaigns

· Cross-sell product recommendation

· Loyalty Points

· Life cycle campaigns and communications

Improve Gross Margin

· Inventory and sell through based targeting to avoid high discounts

· Cross-Sell products that have a higher margin

· Price optimization to understand elasticities and thresholds for optimal product pricing.

· TPR optimization based on top CLTV customers

· Reduce COGS

Reduce Churn Rate

· Restructure your loyalty program to maximize benefits for your high CLTV customers

· Identify you are never out of stock items and optimize their inventory

· Plan your assortment based on your top customers

· Build Predictive churn models to identify potential churners and re-engage them.

· Identity drivers of churn and work on improving them

· Constant surveys and feedback

· Plan their customer acquisition spend based on average CLTV

· Acquire high LTV customers using look-alike models of existing high LTV customers

· Focus on reducing value churn instead of customer churn

· Stock and plan inventory to fulfil wants and needs of the best customers

· Plan your marketing and campaigns budgets based on CLTV based segmentation to maximize your long-term ROI

· Measure your marketing channels based on long term CLTVs instead of conversion rates.

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Businesses that understand their loyal and most profitable customers will continue to be profitable by optimizing different functional spends. Re-engaging and enhancing the shopping experience of the most profitable customers would be the only key to success in the new normal and CLTV would be a metric that would be of paramount importance for each and every business.

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