In business, customer lifetime value, or just life-time value is an estimation of the net profit at the end of a representative period by an individual customer. The number one way to create customer loyalty and increase customer retention is to continuously develop the relationship with current customers. Developing a long-term relationship with new customers is a great way to develop new customers as well. If you continuously build a productive and beneficial relationship with your customers, they will be loyal to your company and continue to purchase products and services from you for many years to come.
A key measure of customer lifetime value is called gross profit margin. This number represents the difference between total revenue and the cost of goods sold to the customer. Any company can calculate its gross profit margin in a variety of ways. Some companies use direct costing methods where items are priced according to their reliability. Others calculate the gross profit margin using a variety of metrics including average order size, average sale price, cost per sale, and cost relative to competitors.
Another important aspect of customer lifetime value is future cash flows. The most common way to calculate future cash flows is to use the present value of expected customer payments. Present value refers to what a company would pay to a customer today in exchange for services rendered. Using present value also takes into account the amount of money a customer will spend over time such as insurance premiums, investment capital, and even dividends. All of these represent potential profits for the company if it were to make the investment necessary to continue providing services to the customer.
A customer lifetime value analysis should also consider the impact of pricing and discounts. Pricing is often directly related to future cash flows. If a service or product is overpriced, a company’s profit margin may decrease because its customers will choose to buy from other companies that offer a better discount or deal. Likewise, a company that sells too many products at too low of a discount rate will incur higher costs and lower overall profits. Determining the correct discount rate for a specific product will help managers determine which products are more profitable and which are less so.
In addition to determining current and future cash flows, a customer lifetime value analysis should also take into account the profitability of a brand. A strong brand is one that commands a premium over its competition. Although the margins for some brands are higher than others, a strong brand will still have a high level of repeat sales. A company’s competitors may be able to command similar margins, but they rarely experience the level of repeat business that a brand does.
Although customer lifetime value can be an important metric to consider when developing a marketing strategy, it is not the only important metric to consider. There are several other metrics that can provide additional insight into a marketing strategy’s efficacy. However, a brand’s level of repeat sales is by far the most important metric in evaluating one’s entire marketing mix. Therefore, developing a marketing mix using these other metrics will help marketers ensure that they are getting the most out of their investment in brand development.