Did you hear the one about the woman who couldn’t cash a $100 check at an out-of-town branch of her bank? The tellers thought she was just a customer who kept running her checking account dry each month. Next thing they knew, her multimillionaire husband shifted all his accounts out to their competition.
How about the mutual fund managers who bent the rules for their most profitable customers, letting them make trades after the 4 p.m. cutoff? The funds were sued by former New York Attorney General Elliot Spitzer. Some funds have paid millions in penalties, and some executives are facing criminal charges. Now they’ve lost the trust of their large bread-and-butter base of “less profitable” (but profit-contributing) customers.
The misuse of customer lifetime value (CLV) and lifetime value (LTV) can lead to discrimination against customers based on superficial or “unscrutinized” estimates of their profitability.
What is customer lifetime value? You can read my primer on CLV. But in brief, CLV measures the stream of costs and revenue associated with acquiring and servicing a customer over a number of years. Because not all customers stay with a business the same length of time, lifetime value includes takes into account customers who leave. For example, 30 percent might leave in the first year, another 20 percent in the second year and, perhaps, 10 percent in the third year.
Why is it important to take into account customer departures? Because when you spend money on acquiring 1,000 customers, you have to match the acquisition and service costs against your revenue over the next few years. At the retention rates in the example above, the initial 1,000 customers will have been reduced to 700 by the second year, 560 by the third and 504 at the end of three years. In calculating customer profitability, you must take into account how long customers will stay with you. CLV gives you a way to do this. CLV, a concept devised by Northwestern University Professor Paul Wang, has been used extensively in direct marketing. It measures the business’ profit from a customer.
A long time proponent of customer lifetime value, I am dismayed to see the use of it in ways that are just plain wrong. Numbers have an unfortunate ability to make things seem “objective,” “real” and “complete.”
Each business has to deliver value to each customer that is worth more to the customers than the price they paid. Customer lifetime value also doesn’t give a free pass to get around the tests of common sense or ethics. Creating a customer profitability index is no substitute for understanding customers and constantly improving the way you match their needs with relevant, timely products and services. It is like thinking you can drive on the road looking at only your dashboard indicators and your rearview mirror. You can’t ignore the road; it’s what guides your steering.
How can CLV be well-used?
Arthur M. Hughes gives an example of a good use of CLV in his book, The Customer Loyalty Solution. Scotiabank, one of Canada’s top five banks, believed they could generate more revenue by helping customers improve their financial situation. They trained their employees on that as the bank’s core value and
rewarded employees whose activities were “respectful, straightforward, insightful and spirited,” identifying those traits as “leading indicators” of results that would contribute to the bank’s core value.
The bank then created bundles of products and services that matched customer needs. The bank used CLV to project the results of the campaign for different groups of customers. Scotiabank’s latest venture is event-driven marketing, the result of savvy employees who looked through database reports to identify “transitions” in customer accounts. Such transitions included the shifting of a substantial amount of money—large enough for a deposit on the purchase of a home—from savings to a checking account.
The employees began manually identifying transitions to send timely information about relevant products and services within 48 hours. “Insightful, spirited” employees in the relationship marketing department asked, “Can we do this on a broader scale?” Today, Scotiabank automatically combs through records of customer transactions every night, looking for “transitions.”
A marketing campaign of this kind would not be possible without the “whole customer life journey” view that CLV provides. CLV is a method that merges the right brain of intuition and insight to the left brain of analytics and finance, so that Scotiabank could do the right thing for the customer, to help its customers be financially better off. That’s the right use of CLV.