Brand loyalty. Lower costs. Increased sales and profits. Collaboration between CMOs and CFOs drive more effective customer-value calculations.
A loyal customer today will be a loyal customer in the future—at least that’s the expectation driving many companies to focus on delivering high-quality customer experiences. Yet, activities that improve the customer experience are only beneficial if a company can quantify its impact.
This is where the customer lifetime value (CLTV) calculation comes in. Many marketing functions try to quantify the long-term value of their customers, looking to accurately forecast the revenue and profit associated with developing a long-term relationship between a customer and their organization. This calculation then drives many of their marketing spend decisions, including which customers to target—such as those considered most likely to do repeat business—or which activities to renew or drop.
The focus of marketing on CLTV has ebbed and flowed over the past decade due largely to the complexity created from the emergence of new technologies and technology channels and the focus from products to customer experience. These trends have made the already difficult task of calculating CLTV even more challenging.
The worth of CLTV has also been questioned in recent years. In particular, concerns have been raised that CLTV calculations don’t consider the intangible values some customers bring, such as helping to drive innovation, providing positive word of mouth, or acting as brand influencers. Some critics have also suggested that a focus on CLTV prevents a firm from investing in relationship building, which might grow low-value customers into high-value customers.
While we agree that traditional CLTV calculations may not capture the intangible value of certain customer groups and it should never be applied myopically, we do believe firms need solid CLTV metrics to help optimize marketing spending that is a key priority for many organizations today. Marketers are under pressure to show the value associated with specific activities.
The challenge is that few CMOs have the expertise needed to understand and accurately measure CLTV.
This has led to companies either overspending or underspending on customers or on targeting the wrong customers based on poor customer value–calculation assumptions.
To develop a robust customer valuation calculation that can inform marketing decisions for the long term, CMOs need to work collaboratively with the CFO and finance function. By working hand in hand with finance, the CMO can ensure that his or her calculation is fiscally sound, considers the appropriate inputs, and is derived based on accurate and reliable data.
Calculating CLTV has always been a challenging quantitative process. A lack of data and analytics modeling expertise has led marketers to construct simple CLTV models largely based on gross revenue or perhaps net revenue, which is revenue minus cost of goods sold. Further aggravating the issue is a lack of marketing financial acumen and understanding of the basics of finance.
While these simple CLTV models were enough when marketing spend was limited to traditional media focused on selling products, with minimal customer sales and service interactions, today’s environment is vastly different. Marketing occurs across many, interconnected channels, making customer experience as important as the product itself.
As a result, simple revenue-based CLTV models don’t provide a true perspective on the value of a customer.
Marketers today need to base CLTV calculations on profitability to truly optimize the company’s customer investment spending.
Collaboration between CMOs and CFOs drive more effective customer-value calculations
The good news is that many firms have invested in big data and analytics, which can help supply the key information and skills to support more sophisticated CLTV modeling. While these resources are critical, we believe the addition of the CFO into the CLTV modeling process is equally as important.
Given the complexity involved with calculating CLTV, it is critical for CMOs to both use the right data to inform their calculations and to use a calculation that considers and accurately accounts for all the costs spent on a customer, including those from outside of marketing control.
The only way to do this effectively is to work collaboratively with the CFO—as finance typically has the best insight into the drivers of financial value and where to get the most accurate information to extract the insights a company needs for decision making. The CMO can provide the marketing insights to inform the calculation of value and to help determine relationships to marketing activities, while the CFO can help ensure the accuracy of the calculation and ensure no variables are missed or discounted.
For example, basing CLTV on profitability requires a firm to have both revenue and cost data. The CMO has significant access to revenue data but might not have complete access to cost data. The CFO, of course, does. CFOs also have a more comprehensive understanding of where cost data resides within the organization and how it may need to be cleaned or standardized for use in CLTV modeling.
Profit-based CLTV models should consider both fixed and variable costs. The CFO is in the best position to help determine the appropriate methodology for cost attribution. Together with the CMO, the CFO can also help establish the best methodology for calculating revenue by customer or customer segment.
When calculating CLTV based on profitability, both the insights and expertise of the CFO and CMO are required to ensure accuracy.
1. Define CLTV
The CMO and CFO should begin their collaboration on CLTV by determining the most appropriate formula for the firm and its objectives. There is no shortage of CLTV formulas publicly available, yet it’s unlikely any off-the-shelf formula will fully meet a firm’s specific needs. CMOs and CFOs should work on either developing their own formula or adapting an existing one. This jointly developed model will require both revenue and cost data. Together, the CMO and CFO — along with help from the CIO — should identify what data is available and what actions might be required to collect and cleanse the information. If data key to the CLTV formula is not available, proxy data may need to be identified or, in a worst-case scenario, the CLTV formula may need to be revisited.
2. Build and refine the CLTV model
When data due diligence is completed, revenue and cost methodologies can be determined, and customer profitability can be calculated. It’s worth noting that few companies start with a perfect model. Even when CMOs and CFOs agree on a model up front, ongoing testing is required to ascertain the validity of the model and to ensure that it continues to drive the information the company needs to make decisions over time. Testing different profitability views can help the CMO and CFO confirm the veracity of the profit calculation. It is highly likely that the model will require adjustments as time passes to account for new information, new marketing activities, and other market or corporate changes.
3. Measure and predict CLTV
With a confirmed profit calculation in place, the CMO and CFO can work with analytics to generate CLTVs for different customer segments. Analytics should apply modeling techniques to validate the predictive strength of the CLTV model.
When the CMO and CFO have a CLTV model they believe is usable, they will then need to focus on creating standard processes. This practice will provide the firm with ongoing access to the required data, regular profitability calculations, and recurrent views into customer profitability. In other words, the work of calculating CLTV based on profitability needs to become a standard operating procedure.
4. Apply CLTV to manage the business
Finally, the CMO and CFO will need to educate the organization on CLTV and help all functions that touch the customer incorporate CLTV into their investment decision making. CLTV should join the prevailing set of financial measures used to help optimize customer investments.
Given customer demand for more personalized and high-value experiences, companies need to understand where they should focus their attention to get the most value from each customer. By working together to develop a robust and well-supported calculation for measuring and predicting CLTV, CMOs and CFOs will be in a better position to make decisions on the best places to invest to build profitable, long-lasting consumer relationships.
To learn more about this topic and how KPMG can help your business, please contact Jason Galloway.